Spotless played its hole card yesterday with the release of the two-hour plus presentation its management gave to determined suitor Pacific Equity Partners. Perhaps of even greater consequence, however, will be the meetings its chief executive Jo Farnik has today with some of the group’s hitherto sceptical and restless institutional shareholders.
It is self-evident that PEP sees a lot more value in Spotless than the indicative price of up to $2.68 a share it has foreshadowed offering if Spotless allows it to conduct due diligence and ultimately unanimously endorses an offer. It wouldn’t be so keen to bid if it didn’t.
The presentation, with its depiction of a step-change in Spotless’ profitability in three or four years’ time, once its complex business transformation program has been completed, may convince PEP to sweeten the indicative price further, but is unlikely by itself to lead to a price that reflects the latent value Spotless itself will unlock by its transition from its original portfolio of siloed service businesses into an integrated multi-service business.
In that respect, Spotless’ confidence that it could be generating $140 million to $150 million of earnings before interest and tax in three or four years’ time, compared with the $90 million to $94 million it expects to earn this financial year, entrenches the board’s position that, thus far, PEP’s approaches fall well short of their own range of perceived value.
If Spotless is capable of the kind of structural leap in earnings the presentation envisages, it would clearly be worth considerably more than $2.68 a share and therefore the board couldn’t contemplate allowing due diligence or recommending an offer at the levels PEP has foreshadowed.
It should be said that, while there are pages of assumptions detailed in the presentation and the wording around the numbers in it has been very carefully framed, the directors would be very conscious of their potential liabilities in an increasingly litigious environment. That tends to indicate the strength of their conviction about the group’s future performance.
The problem for the board, of course, is that a significant proportion of their register – at least 40 per cent – is backing the PEP approach, having lost patience with Spotless’ lengthy history of lacklustre performance.
Farnik and his team, if Spotless is to either prise a significantly higher offer from PEP or remain independent, will have to convince those shareholders that the transformation project outcomes are realistic and achievable.
The Spotless strategy, which involves a $110 million investment in a new business and IT platform to support the multi-service model, isn’t radical. There are a number of facilities services groups offshore that operate with the model Spotless is seeking to build and which generate margins considerably fatter than those Spotless has traditionally generated.
Not only is the model proven but in this market Spotless, because of the range of services businesses it has within its portfolio, is uniquely positioned to implement it and gain a material competitive advantage from it.
The real issue for the shareholders, rather than PEP, is whether they have faith in Farnik and his team’s ability to execute the transformation program.
The technology element of the program is on time and on budget and there have been some encouraging wins in big tenders because of the group’s ability to make an integrated services offering, but three to four years is a long time for institutions focused on their current performance to wait for results, particularly in this market.
In some respects, what Spotless is trying to do as a public company would be easier for private equity to do away from the spotlight and without shareholders anxious for near-term performance, which may explain the strength of PEP’s interest in the group.
PEP would be very familiar with the disparity in performance between Spotless and those offshore peers that have implemented the multi-service model and would back its ability to put in place a team that could execute the final phase of the Spotless program.
If Farnik can convince his shareholders that the potential value is real and realisable and fracture the quasi-alliance some of those institutions have formed with PEP, Spotless would be in a stronger position to either negotiate something materially higher with PEP or to see off the private equity approach.
If he can’t, he and his board won’t have negotiating leverage other than their continuing ability to refuse the due diligence PEP’s lenders require, which could ignite a destructive and rather more formal shareholder revolt.