Amcor demerger: the kindest cut
Demergers are becoming the new black as investors - and investment banks - pressure company boards to unlock value by hiving off the parts of the empire that drag down returns.
Brambles led the charge last month when it announced the demerger of its document management business, and Amcor followed suit on Thursday with a plan to spin off its $2 billion Australasia and Packaging Distribution (AAPD) empire into a separate listed entity.
There have been a bevy of reports from investment banks in the past few months extolling the virtue of demergers as the key to extracting shareholder returns. The bankers are banging the drum at a time when corporate activity has been in a slumber since the big fee fest in 2009, when companies were forced to recapitalise their balance sheets through equity issues.
Macquarie's report into the performance of 29 spin-offs since 1995 found that the "child entity" can underperform by up to 9 per cent in the six months following a demerger, but 12 months after the split it typically outperforms.
Merrill Lynch wrote that a split generally improved the parent's return on invested capital and a year after the demerger both entities tended to outperform the market.
The trend is expected to put the spotlight on Wesfarmers, which has a number of divisions that could easily be sold off or listed as separate entities. Other no-brainers include UGL's global property business DTZ, Qantas' frequent flier business, the wealth management businesses of the banks and Incitec Pivot's fertiliser business.
From Amcor's perspective, shareholders have been asking the board some tough questions in recent months about its AAPD business and how it fits in with the overall strategy.
Citi analyst Tim Mitchell wrote a report in February that spelt out the issues: "Currently the AAPD business drags down group returns. We believe the lower returns nature of Amcor is a key reason for it trading on a lower PE multiple compared to its competitors." He looks at the Amcor returns pre and post a hypothetical demerger and concludes a demerger of AAPD could lift the remaining Amcor return on invested capital by 150 basis points.
Demerging AAPD from the mother ship not only unlocks value for the Amcor shareholders but gives the smaller entity a chance to focus on growth. The reality is Amcor has performed well on the ASX but has historically traded at a discount to its global consumer staple peers.
AAPD consists of Amcor's Australasian glass, beverage cans, fibre and US packaging distribution business. Details of how much debt will be loaded into the entity and how it is travelling in 2013 are expected to be revealed at its full-year results on August 19.
In 2012 AAPD generated $2.8 billion in revenue and on Citi estimates it will report earnings before interest and tax of $150 million for 2013. The new board will be chaired by Chris Roberts, who will step down as chairman of the Amcor board. Chief executive will be Nigel Garrard, who is running the AAPD division. The market reacted positively to the announcement, with investors pushing the share price up 1.4 per cent on a day when the market was flat.
One of the positives of the demerger is separate boards and management strategies will allow both listed entities to focus on what is important to them. Amcor boss Ken MacKenzie has spent a lot of time in recent years improving the returns of the lower-growth AAPD business.
He has left it in good shape, with $68 million of profit set to flow into the group's bottom line in the next two to three years. Since 2006 he has reduced it from 10 segments to four, divested some businesses and closed four paper mills and reduced 65 scaled plants to 26.
It has also spent more than $1 billion in AAPD over the past few years, including a new recycled paper mill at Botany and several acquisitions.
But it is a mature business and by cutting it loose it will allow the Amcor empire to have more potential for capital management. According to Citi, the higher margin and stable cash flow generation characteristics of Amcor post a demerger could support higher debt levels, which would result in greater potential for capital management.
From an AAPD perspective, it would make it easier to sell the smaller entity.
The demerger is the latest chapter in a fascinating journey at Amcor that began in July 2005 when MacKenzie took on the role of rejuvenating a business that had lost credibility with shareholders.
The transformation has been nothing short of breathtaking as he took the hard decisions such as selling $1.5 billion of non-core assets, cut costs, slashed debt and rebuilt the company's image after the news that it was involved in a price-fixing cartel with Visy.
In the process of this change, MacKenzie has created the biggest packaging company in the world. Since 2009 the group's total shareholder returns have been 185 per cent. The group's shares have risen 135 per cent, compared with 30 per cent for the ASX 200 index. With the profit season looming, many companies have already flagged substantial downgrades to forecasts and tried to pacify shareholders with deep cuts to costs. Shareholders want more.
Demergers of non core businesses and return of excess capital are a good start. Let's see who's next.