Transfield puts its credibility on the line

You'd have to say that the Transfield Services board is either confident or brave in dismissing the modestly-revised $1 billion proposed takeover offer from Spanish infrastructure giant Ferrovial.

While Ferrovial added only a meagre five cents a share to its original $1.95 a share indicative and conditional opening offer after undertaking 'limited' due diligence, the board remains adamant that the $2 a share on offer doesn't reflect the underlying value of Transfield's shares.

Transfield shares were trading at $1.50 (after a sharp run-up) before Ferrovial's interest was revealed in October, and they fell back more than 10 per cent to $1.60 after Transfield revealed its latest rejection. The board, led by chairman Diane Smith-Gander, is putting its credibility on the line by opting to continue to go it alone.

Ferrovial said today it had ceased discussions with Transfield. The Spanish group was always unlikely to go hostile in its approach to the attempt to acquire Transfield so, at least in the near term, Transfield has seen it off.

There is said to have been a veritable gulf in the differing views of Transfield's value between aspiring bidder and defending board.

Much of that relates to Transfield's big exposure to the defence and social services sectors as a consequence of its $1.2bn contract with the Australian Government to manage the offshore immigration processing centres and Manus Island and Nauru.

A second area of disagreement relates to the group's other big exposure: the oil and gas sector.

The offshore processing contract is up for renewal or renegotiation in about October next year and it would appear reasonable to assume that, if Transfield retains the contract, the government will be focused on trying to improve its terms, reducing Transfield's margins.

The oil and gas sector, in turmoil after the savage fall in oil prices, represents nearly 30 per cent of Transfield's revenue base and one of the keys to the group's continued recovery. If the lower oil prices are sustained and impact activity levels, it could have a significant impact on Transfield's earnings.

It would seem obvious that Transfield's board is more optimistic about the likely outcomes from the negotiations with the Federal Government and the medium-term outlook for the oil and gas sector than Ferrovial, although it could be that Ferrovial was simply being opportunistic.

The board would, however, have been encouraged by the support it received from institutional shareholders. Transfield is owned nearly 19 per cent by Alan Gray Australia, which earlier this month said it believed the group was worth between $2.50 and $3 a share "through the cycle".

Last month, at its annual meeting, Transfield upgraded its guidance for this year from underlying earnings before interest, tax, depreciation and amortisation from the previous range of $240 million to $260m to a new and higher range of $260m to $280m. Last financial year underlying EBITDA was $217m.

Chief executive Graeme Hunt said 74 per cent of the 2014-15 financial year's revenues were locked in and that earnings for the year to date were well ahead of the same period last financial year.

Hunt, a former senior BHP Billiton executive, has presided over a major restructuring and debt-reduction program within Transfield. It is evident that the Transfield board is confident, despite the question mark over the offshore processing contract and the current state of oil and gas markets, that the underlying momentum within the group will continue.

Given the discrepancy between Transfield's share price and what Ferrovial said it was prepared to offer, there will be increased pressure on Hunt and his board to deliver results that reflect their confidence in the group's outlook.

Any downgrade to their rather bullish expectations would be seen in the context of the rejection of Ferrovial's overtures, sparking recriminations and destabilisation. Ferrovial, with a market capitalisation of about $18bn -- or another of the global services businesses -- could easily return in future if that were to occur.

That latent threat could emerge as early as Transfield's first half results announcement next year, when it has promised to provide an update on its outlook, but will remain alive for the next year or so.

If Hunt can maintain the momentum that he has engendered since his appointment as CEO two years ago, however, the board's rejection of Ferrovial will be vindicated and Transfield's value ought to reflect that.