Flexigroup’s attractive rights issue

The consumer lending business’ acquisition of Fisher and Paykel Finance is positive over the longer term.

Consumer lending business Flexigroup Limited (FXL) has announced that it will purchase Fisher & Paykel Finance (F&P) for a total consideration of $315 million, $65m of which is deferred consideration.

On the face of it, the purchase price looks fair, and the company has suggested that the acquisition will add substantially to earnings.

In order to fund the upfront $250m, FXL has also announced a 1 for every 4.46 pro-rata entitlement offer. This offer will raise around $150m at an offer price of $2.20.

But risks remain as FXL management has not provided an updated earnings guidance range for the business. Additionally, the company has suggested that the dividend payout will be at the lower end of the 50 per cent to 60 per cent policy range, which is below our expectations.

When all is said, it appears that FXL’s earnings are likely to beat our expectations for the low end of cash net profit after tax (NPAT) guidance of $92m, especially if the acquisition is accretive to earnings per share. However, this is offset by the need for the lower dividend payout ratio in the shorter term, and the additional shares that will be on issue.

We will continue to hold FXL in the portfolio, maintain a buy call on the stock, and note that despite the materiality of the transaction, our valuation is only slightly impacted, rising from $3.14 to $3.22. Effectively this can be interpreted as indicating that FXL has paid a fair price for a good asset, but any additional value will come in future years if and when further growth or productivity gains are realised. Overall, this acquisition can be viewed as a case of reinvesting in the business in order to grow both cash earnings and dividends in the future.

Should I participate in the rights issue?

Generally, the offer looks attractive, and likely to add value to a portfolio. The Income First model portfolio holds 2326 shares in FXL, so is eligible for 521 rights. It is intended that these will be exercised at the $2.20 price of the offer. That said, investors should consider their own situation and needs before making any decisions here. With respect to the model, the lift in FXL exposure will take the number of units to 2847, which is a value of around $7,000 (based on the theoretical ex-rights price (TERP) of just under $2.49).

I have decided to exercise the portfolio’s rights for a number of reasons. First, the offer price is attractive, and the issue is non-renounceable – meaning that existing holdings will be diluted if the rights are not exercised. Second, the acquisition is expected to add to the company’s future profile and ability to grow both earnings and dividends. This is a key point. When a company raises capital, the use of funds is key.

It should be noted that while the TERP is $2.49, there is a chance that the share price of FXL will trade lower than this. The retail offer opens on November 4, and closes on November 16. We will monitor the FXL share price, with the intention of buying a similar allocation (521) units on market should the share price fall below the $2.20 offer price. My view is that at $2.20, unless you can buy for less on market, it will be money well spent to take up the rights.

What exactly is FXL buying?

Fisher and Paykel Finance is a business that provides financial products and services throughout New Zealand. The main business is credit cards and point of sale finance and the affiliation with Fisher and Paykel appliances is now more historical than functional in terms of earnings. F&P will add to the broader business materially, lifting the NZ-based contribution to volumes from 5 per cent to 38 per cent and to receivables from 12 per cent to 38 per cent. The main brands within F&P are Qcards and Farmers, with QCards accounting for $NZ468m of the acquired receivables, and Farmers accounting for $NZ170m (total acquired receivables is $NZ662m).

F&P’s adjusted accounts suggest that the business made $27.7m in cash net profit for the 12 months to end June 2015.  Pleasingly, the purchase is expected to create in excess of $5m in annual synergies as a result of the removal of duplicated costs, cross selling, and the leveraging of FXL’s collections processes and debt sales expertise.

FXL has stipulated in its presentation to the market that this transaction is expected to be high single digit cash earnings per share accretive in FY16 (on a pro forma 12 months ownership basis). The acquisition multiple implied by this is 8.8 times if we include synergies, which in my view is an attractive price.

Important dates for investors

The retail entitlement offer opens on November 4, with the institutional leg of the capital raising already completed. The closing date for the offer is November 16.

Source: Flexigroup statement

The entitlement offer will raise $150m. The remaining $100m up front consideration will be funded through an expansion of the company’s corporate debt facility.

Lack of earnings guidance upgrade and lower payout ratio

FXL has reiterated its cash net profit guidance for a range between $92m and $94m, excluding any contribution from the F&P acquisition. The position is that the guidance will be updated to the market once the acquisition is completed. Unfortunately, this detracts slightly from management’s assertion that the acquisition is highly earnings per share accretive. While the numbers look impressive, and the acquisition multiple paid seems quite reasonable, I would have liked to have seen some indication on the expectations for combined cash NPAT for the business during FY16. Completion is expected in early calendar 2016, but the transaction is subject to both Overseas Investment Office and RBNZ approvals.

Perhaps a little more surprisingly, FXL has indicated in its presentation that it expects the dividend payout ratio to be at the lower end of the previously guided range of between 50 per cent and 60 per cent of cash net profit. Our expectations were nearer the upper end of this range, so there has been a need to adjust our payout assumptions lower.

Our dividend expectations are lower as a result of the additional shares on issue at the end of the year, and given a three-month contribution from F&P to full year forecasts. This is probably the only frustrating part of this deal. Effectively FXL will issue an additional 68m shares by mid-November, but only receive the benefits of additional earnings from when the deal is completed (probably April 1, 2016). The lag in this is caused by regulatory hurdles and approvals and makes the deal impact FY15 accounts negatively. Patience is key here as the deal will likely be fruitful from FY17 and the market should look past the short-term cosmetic impacts on FY16.

What’s next for FXL?

Integration of this acquisition. If FXL can realise the expected synergies and deliver on the suggested numbers for F&P, and for its own existing business, then FY17 should see a significant uplift in the business. The company’s balance sheet remains resilient at a pro-forma gearing level of 23 per cent (debt to equity excluding secured lending). There is also an expectation that the company will deploy excess cash into repaying debt – hence the lower dividend payout ratio this year.

Despite this lower dividend payout ratio, I believe that this acquisition will add positively to future earnings and future dividends. The short-term dividend may see some pressure but the longer run potential for both earnings and dividend growth is enhanced by this latest announcement.

I have upgraded my valuation for FXL to $3.22, from a previous level of $3.14. It is intended that the portfolio will add more FXL as a part of the pro rata entitlement, and I will provide a further update when this transaction occurs.

To see Flexigroup's forecasts and financial summary, click here.