WH Smith mulling demerger of news distribution division

WH Smith has put the separation of its news distribution arm back on the agenda almost five years after backing out of an agreed sale at the last minute.

The retailer, which is under growing pressure from investors to demonstrate it has a credible growth strategy, is believed to have drawn up plans to demerge the division, which could be worth up to £400m.

Hiving off its news arm would be the group's final step in a break-up journey it embarked on in the wake of Permira's failed bid attempt in 2004. Hodder Headline, its publishing arm, was sold to enable it to focus on its UK retailing interests following its withdrawal from other parts of the world, including the US and Australia.

The group's board, which is headed by its chief executive Kate Swann, met to discuss the proposed separation of its news distribution arm on Friday afternoon. It is thought that the group favours seeking a separate stockmarket listing for the division, much as GUS demerged its Burberry luxury goods house, rather than seeking a sale. City sources said the move was given the nod, although executives have yet to make a final decision. The company declined to comment.

The timing of any announcement is likely to depend on when the Office of Fair Trading reports back on its long-running inquiry into the newspaper market. The watchdog, which is investigating whether the distribution arrangements in the UK violate European Union competition law, is expected to give its verdict this month.

Under the existing set-up, wholesalers such as WH Smith and John Menzies have regional monopolies.

WH Smith last toyed with divesting its news distribution arm in 2001. It was poised to sell the unit to ABN Amro Private Equity for £215m, but the deal fell apart at the eleventh hour after the private equity group sought to cut the price it was prepared to pay. At the time, other interested parties included Electra and 3i.

Retail analysts had mixed views over whether spinning off the division made sense. The news distribution unit provides a steady source of cash flow at a time when the group's core retail estate is under more pressure than ever, they said.

The wholesale arm reported a 2 per cent fall in underlying sales for the 21 weeks to 21 January, blaming a subdued monthly magazine and part-works market. Last year it made £37m of operating profits, up modestly from £35m the previous year, on sales of £1.2bn. "It's difficult to imagine [a sale] being accretive to shareholders. It generates more in operating profit than it would generate in interest," one retail analyst said. Another added: "It's a classic low growth, cash-generative business, so it won't be the sexiest IPO of 2006. It would have to be relatively high yield to get away."

City sources said the board hoped that breaking up the group would unlock hidden value in the company and put a rocket under the share price. WH Smith shares have risen by about 25 per cent in the past five months to more than £4, giving it a market valuation of £730m, as rumours have intensified that some form of corporate action was imminent.

Ms Swann is anxious for the share price rally to continue because she is in line for a potential £4m windfall under a three-year management investment plan if the stock hits 557p by August 2007. If it gets there, she will have added £500m to the company's value since Permira walked away from its bid over pension issues.

Ms Swann has boosted margins and cut costs faster than expected, but has failed to convince many analysts that the group has a long-term future because she has failed to re-ignite the top line. Over Christmas, the group's 542-strong high street chain saw underlying sales slump 6 per cent, although its margins improved by 250 basis points.