The Distillery: Brambles' binary benefits

Demergers don’t always work. Then again, trade sales aren’t a sure bet either. Pallet company Brambles has decided to demerge its US document management business Recall after failing to find a buyer for the business. The circumstances under which the company finds itself today are slightly different to when the sale efforts were launched, but the business commentators agree that splitting pallets and document management apart still makes absolute sense.

The Australian’s Criterion columnist Tim Boreham expresses the thinking behind the Recall demerger in the simplest of terms: “Brambles is following the school of thought that like adding water to noodles, you’ll get something bigger in the sum of the parts”.

The Australian Financial Review’s Chanticleer columnist Tony Boyd points out that not all demergers have delivered stronger share prices for the registers of the parent and the spinoff, while sharing some research that indicates it’s usually a good idea in the long run.

“A study by Morgan Stanley earlier this year showed that patience paid off for those participating in demergers. The value of the two companies grew over the 12 to 24-month period after the demerger. In some cases, such as the AMP demerger of Henderson Group, the value grew as more time elapsed. However, there are several examples where value was destroyed if you hung in too long. The outstanding example is the demerger of Toll and Asciano. Bankers will tell you that demerger deals are hard to get past boards of directors because they involve shrinking the ­company. That usually hurts the egos of directors. Also, it can raise uncomfortable questions about over-inflated director salaries when the company is suddenly much smaller. Some companies, such as UGL, are too small to conduct a demerger. If it split its businesses apart, both would fall off the radar of big fund managers.”

Business Spectator’s Stephen Bartholomeusz recounts that Brambles’ initial effort to sell Recall as part of a trade sale was partially motivated by balance sheet issues and when the pallet company failed, it had to raise capital.

“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.”

And The Australian’s John Durie goes way back to explain how Brambles became the company it is today, with a seemingly unrelated side business to go with its CHEP pallet business.

“The old guard at Brambles had used CHEP as the cash cow to build a once mighty conglomerate, which then chair Don Argus effectively dismantled soon after the demerger with the sale of the Cleanaway and the industrial services business. The record handling business Recall was kept in part because the board thought it could maximise value by building it up further, but divestment was always rumoured for the simple reason that it made sense to run CHEP as a separate business.”

In other company news, Fairfax’s Malcolm Maiden writes that when QBE Insurance boss John Neal took over from Frank O’Halloran, his chief task was to tap latent economies of scale that had built up under the more than 120 acquisitions overseen by his famous predecessor.

“The progress report he gave on Tuesday shows he is well on the way to doing it,” says Maiden.

In a separate piece, Maiden writes that it was probably the slide in the Australian dollar since the Reserve Bank of Australia's last board meeting that kept them from cutting interest rates at yesterday's gathering.

In politics, The Australian’s contributing economics editor Judith Sloan says returned prime minister Kevin Rudd has “no understanding” about her area of expertise.

Meanwhile, Fairfax’s Elizabeth Knight notes that Rudd has kept the prospect of major tax changes, including the Minerals Resource Rent Tax, on the table and first call on the matter would probably be to old friend Andrew Forrest from Fortescue Metals Group.

The Australian Financial Review’s economics editor Alan Mitchell looks at the balance between emissions trading and a carbon tax, adding that it’s not inconceivable for the United States to go the way of the latter.

“The US faces a massive fiscal consolidation task and the International Monetary Fund believes Congress will have to increase taxes. It is urging the introduction of a value added tax. A carbon tax might be seen as one of the more politically attractive alternatives. After all, if you have to increase taxes, why not increase them on the one thing that a big chunk the electorate thinks should be more heavily taxed?”

And while we’re talking about the land of the free, The Australian Financial Review’s Karen Maley tests the argument from a growing number of analysts that the commodity price slump is vulnerable to growing US economic activity. Copper and oil are of particular interest.