Warrnambool's a better buy for Bega

Bega Cheese has timed its $319 million attempt to end the impasse on the Warrnambool Cheese and Butter Factory register and transform itself into the largest listed dairy company near-perfectly.

Last month, both Bega and its target tabled their 2012-13 results. Bega’s results took the market by surprise, with revenue rising 8.3 per cent to pass $1 billion for the first time and profit up 25 per cent. Warrnambool’s might have been better than the 80 per cent dive in earnings it had foreshadowed earlier in the year, but it still reported profits that were 50 per cent lower than the previous year.

While Warrnambool’s share price rebounded from around the $4 level to about $4.50 after the better than foreshadowed result, Bega’s surged from about $2.75 to around $3.20. This gave it the currency for a bid weighted 65:35 between scrip and cash and the ability to point to takeover premia that range from almost 40 per cent on a 12-month volume-weighted average Warrnambool price through to a still-solid 28 per cent using yesterday’s closing price.

Bega’s interest in Warrnambool emerged after the giant Victorian dairy co-operative Murray Goulburn tried to acquire the company back in 2009. That attempt failed, but Bega and Murray Goulburn both emerged with substantial shareholdings. Bega owns about 17.1 per cent of Warrnambool and Murray Goulburn about 16.3 per cent after lifting its shareholding earlier this year.

Bega’s timing may not just be about the relative performances and share prices of bidder and target.

Murray Goulburn is significantly bigger than Bega, with an equity base last year of $759 million against Bega’s $262 million and its market capitalisation of about $500 million.

As a co-operative, however, it doesn’t have easy access to equity and obviously can’t issue scrip. Moreover, earlier this year Murray Goulburn agreed a 10-year deal to supply Coles with milk for its home brand and committed to spending $120 million to building two new processing plants in Melbourne and Sydney to support the contract.

Without access to external equity or the ability to issue scrip and a commitment to distributing most of its surpluses to its farmer members, it would be difficult for the co-operative to finance those plants and mount a counter-offer. Murray Goulburn has been talking to its members about retaining more of its earnings to fund its growth aspirations, but that’s not an instant option for raising equity.

With Bega’s offer of 1.2 of its shares and $2 of cash having no minimum acceptance condition, it would also be impossible for Murray Goulburn by itself to block the bid and prevent Bega from benefiting from a major consolidation of the dairy sector and the operational and financial scale that would create. If Bega were to gain 100 per cent of Warrnambool, the combined group would have a market capitalisation of around $650 million and total assets of almost $1 billion.

The scrip component of the offer means that Murray Goulburn could decide to accept the bid and, the Australian Competition and Consumer Commission willing, hope to have a crack at the enlarged group at some later date. Its shareholding in Warrnambool would, however, only give it a shareholding percentage in the mid-single digits.

The absence of a minimum acceptance condition and scenarios within its bidder’s statement outlining various outcomes at shareholdings between 30 per cent and 100 per cent indicate Bega’s first objective is to secure an unchallengeable position on the register, if not effective control. Given its existing shareholding, it is probable that it will actually gain effective control.

The discrepancy between the performances of Bega and Warrnambool (a 65 per cent total shareholder return since its 2011 listing for Bega, compared with Warrnambool’s 20 per cent return over the same period), the $7.5 million a year of expected synergies, and the continuing exposure to the businesses and their upside because of the strong scrip component would assuage some of the concerns of the dairy farmer shareholders and suppliers on the Warrnambool register.

It is worth noting that Bega’s chairman Barry Irvin referred to the greater global reach, customers and product range as well as the financial strength the combination of the two companies would offer. The enlarged Bega would produce about 350,000 tonnes of dairy products and $1.5 billion of revenue a year.

It is inevitable that there will be increasing discussion about further consolidation of the agribusiness sector to create the scale, the efficiencies and the financial capacity to take advantage of the growth in demand for agricultural commodities, including dairy products, within Asia over the next few decades.

A much bigger Bega would be well-positioned to participate as well as to make the significant investments needed in upgrading the nation’s processing capacity. If Murray Goulburn (which would also probably face greater ACCC scrutiny) could find a way to get into the contest, of course, the same would apply to it.