Sum of a Fairfax break-up

APN and Fairfax boards are going through an unpleasant experience but one many others will face in the current market.

Fairfax and APN directors must now know that the market is using a break-up basis to value their stock and not the normal earnings calculations.

The level of redundancy packages had a big bearing on break-up values.

In the case of APN the market is close to moving to the next stage of the downward slope – a battle for survival.

APN shares have fallen from around 90 cents to below 30 cents, which causes shareholders funds to be valued by the market at less than $200 million.

Debt is $500 million so when the chief financial officer resigns it triggers alarm bells. Last week I found myself in the company of people who have been putting the break-up ruler over Fairfax.

They were not happy with what they found in the latest profit report. The market value of Fairfax shareholders' funds now totals less than $1 billion, compared to gross debt of about $1.2 billion. The company's cash at balance date reduces net debt to $914 million, of which $99 million is in the listed 51 per cent owned subsidiary TradeMe.

The problem is that redundancy costs triggered by last month's restructure were around $200 million, or just over 20 per cent of the market value of Fairfax shareholders' funds. This will reduce the company's cash.

In the full accounts the additional redundancy provision was reduced by $60 million to $140 million, using the future tax benefit mechanism. And Fairfax has also classified about half the redundancy provision as a non-current liability, which further assists the current assets.

When they see these sums those doing the break-up calculations get very nervous because of the potential liability in future redundancy costs.

Fairfax's regional assets generate strong cash but as we have seen with APN, the break-up value of these assets is limited in this market.

The prized Fairfax Australian asset is The Australian Financial Review, which would be expected to have a break-up value of between $200 million and $300 million. But the AFR only achieves earnings before interest and tax of $3 million. A buyer at, say, $300 million would want earnings of at least $20 to $25 million. Unless better revenue could be found those additional earnings would come via staff reductions, which in turn would trigger an unknown redundancy.

In addition, having a partly owned listed subsidiary like TradeMe prevents the free movement of cash between the group. Conversely, Fairfax can reduce its debt substantially by selling its 51 per cent stake in NZ based TradeMe but it is then left with Australian assets that carry the unknown latent redundancy charge.

The people putting the break-up ruler over Fairfax decided it was too dangerous so they moved on. Others may take a different view and of course if Gina Rinehart's Roy Hill iron ore mine does not get its bank funding she will gave a lot of cash available to "save” Fairfax (Rich Pickings: Gina loses ground, August 31; Rinehart should abandon Fairfax dream, August 27).