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JOHANNESBURG (Reuters) - Minority investors in South Africa's Shoprite (SHPJ.J) are worried they're getting a raw deal in the supermarket chain's potential tie-up with international furniture and household goods merchant Steinhoff (SNHG.DE) to create an African retail giant.
Under the proposed deal, Steinhoff will sell its African assets to Shoprite in return for a controlling stake in the $8 billion grocery chain, and Steinhoff will exchange its shares for those of Shoprite's top two shareholders.
If approved, it will allow Steinhoff to hive off its struggling African assets - made up mainly of clothing, shoe and textile company Pepkor - into a new, separately listed merged entity called Retail Africa and possibly prompt a higher investor rating for its fast-growing European businesses.
But three minority shareholders in Shoprite that spoke to Reuters are not in favor of a merger they say will short-change them and benefit Steinhoff investors and Christo Wiese, a top shareholder in both companies and the architect of the estimated 180 billion rand ($14 billion) proposed deal.
The push back, although not enough to torpedo the deal at this stage, could complicate it if their views spread, and could test the retail billionaire's determination to bring more of his assets under one roof.
At the heart of the Shoprite investors' complaints are a lack of obvious cost savings from overlaps between Pepkor's shoe, furniture and clothing chains and grocery retailer Shoprite and exchanging a stock with bigger potential for what they called inferior businesses.
"It's a good deal for Steinhoff shareholders but it's not a great deal for Shoprite shareholders," said Tota Tsotsotso, managing director at Bataung Capital, a Shoprite shareholder. He declined to disclose the stake the fund holds in the company.
"Through this deal, Shoprite will inherit some problematic businesses in Steinhoff while Steinhoff will add a defensive, fast-growing supermarket chain to its portfolio."
Steinhoff's African businesses, which include furniture store JD Group and electronics brand Incredible Connection, have been a drag on earnings due to weak consumer spending, slowing economies and faltering currencies.
Operating profit at those businesses grew just 1 percent last year, compared with a 16 percent rise at Steinhoff's European chains and almost double in Australasia.
The deal has depressed Shoprite's stock price. It booked its worst one-day fall in more than a decade on Dec. 14 when the talks were announced and has extended losses to about 15 percent at around 175 rand since then as of this week.
Zwelakhe Mnguni, chief investment officer at Benguela Global Fund Manager, a Shoprite investor, said a merger could further dampen a stock that has big upside potential because Shoprite's store and supply chain network outside its maturing home market had reached a stage where it can be scaled up.
Shoprite's shares should be trading at 205 rand, or nearly 20 percent higher that the current level, based on its most likely earnings growth trajectory, according to Thomson Reuters Starmine intrinsic valuation model.
"Our assessment is that this deal is not in the best interests of our clients," said Mnguni, whose firm owns nearly 1 billion rand ($75 million) worth of Shoprite shares. "There are no obvious synergies in the deal, so the idea of creating an African retail giant doesn't make sense."
Shoprite and Steinhoff have said the deal will not lead to job cuts.
Another fund manager, who owns shares in Shoprite, said the takeover appeared tailored to benefit Wiese, who told Reuters in September a merger would be a "natural development" as he continued to look for ways to consolidate his assets.
"I can't see either party adding value to each other. It's obviously in Christo Wiese's long-term interests and doesn't mean it's in other shareholders' interests," said Evan Walker, a fund manager at 360ne Asset Management.
Wiese, who initiated the tie-up along with the Public Investment Corporation (PIC), has 16 percent in Shoprite and 23 percent in Steinhoff and is a board member in both. Government-owned pension fund PIC is the second-biggest investor in Shoprite and Steinhoff with 11 percent and 8 percent, respectively.
The companies have not disclosed the exchange ratio of the all-share deal but one retail banker expected the two businesses to be combined at around 12 times Shoprite's estimated 2017 core earnings, or EBIT, and closer to 15 times Steinhoff's African retail assets.
That multiple values the combination at more than 180 billion rand ($13.52 billion).
"Pepkor might fetch a higher valuation than Shoprite. They are both affected by weak economies in Africa but Pepkor boasts higher margins," the retail banker, who declined to be named, said.
The transaction would require the backing of 75 percent of both companies' shareholders to go through. It could be a sure thing if Wiese and the PIC are allowed to vote their shares.
Besides his direct Shoprite holding, Wiese owns another 35 percent in deferred shares, which carry the same voting rights, through his investment vehicle, Thibault Square, meaning he controls about 50 percent of Shoprite's voting rights.
Given that Wiese and PIC, led by Chief Executive Dan Matjila, are the architects of the tie-up and significant shareholders in both companies, experts say they could possibly be barred by the Takeover Regulation Panel from voting their shares, giving minorities a bigger say in the fate of the deal.
The two companies said last month they were still in exclusive talks.
Wiese did not respond to emailed requests for comment but other investors in Steinhoff said there was scope for cost-savings between Shoprite and Pepkor.
"There may be some synergies between food and clothing even though it does not seem obvious at first glance," said Nino Frodema, portfolio manager at Vunani Fund Managers, holders of Steinhoff shares.
He cited Shoprite rival Pick and Pay's (PIKJ.J) clothing business, which had been "growing quite well in a predominately food supply chain infrastructure".
A top 10 investor, who owns shares in both companies, said his fund was in favor of the potential tie-up because it would create a diversified African retailer that could take on the likes of U.S. company Wal-Mart(WMT.N), clothing chain Zara (ITX.MC) and UK grocer Tesco (TSCO.L).
"You cannot do it with a spaza shop," the investor said, referring to local 'mom and pop' stores found in South African suburbs.
($1 = 13.0844 rand)
Editing by Susan Thomas