Transcript of Anthony Srom interview

Transcript of Michael Pascoe's interview with Anthony Srom, ABN AMRO transport analyst.

Michael Pascoe: The share prices of both Toll and Patrick have been pushed around by the takeover bid and the uncertainty of it. Where are they in regards to valuation? What are those two companies actually worth?

Anthony Srom: Look, in terms of Patrick, our estimate of valuation is $6.60 per share. So, it's trading slightly above that. It has been well supported by corporate activity overseas, particularly in relation to P&O in London. In terms of Toll, our valuation is $14 per share. It’s trading substantially below that. I think uncertainties around the potential breakup of Pacific National and the longer-term outlook for growth is weighing on sentiment at this particular point in time. So, a bit of disparity between the two; Toll being more harshly dealt with by the market.

You expect that if the bid doesn’t go ahead for Patrick, it will be the one with uncertainty; it will be at the big discount?

But, again if you look at the takeover of P&O in London and the multiples that Dubai Ports World or Port of Singapore are prepared to pay for container terminal assets – they are quite ritzy '” 17 times EBITDA is what I’m estimating. Or, if you look at P/E terms, circa 35 times. So, it is quite rich, and again, with that spectre of corporate activity out there supporting Patrick, Pacific National only being about 20% of earnings as well. So from Patrick’s point of view there is an argument that there is more valuation support out there, particularly given the rarity of port assets and they’ve got those.

With those sorts of valuations, there has already been a suggestion by Paul Little that if the Patrick takeover doesn’t go ahead he will look at P&O’s Australian operations or some other opportunity. Does that make sense?

It makes good strategic sense for Toll and there is nothing to lose by having discussions with the successful acquirer of P&O. If you look at the strategic framework for logistics over the next two or three years, there is definitely a push towards vertical integration. My reading of the situation is that the ACCC doesn’t really have a problem with two vertically integrated operators. I think if Pacific National is broken up, Patrick will be vertically integrated and that in itself could allow Toll to pursue vertical integration with an acquisition of something like P&O’s Australian port assets. So again, the way this could play out over a two or three year time-frame does leave the opportunity for Toll to enter the port arena via P&O.

Do you think the takeover bid will succeed?

There’s a long way to go just yet. A lot of scenarios could play out. We will see how fruitful the ACCC discussions with Toll are at this particular point in time. There are a lot of hurdles to overcome there, particularly in relation to Pacific National and concessions. Barring that, the Federal Court is another course of action that Toll can pursue. But I would say that’s potentially a long way off before we hear resolution.

Will that be a hard road for Toll to take?

The Federal Court?

Yes.

If you look at past precedents in the transport sector, Qantas was quite successful going to court in its bid to have a joint operating agreement with Air New Zealand. And I think, looking at the Federal Court, they tend to take a more liberal view on market definitions; a bit broader than what the ACCC has done in the past. So, looking at that I'd say the odds of Toll succeeding through the Federal Court would be slightly higher but it will take a substantially longer amount of time.

Eureka Report has looked before at the role of hedge funds, in general, in takeover battles. Could this be an example of where hedge funds have taken a big punt and could be losers?

I would say the contrary. Leading into the ACCC discussions about a week ago, my reading of the situation was that particularly overseas hedge funds were short Toll. So, they would have made, I suppose, substantial of profits in the last week or two. Again, we’ll wait and see whether they close out those positions, but the hedge funds at the last minute were of the view that the deal would not progress as it currently stood.

The buying of Patrick, and pushing it above the bid price – who loses there?

I'd say that’s largely driven by domestic institutions really taking the view there that Patrick will pursue the vertical integration strategy that it has been doing over the past few years. In particular, ending up with parts of Pacific National should it be broken up; so not losing too much on that front. And also, if the bid falls by the wayside, being able to pursue acquisitions such as FCL, which it has flagged in the past and maybe others out there in the logistics sector like Linfox, for example. So building much more or a land-side logistics presence; becoming vertically integrated and gaining support from the market as well as potential turnaround in Virgin Blue’s earnings.

It sounds like you’re fairly optimistic about both companies' longer-term outlook but Toll’s a better buy at present?

In terms of the long-term outlook for Toll versus Patrick: if the bid falls through, there will be some short-term pain in the rail business, as Pacific National, one way or another, will be broken up, particularly the intermodal assets that they’ve got. That will probably hurt Toll shorter term in terms of sentiment, the way the market's treating it. But in terms of a longer-term view, that three to five year time-frame as we discussed earlier, the opportunity to vertically integrate via P&O '¦ I think, again, Toll’s been harshly treated in the short-term versus Patrick.

Something of a byplay in this is that Virgin Blue share prices have been pushed along this week on the basis that Patrick has to get a big lift from somewhere to make up for its Pacific National fall, and Virgin Blue is the likely suspect. How do you see it?

I can concur with that. I think if you look at the earnings outlook for Virgin, it’s quite positive. Bear in mind the big risk is the oil price, given that they are unhedged. What we’re seeing in the domestic market at the moment is the improvement in the yield or the average fare that the airlines are getting. That’s largely driven by a slowing capacity growth '” less aircraft coming into the market. Looking at Virgin Blue, the yield environment is relatively good; however, the statement by them yesterday to the ASX indicates they are tracking within plus or minus 15% of last year’s figures. Given what you’ve just said, I’ve interpreted that as that they are doing modest growth but not as high as 15%.

So not as much as the speculation in the market would have us believe?

At this particular point in time, I believe so. That’s for the first half, bearing in mind the guidance that they’ve just provided, so for the six months to March. I think if you look further afield for Virgin, the second half of 2006 '” which is April through to September '” is looking very interesting for them, bearing in mind last year they got hit quite badly in terms of profitability. So if oil stays at current levels and the yield environment persists I think that it is where you could start seeing some more more meaningful earnings upgrades coming through for the stock.