Building value from Brickworks

The diversified group is a discounted asset play, fighting to keep its cross-holding with Washington Soul Pattinson in place.

Brickworks (BKW), the $2 billion company best known for its building products division, is a discounted asset play with further material upside if the Washington Soul Pattinson (SOL) cross-holding is ever removed.

It is a diversified business with an excellent track record of shareholder returns, run primarily by the Milner family who are substantial shareholders. The three main divisions are building products, land development, and the cross-holding investment in SOL.

Robert Milner is chairman of both SOL and BKW, Lindsay Partridge is the managing director of BKW, and other members of the Milner family are also involved.  

The cross-holding which has been in place since 1969, includes BKW owning 42.7% of SOL and SOL owning 44.3% of BKW. Whilst it has served the Milner family well as a long-standing takeover defence, it has also ensured that the share prices of both have usually traded at a large discount to their asset value.

Carnegie / Perpetual Proposal

Last year venture capitalist Mark Carnegie, and Perpetual’s head of equities Matt Williams, launched a campaign to unwind the cross-holding – presenting that it is in shareholders’ interests to remove the complex structure. Carnegie and Perpetual own 12.5% of BKW and 11.7% of SOL, with Perpetual being long-term shareholders of both.

In October last year, John Abernethy reviewed the proposal in detail, in Does a Brickworks demerger proposal stack up?

The major components include the demerger distribution of SOL’s 27% shareholding in TPG Telecom (TPM), then the cancellation of BKW’s holding in SOL in return for cash and interest bearing promissory notes. Carnegie/Perpetual claim BKW would have a tax bill of $179-$247 million, which would be far outweighed by the valuation uplift. Under this proposal the valuation of BKW would be $18-20, assuming the tax rulings are as suggested.

Ongoing Battle

The general meeting for BKW shareholders relating to the Carnegie/Perpetual proposal has been further delayed until the September 5 this year.

BKW has also launched legal action, challenging the disclosure which Perpetual/Carnegie had given to BKW shareholders in relation to the general meeting originally called for them for November of last year.

On May 2 this year it was announced that Perpetual/Carnegie had filed a statement of cross-claim in the ongoing litigation proceedings.

It is very difficult to predict who will win the battle, but one thing that can be guaranteed is that neither side is likely to give up lightly.

The cross-holding and personal director holdings of the respective boards is over 50% of the register for each of SOL and BKW. Hence, the final decision on whether or not these interests are to be included in the vote will go a long way to the final outcome.

The other major uncertainty is around the nature of the legal advice each side has received, and the final tax rulings for the proposal.

Earnings Mix

Despite the cross-holding most likely not being in shareholders’ best interests, it is tough to criticise the company’s ability and long track record of outperformance. The mix of earnings diversifies the cyclical effects of the different industry exposures. That is, rarely will all of the cyclical drivers be moving in the same direction. For example, in recent times the building materials division has been operating in a positive environment with the lift in residential housing construction, whilst coal has been weak.

Building Products

Lindsay Partridge is widely regarded as one of the best managers in the building materials sector. The ability to manage the business through the different points of the cycle has ensured the maximisation of earnings margins. For example, the ability to build up inventory when sector conditions are improving and vice versa when they are declining.

Over the past 12 months especially, there has been ongoing strength in building approvals which will flow through to increased earnings for the remainder of this year at least.

One note of caution is that new apartment construction has been growing at a faster rate than detached housing. Brickworks’ earnings are more exposed to detached housing, with a significantly smaller amount of its core products required for apartments.

Traditionally the upswing of the building cycle has lasted 2-3 years. If history was to repeat, it would suggest there is approximately another year of residential building growth to flow through. 

Building Products EBIT has ranged from $29 million to $100 million over the past decade. Our $500 million building products valuation comprises an EBIT multiple of approximately 8 times the mid-point of this range.

Property

The land investment and development division began after transitioning old brick production sites into industrial developments. Earnings were previously inconsistent and reliant on the timing of asset sales. There is now a property trust that is a 50:50 joint venture with Goodman Group, with the BKW component worth $285 million and the remaining land bank worth $400 million.

Investments

The investment division now comprises purely the 42.7% stake in SOL. Washington Soul Pattinson’s major investments are its 60% investment in New Hope Coal (NHC) and its 27% stake in TPG Telecom (TPM).

Some of the other SOL investments include Ruralco (RHL) Clover (CLV), Exco (EXS) and Pitt Capital Partners, as listed below.

With the NHC share price at $2.86 it has a market cap of $2.4 billion, and $1.2 billion of net cash.

TPG has been an exceptional investment for SOL, with its 27% stake purchased more than a decade ago and now worth $1.2 billion.

Despite our view that SOL is also undervalued, we have only included the market value of BKW’s stake in our sum of parts valuation. 

Valuation

Brickworks (BKW)

Listed InvestmentsShares Out (Million)% OwnershipPriceMarket Value (Million)
Washington Soul Pattinson239.442.70%14.751,507.8
BKW - Valuation Summary
Midpoint ($m)
Building Products 500
Property 685
Debt-280
Listed Investments1507.8
Overall Valuation2412.8
Shares out148.0m
Valuation per share  $16.31
Share Price$13.40

Summary

Our view is that the proposal to remove the cross-holding is clearly in shareholders’ best interests, and would result in a 20-30% minimum re-rating of the BKW share price if it ever succeeds. However, given the uncertainty and likely ongoing legal battle for now we are assuming the cross-holding will remain in place.

The upside for shareholders of a Carnegie/Perpetual proposal win would be a valuation of $18-20. Given the current complex structure we view a sum of parts valuation as the most relevant, and don’t apply much weight to a P/E, or cash flow valuation.

Applying the market value of BKW's stake in SOL gives a $16.31 sum-of parts valuation and our target price of $14.70 applies a 10% discount due to the current cross-holding.

We have a long term "Buy" recommendation.

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