Skilled walks a fine line in rejecting Programmed's merger

As a highly respected investment banker in an earlier phase of her professional life, Skilled Group chairman Vickki McFadden would have been well aware she needed to walk a very careful and nuanced line in rejecting merger overtures from Programmed Maintenance Services that have been embraced by some sections of the market and Skilled's shareholder base.

Thus, in rejecting the largely scrip-based approach from Skilled's smaller competitor, McFadden has conceded that there is some "industrial logic" to the combination, but argued that it isn't compelling.

She also conceded that putting the two groups together would provide diversification and increased scale, but said her group's focus is on delivering a better business, not just a bigger one.

While she accepts that a merger would generate synergies of about $20 million a year, she says they would take a number of years to achieve, were centred mainly on corporate overheads, could involve 'dis-synergies'. She also said the costs of achieving them were likely to outweigh the benefits in the first year and they wouldn't do anything to position the businesses for future growth.

The strongest argument Skilled has against the Programmed proposal relates to its terms. When Programmed unveiled its proposal late last year, Skilled shares were trading at levels more than 60 per cent below last year's peak.

Programmed's had fallen only about 30 per cent. Therefore, where Skilled had been (in terms of its market value) a far larger business than Programmed earlier in the year, they two companies were being valued roughly at the same level. There was a significant degree of opportunism to the Programmed approach.

Nevertheless, the proposal, which would see Skilled shareholders receive 0.5032 Programmed shares for each share they hold plus 25 cents cash, has gained some traction in the market. It would give each set of shareholders 50 per cent of the merged group.

With a significant overlap within the two share registers, and Skilled's share price moving up to reflect the merger terms, an expectation of a transaction has been priced into the market.

The McFadden argument is that Skilled is better positioned strategically as a standalone business than a merged business would be, which in effect is an argument that its prospects are better than Programmed's.

Skilled has made several acquisitions in recent years to build its engineering business and says it has strong growth prospects in segments where Programmed doesn't operate. It also says it has a strong exposure to the full life cycle of oil and gas projects, whereas Programmed's exposure is to the offshore construction segment.

It also claims some upside from its own cost reduction program, which has generated $28m in savings in the past two financial years and which Skilled believes will deliver a further $15m this financial year.

Had there been a zero premium scrip-only merger of the two companies a year ago, based on the relative market capitalisations Skilled shareholders would have emerged with about 65 per cent of the combined businesses.

McFadden said today that Skilled's board remained open to considering a transaction on terms that appropriately reflected Skilled's value and contribution to a merged group. One suspects she and her board would be looking for terms that gave them something closer to that 65:35 split than the 50:50 proposal on offer today.

The immediate 4.3 per cent fall in Skilled's share price in response to the rejection would suggest the market doesn't think they will get them.