Why would KKR want PacBrands?

PORTFOLIO POINT: KKR’s unsolicited proposal turns the spotlight on other companies in the sector that might be on the block.

Pacific Brands (PBG). The year has kicked off with a few deals, but one of the strangest rumours to come out is Kohlberg Kravis Roberts’ (KKR) proposal to takeover Pacific Brands. Strange, because I can’t think why the private equity group would want to buy the company.

What happened was that KKR lobbed an unsolicited takeover proposal at Pacific Brands, putting a value on the business of about $600 million. Everyone has divided that number by the shares on offer and come up with a per-share price of 66¢ – but that’s only a guess because that figure may or may not include Pacific Brands’ debt.

The clothing wholesaler has traded as high as $3.57, but before the offer was made it was hovering around 56¢ and it closed Monday at 63¢. Would the board approve it? It has already dug its heels in a little by not granting exclusive discussions, and accepting 66¢ a share would be a clear sign that the future for Pacific Brands was not good. One the other hand, life is not easy for the company. Retailers are going direct to suppliers and creating their own house brands, and competition in the sector is cut-throat.

Other companies in the sector that might be on the block, according to a Deutsche Bank analysis at least, could be Harvey Norman and David Jones, mainly for their property portfolios. David Jones owns its Sydney and Melbourne CBD stores, while Harvey Norman CEO Gerry Harvey has accumulated a sizeable property portfolio in the company. But then again, the only thing you could do with the Harvey Norman sites is put a similar store on them – you couldn’t just knock the buildings down and build houses, for example. And what about the retail businesses? The sector is not doing well and I think this is a structural problem, not cyclical.

Which brings me to why KKR would want to buy Pacific Brands. PacBrands’ CEO Sue Morphett made the tough decisions a few years ago by closing Australian manufacturing and outsourcing to China, so there’s not that much fat left to cut.

But then again, private equity only starts to collect fees on the funds they’ve raised when they invest the money, so there’s a driving urge to make a deal. This can lead to some dumb deals – just look at CVC’s acquisition of Nine in 2007, and the attempt on Qantas via a leverage buyout in 2006 – but I think that people in private equity, like everyone else, sometimes can’t see the wood for the trees. They look at something and think it’s a good deal because it’s bashed up and might come back, without realising that sometimes sectors fundamentally change and will never be the same.

Senex Energy (SXY), Woodside Petroleum (WPL). Gas has arrived as a sector in Australia. Today, M&A rumours were spurred by French corporation Total SA saying it has plans to invest $13–14 billion in the Cooper Basin over the next five years, either via takeovers or other means, and speculation that Cooper Basin producer Senex (formerly Victoria Petroleum) could be in the sights of AGL.

Total could take up the 24% shareholding in Woodside that Shell is trying to sell, or it could take a look at Senex (which has been suggested) and ruffle some feathers if AGL is indeed running a ruler over the company.

Because gas is such a hot sector be prepared this year for a lot of talk about takeovers that will never happen, and remember that there are a lot of projects in Australia and around the world looking for capital right now. In this country alone you have shale gas in the Cooper Basin, coal seam gas in Queensland, NSW and Victoria, the North-West Shelf field off the coast of Western Australia, Japanese company Inpex’s $32 million project near Darwin, and Woodside’s Pluto project.

Like with uranium stocks, potential suitors in the gas sector will have heaps of small businesses to choose from that don’t have the funds to develop their assets. For this reason I have stuck with big companies when trying to pick takeover targets, like Santos, Woodside and Origin. They’re the ones that can deliver the game-changing results.

For smaller companies, they could just end up with a joint venture or sharing agreement. This may suit them, but not investors if you’re looking to play a takeover.

African Iron (AKI). Gas might be the main attraction but iron ore hasn’t lost its lustre. South African miner Exxaro has tipped a bid at Congo miner African Iron for 51¢, if it gets to 50% acceptances, or 57¢, if they get, interestingly, over 75% – not 90%, which would deliver the company into their hands via compulsory acquisition.

There’s another detail that is initially looking quite exciting too. Cape Lambert Resources owns 25.25% and Equatorial Resources owns 20%. Some people have been getting quite excited because with two strategic shareholders the scene is set for a joint counter bid. Alas, Cape Lambert has already committed 19.99% of its holding to the bid, and now it just rests on whether Equatorial Resources will follow their lead. I don’t think it has the capacity to make a counter bid by itself.

The market is pricing the deal at 56¢ as at the close on Monday, so at worst you’re looking at a 9% downside if Exxaro’s offer doesn’t appeal to more than 75% of shareholders (I think it will make it to 50%), and at best you’ll get an extra 1¢.

But if you want an example to follow, hedge funds are piling into the stock, probably with the view that it’s an interesting sector and Exxaro has plenty of money, so why not?

Spotless Group (SPT). We have a real standoff here and a really unusual situation. The Spotless board has told Pacific Equity Partners (PEP) that if it agrees to pay $2.80 a share for the company (as well as meeting a few other conditions) it will allow the private equity group to conduct due diligence.

I think the directors are being obstructive: I think they should let PEP in to do the due diligence and then talk to them about value and why they think Spotless is worth $2.80 afterwards.

Then again, the $2.80 figure includes a 6¢ dividend, so effectively, the price the board has put on the company is only $2.74, which is not much higher than PEP’s initial $2.68 offer. But as we know, private equity runs the numbers, decides on a price, and if they don’t get it, is happy to walk away; $2.80 may be just too much to agree to without having done due diligence.

This is a three-way standoff: the directors, led by Peter Smedley, a hard negotiator, have nominated a face-saving figure to say they extracted some value for all of their bluster; the bidder; and the shareholders, some of whom are putting a lot of pressure on the board to talk to PEP and not drive them away.

However, because of the board’s obstreperous attitude there’s a real risk that PEP will walk away. No private equity firm is going to agree to a price before looking at the books and the market is telling you that it’s unsure of whether a deal will be done. Spotless stock closed at $2.35 on Monday, which is slightly closer to where the share price is likely to fall to than to the board’s counter offer, if a deal isn’t made.

PaperlinX (PPX). If you have a very high tolerance for risk, want to get involved in a battle between ordinary and preference shareholders and enjoy speculating on companies that have a high chance of going bust, this one may be for you.

An unnamed private equity fund has made a bid of 9¢ a share for ordinary PaperlinX shares and $21.85 a share for the preference ones. The interesting part is that the preference shares have a face value of $100 and owners have the right to veto any change of control transaction and to demand that face value.

Clearly no one is going to pay $100 a share so it’s turning into a duel between shareholders as to how much value ordinary shares would be ascribed in any takeover situation. The bidder isn’t involved here, it just offers the money and doesn’t care how it’s split. The fact that the stock is trading at 7.3¢ now suggests that the funds from a takeover won’t be weighted towards the ordinary shareholders.

While we don’t know who the bidder is (I suspect it’s a European fund, because most of PaperlinX’s assets and business is in that region), there is a way to profit from the drama unfolding in the local offices – be it a takeover or a bankruptcy. You need to be able to short the ordinary shares (a difficult thing to do because it’s not owned by many) and go long the preference shares. If everything goes bust your long and short positions cancel each other out.

Gloucester Coal (GCL). Just a couple of days after I wrote my list of top 10 takeover targets, the sole coal company on the list went, but not in the way I expected and I want to offer a word of caution about the offer.

I thought Noble Group would take out the remaining 35% it didn’t own, but instead it sold that to Chinese company Yanzhou Coal. That’s the thing with strategic shareholdings: it’s not necessarily the shareholder that makes the bid, they can sell it to someone else who can make the offer.

But this bid is not straightforward. It’s nominally valued at $10 a share, and trading at $8.33 now, but the reason it’s trading here is partly because the deal is only in its early stages and partly because of how you get your money. You get about $4 cash up-front, some shares in the merged entity and what they’re going to call “performance rights”, which will be shares guaranteed to be worth a certain price in 18 months’ time.

It’s a slightly murky deal because no one has seen the structure of it yet and you might not get your $10 for some time – remember the Wesfarmers-Coles deal? When Wesfarmers bought Coles they did the same thing, but as the evil day to vest the “performance rights” drew nearer, Wesfarmers just extended the date.

Tom Elliott, a director of Beulah Capital and MM&E Capital, may have interests in any of the stocks mentioned.

-Takeover action, January 9-13, 2012
Date	Target	ASX	Bidder	(%)	Notes
11/01/12	Adelaide Energy	ADE	Beach Energy	94.79	Delisted
13/01/12	African Iron	AKI	Exxaro Australia	19.99	Pre-bid acceptance
10/01/12	Anvil Mining	AVM	Minmetals Resources	40.10	Lock up deal on 40.1%. Ext to Feb 16
13/01/12	Brockman Resources	BRM	Wah Nam International	55.33
09/12/11	Contango Capital Partners	CCQ	Contango Micro Cap	72.82
16/12/11	Gold One International	GDO	BCX Gold Investments	82.80	Unconditional
15/12/11	Hastings Diversified	HDF	APA Group	20.71
13/01/12	Laguna Resources	LRC	Kingsgate Consolidated	98.14
13/01/12	Living and Leisure	LLA	Merlin Entertainments	50.83
18/07/11	Mintails	MLI	Seager Rex Harbour	37.33
16/12/11	MSF Sugar	MSF	Mitr Phol Sugar	22.01	FIRB approves
13/12/11	oOh!media	OOH	Champ III Funds	19.60
13/01/11	Razor Risk Technologies	RZR	TMX Australia	67.93
12/01/12	Signature Metals	SBL	LionGold	21.23
12/05/11	Sphere Minerals	SPH	Xstrata	75.29	Unconditional
Schemes of Arrangement
12/12/11	Aston Resources	AZT	Whitehaven Coal	19.99	Vote late Mar
08/12/11	Austar United Communications	AUN	Foxtel	0.00	Vote Feb 17
21/12/11	Bow Energy	BOW	Royal Dutch Shell/PetroChina	0.00	Approved
29/08/11	Auzex Resources	AZZ	Bullabulling Gold	0.00	See GGG Resources - 50/50 merger
25/11/11	Flinders Mines	FMS	Magnitogorsk Iron and Steel Works	0.00	Vote Mar 1
29/08/11	GGG Resources	GGB	Bullabulling Gold	0.00	See Auzex Resources - 50/50 merger
11/10/11	Sundance Energy	SDL	Hanlong Mining Investment	17.99
Reverse Takeover/Scheme
30/12/11	Bondi Mining	BOM	World Titanium Resources	0.00	Scheme implemented
Backdoor Listing
14/09/11	Consolidated Steel	CGQ	CFT Holdings (HK)	0.00
12/08/11	Millepede International	MPD	Cool D'Fine	0.00	Marine HVAC provider. Vote mid-Nov
Foreshadowed Offers
27/09/11	Bannerman Resources	BMN	Sichuan Hanlong	0.00	Conditional proposal. Talks continue
05/10/11	Charter Hall Office REIT	CQO	Macquarie Capital consortium	0.00	Indicative offer. Further due diligence
21/12/11	CSG	CSV	Unnamed party	0.00	Talks closed
21/12/11	CSG	CSV	Other unnamed parties	0.00	Talks closed
17/10/11	Customers	CUS	Unnamed party	0.00	Non-binding discussions
08/12/11	Endocoal	EOC	Unnamed parties	0.00	Unsolicited approaches
05/10/11	New Hope Corp	NHC	Unnamed parties	0.00	Proposals invited
06/06/11	Pulse Health	PHG	Unnamed party	0.00	Expression of interest
01/12/11	Spotless Group	SPT	Pacific Equity Partners	19.64	Revised proposal

Source: News Bites