Qube: the rights issue

One of our favourite growth stocks makes its biggest move so far.

Summary: While subject to a number of conditions, including shareholder approval, Qube is one step closer to a sale agreement on the Asciano acquisition, which will give the company management of the Patrick ports business. As part of the deal’s funding, an entitlement offer has been announced and we see this as a good opportunity for long term value.

Key take out: We maintain our buy recommendation and view the entitlement offer as an attractive long term opportunity.

Key beneficiaries: General investors. Category: Shares.

On Tuesday Qube moved one step closer to owning Asciano ‘s prized Patrick Ports business. It was announced that Asciano has entered into binding documentation with the Brookfield consortium and Qube consortium in relation to the sale agreements of the Patrick’s container terminal business (Ports) and the Bulk and Automotive Ports Services Business (BAPS).

The consortiums will acquire 100 per cent of Asciano (AIO) for $9.15, reduced by the $0.13 planned interim dividend. The final amount may be further reduced depending on AIO paying out a special dividend of up to $0.90, with the purpose of releasing franking credits. The value of the franking credits for the interim dividend and the special dividend are up to approximately $0.05 per share and $0.39 per share respectively.

The combined value implies an enterprise value of approximately $12 billion, which is an EV/EBITDA multiple of 10.5 times for the 12 months to December 2015. Much of the detail is similar to the previously announced initial discussions. (read more in our analysis from February 24: Qube breaks into the big time).

The deal is subject to a number of conditions including Asciano shareholder approval, regulatory approval (ACCC, FIRB etc), and an independent expert report recommendation. A break fee of $88 million will be payable to Qube under certain circumstances. 

The key details include –

-        Rail consortium will acquire all of the shares in Asciano, and with it the Pacific National rail business of Asciano.

-        Qube and Brookfield consortiums, as previously announced, with the addition of the Qatar Investment Authority, joining the Brookfield Consortium.

-        Patrick business acquired for $3.84bn.

-        A terminals joint venture between Qube and Brookfield consortiums for $2.915bn.

-        Brookfield consortium to acquire 100 per cent of the Bulk and Automotive Ports Services Business (BAPS), including 50 per cent stake in AAT for $925m. Qube has an option to acquire this AAT stake, pending ACCC approval.

-        Relevant Qube and Brookfield entities would sell their existing Asciano shareholdings to BidCo at the scheme consideration price.

The indicative timetable suggests that assuming all conditions are met and approved the deal will be effective from June.

Capital raising

As part of the funding for the deal, Qube announced a fully underwritten 1 for 4.4 accelerated non-renounceable pro-rata entitlement offer of new ordinary shares at an issue price of $2.05 per share to raise approximately $A494m. The offer includes both an institutional component and a retail offer. The retail offer opens on March 21 and closes on April 1.

What does it all mean?

In the short term on a worst case basis (ie. assuming low end of synergy guidance range), the deal is likely to be earnings per share neutral for Qube’s FY17 earnings. That is, the positive earnings benefit from Asciano’s ports business is equally matched by the debt and equity funding costs.  

In the longer term after synergies are realised, the deal is likely to be earnings per share accretive and is also strategically very important.

The strategic positive is greater control of the container supply chain, where the benefits will increase as the Moorebank intermodal terminal volumes ramp up over the next decade.

Qube is paying $1.46bn for its 50 per cent share in the Terminals joint venture. It is to be funded by $800m in new equity and debt of approximately $200m, on top of the $1.05bn debt from Patrick (Qube’s share is $525m).

For the equity component, $306m is raised from CPPIB’s agreement to acquire 143m shares at $2.14 per share, and $494m from the previously mentioned retail and institutional non-renounceable entitlement offer. The CPPIB equity component is conditional on the transaction been approved. 

The $1.05bn of Patrick non-recourse debt comes at a cost of 3.2 per cent.  Transaction costs are estimated to be $40m, on top of the $160m debt Qube guided towards. A profit of circa $35m will be achieved from Qub’s 6.3 per cent stake in Asciano.

If the deal is completed in June, it provides the opportunity for one-off costs to be recorded in FY16, and a clean full FY17 year of the combined business.

Upside scenario

Management has guided towards $30-50m of synergies from the deal over a two to three year timeframe. The top end of this range would be equivalent of up to five per cent earnings per share accretive.

Over the longer term it is challenging to quantify the benefits of continued integration of the container supply chain, for example as Moorebank volumes increase, and warehousing customers build capacity on site at Moorebank. But there is little doubt that greater control of container movements will ultimately provide cost savings.

The cost of the import/export container supply chain is believed to be $1500 per TEU container. That is from ship to retail store. Qube management’s long term view has been that it can reduce the costs of this supply chain through a more integrated service that reduces some of the unnecessary steps.

Summary

With the deal not yet approved, our Qube forecasts don’t yet include the impacts from the potential transaction. But as mentioned on a pro-forma basis the worst case is for the deal to be EPS neutral for FY17, and accretive over the longer term. The deal is likely to create substantial value for Qube, and it de-risked the business model by owning a larger component of the container supply chain.

Short-term earnings multiples for Qube look inflated compared to Aurizon (AZJ), and the price Asciano (AIO) traded on prior to takeover bids. But in our view this is justified given current non-operating assets that will produce significant earnings in future years (eg. Moorebank, and Quattro grain).

We maintain our long term buy recommendation with $2.65 valuation. Given the $2.05 entitlement offer is at a large discount, we view it as an attractive long term opportunity.

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