A year ago Brambles abandoned an attempt to sell its Recall information management business in the midst of market turmoil sparked by concerns about the state of Europe. Today it unveiled ‘Plan B’, a demerger of the business to its own shareholders.
The 10-month attempt to sell Recall was originally motivated by Brambles' desire to restore its balance sheet after its $1.3 billion acquisition of another pallet and logistics group, IFCO Systems. When the Recall sale process ended without a sale, Brambles resorted to a $448 million capital raising to reduce its debt levels.
While the circumstances might have changed and there isn’t the same need to raise capital, the logic behind the separation of its core pallet business from Recall remains.
While Brambles has been in the document management business for decades, there is nothing synergistic about the combination of Recall and its core pallet and logistics operations and as, over the past decade, Brambles has shed its other unrelated activities the absence of an underpinning logic for retaining Recall has become ever more evident.
That’s not to say Recall isn’t a good and valuable business. When it was on the market there was a lot of interest from trade and financial buyers around Brambles’ asking price of about $2 billion until the financial market volatility made the funding of an offer problematic.
Despite a material blip in Recall’s performance that was revealed today – its sales are expected to be down 3 per cent and its underlying earnings are expected to fall from $US174 million to between $US138 million and $US142 million this financial year – the group has demonstrated very attractive financial performance characteristics over a long period.
Until this year it has grown sales and earnings steadily, generated very strong cash flows and produced returns on capital pushing towards the mid-teens. Unlike the pallet operations, it hasn’t been a business that needed much capital. Within Brambles, however, it has been very much a secondary business with the pallet operations dominating the group and market’s focus.
The demerger – giving the business to Brambles shareholders – is a sensible option, particularly given the lower earnings this year. Brambles doesn’t need new capital and its shareholders will have the option of retaining an exposure to Recall’s return to sales and earnings growth that Brambles expects in 2013-14.
Separation will allow Brambles’ board and management to focus exclusively on the pallet businesses and give Recall’s new board and existing management the freedom to use its cash flows to grow its operations or to return surplus cash to shareholders.
Recall will start its independent existence with about $US450 million of net debt and something over $US400 million of lease liabilities, well positioned to fund growth across its global footprint and, in particular, Asia where it has a modest foothold relative to its operations in the Americas, Europe and Australasia.
The continuing Brambles business appears to be in good shape, with the group maintaining its guidance of an underlying profit of $US1.03 billion to $US1.06 billion this financial year despite the lower contribution from Recall.
The relatively modest size of Recall’s contribution to the overall group’s earnings base and value – Brambles has a market capitalisation of more than $14 billion – makes the logic of a demerger even more compelling. Distancing Recall and its cash flows from its core won’t have any material impact on Brambles’ ability to pursue its own ambitions.