Transpacific waste story tarnished

IF TERRY PEABODY expected Transpacific Industries, his waste management concern, to quickly regain market darling status when it returned to trading this week after five months' suspension for completion of a capital structure review, he would surely be disappointed by performance thus far. Despite raising sufficient capital to substantially address the company's excessive debt burden, the share price has fallen by about a third from its level immediately before the long suspension and has struggled to hold the $1.20 price of the current underwritten capital raising.

Transpacific's success in both renegotiating the maturities of its corporate debt facility and securing the support of Warburg Pincus to underpin an $800 million equity placement and rights issue has been overshadowed for the short term at least by disclosures that accompanied the equity raising.

The most telling revelation is that, contrary to the company's earlier predictions, waste management is not a consistently high growth sector resilient to economic downturn. While Peabody had guided investors to expect double-digit profit growth from the $541 million EBITDA recorded in 2008, the company has actually recorded operating EBITDA for 2009 of just $447 million as part of the waste market, such as those relating to construction and demolition activity, experienced a significant dip.

Confidence in management and the company's corporate governance practices has also been shaken by revelations that Transpacific's 2008 EBITDA was artificially bolstered by $48 million in irregular items. This sent analysts scurrying back to their models to reconsider future profitability.

Investors are now viewing Transpacific very differently from the rose-tinted perspective that saw the company burst out of the starting blocks to be the top-performing initial public offering of 2005. After floating at $2.40 the company raced to $6 a share by early 2006 before peaking at about $14 in mid 2007. At one point Transpacific traded on 20x EBITDA, reflecting enormous confidence in the company's ability to continually sniff out value creating acquisitions. Eighteen acquisitions were completed in the year to June 2006 alone as Transpacific stormed down the path from niche business to dominant player in waste management in Australia and New Zealand.

All aspects of the acquisition strategy that drove Transpacific's growth from listing through to 2008 are now under scrutiny. There are the usual allegations of overpaying as analysts recalibrate their views on reasonable valuation metrics for waste management businesses.

Despite these concerns, analysts are united in their respect for the quality of Transpacific's assets including valuable landfills and liquid waste facilities.

Several brokers have assessed the fair trading price at a hefty discount to current trading. Austock has a price target of 84 cents, representing an 8x 2011 price earnings multiple, while Goldman Sachs JBWere's has a 77 cent price target.

While there is no rush to acquire ordinary shares, there may be richer pickings in the company's step-up preference shares, currently trading at a price that does not fully reflect Transpacific's reduced risk profile after the recent capital raising.

Originally marketed to superannuants looking for a product that paid better than bank interest, these securities (which trade under the code TPAPA) were trading at a deep discount to their $100 face value immediately before Transpacific securities were suspended in February. The discount was fair at the time given Transpacific's challenged financial position, but a discount of about 50 per cent in the days following the successful recapitalisation is consistent only with a minority of investors suffering from fatigue after the five-month suspension.

When it comes to preference shares, the devil is always in the detail. Expressed simply, the TPAPAs may either be redeemed for $100 in September 2011 or a higher interest rate will apply from that date. Currently paying a distribution of 3.5 per cent above the bank bill swap rate, this margin would increase to 6 per cent in the event that the preference shares are not redeemed.

A key risk for preference share investors is that the distributions are discretionary and non-cumulative. While Transpacific recently announced an intention to continue to pay the distribution, as dividends on ordinary shares are currently suspended there is a risk to preference share distributions in the short term at least. Nevertheless, ABN AMRO Morgans recently assessed the fair value of the preference shares at about $86. With the risk profile of Transpacific now greatly improved, Carpathia rates these securities a Buy at the current price of about $50.