Bega leverages its strategic wedge in the WCB war

Bega Cheese has cleverly leveraged off both the dramatic $1 a share increase in the bidding for Warrnambool Cheese and Butter by Murray Goulburn on Wednesday. It has now made a final attempt to overcome long odds and win the fiercely contested auction for WCB.

Bega today lifted its offer from 1.2 of its shares and $2 cash for each WCB share to 1.5 of its shares and $2 cash per WCB share. At Wednesday’s closing price, that values WCB shares at $8.87 each. It also declared the offer both unconditional and final.

On Wednesday, Murray Goulburn over-bid the third bidder, Canada’s Saputo, by $1 a share, offering $9 a share.

Its offer is, however, conditional on gaining an Australian Competition Tribunal clearance for the acquisition – a process that could take up to six months. The size of its increase was designed to try to compensate WCB shareholders for the delay and the significant uncertainty that the bid will be allowed.

Bega’s decision to go unconditional and declare the offer final at a value pitched below (but not that far below) Murray Goulburn’s is clearly designed to exploit that delay and uncertainty.

It can give WCB shareholders cash and shares within eight business days. The time-value of money alone, let alone the possibility that Murray Goulburn can’t get past the regulator, would give it the advantage over Murray Goulburn, if value were the only consideration.

The other bidder, Saputo, has a 50.1 per cent minimum acceptance condition. With Bega (18 per cent), Murray Goulburn (17.7 per cent) and Kirin’s National Foods (10 per cent) on the WCB register (and unlikely to help it achieve that condition), it also faces uncertainty about whether its offer can succeed and over the timing of payment, assuming it is prepared to increase the value of its $8-a -share offer.

Value is a moving concept. Bega has an 18 per cent shareholding in WCB, valued at about $92 million at WCB’s current share price, but which is estimated to have cost it less than $30 million. It is sitting on a very significant profit, which has soared in line with the bidding for WCB.

On Wednesday, Bega shares jumped 22 cents each in response to Murray Goulburn’s increased bid, which added about $10 million to the value of the WCB shareholding.

Had Bega increased the terms of its offer on Tuesday, for instance, the new bid would only have been worth $8.54 a share, not $8.87. It is capitalising on the impact of the Murray Goulburn offer on its own share price.

Even starker are the impact of the change in Bega’s share price and the value of the scrip component of its offer since its first bid in mid-September to today. At its pre-bid price of $3.15 a share then, its revised offer today would have been worth only about $6.72 per WCB share.

Conventionally, when an offer based largely on scrip is increased by adding more scrip, the bidder’s share price falls to adjust for the additional dilution.

That didn’t happen initially today – Bega shares were up in early trading – but they had dropped back from their close of $4.58 on Wednesday to $4.45 in afternoon trading, at which level the bid is worth about $8.67 per WCB share.

Bega shares have defied conventional market dynamics throughout the course of the bidding that it ignited in September. Since then, Bega’s market capitalisation has grown by about $200 million, or about 40 per cent.

Given the size of that increase, it’s clearly not just down to the value of its WCB shareholding or some pre-emptive capitalisation of the synergies it might extract from acquiring WCB. It has estimated those synergies at about $7.5 million a year.

What the fierce bidding for WCB has demonstrated quite dramatically is the strategic value assigned to it by three industry players.

It provides the biggest available exposure to the dairy industry in the most productive region for dairy in the country. Therefore, it provides exposure to the perceived long-term and large-scale upside from rising demand for dairy products throughout Asia.

That is the motivation for both Murray Goulburn (which would also garner considerable synergies and, because of its co-operative structure, enhance its ability to incentivise dairy farmers to increase their production and its export capacity) and Saputo.

Bega would get some synergies. However, while acquiring WCB would help it fulfil its domestic supply contracts (its brands are owned by New Zealand’s Fonterra) against the current backdrop of declining milk production, it wouldn’t make it a meaningful exporter and might in fact constrain the export volumes of the merged entity.

If Bega were to prevail in the contest for WCB, Murray Goulburn (despite increased competition policy hurdles) and Saputo would inevitably turn their attention to the enlarged Bega and the bigger base it would provide for their own ambitions. If Bega loses out on WCB, as the smallest and last available listed local dairy business, it would still be a target with some strategic and scarcity value.

It is the recognition that, regardless of whether it wins or loses, Bega will almost certainly be in play once the WCB auction ends. That appears to be behind the continuing surge in its share price.

If, post-WCB, Bega  wasn't available to Murray Goulburn or Saputo for regulatory reasons, the increase in its value since September would ultimately be largely unwound. That is something the WCB board and shareholders will have to think their way through.