GPG: where does the thread lead?

Conglomerates are best valued using a sum of the parts approach: value the components, deduct parent-level liabilities and compare the total with the current share price to see if there’s an opportunity. Easy.

In GPG: Profiting from a breakup from 18 Jul 12 (Long Term Buy – $0.365), we made the case that there was such an opportunity. The market was only assigning value to some of Guinness Peat Group's parts. The stake in Coats plc, the global market leader in industrial threads and textile consumer crafts, was being ignored.

GPG is soon to be renamed Coats because that’s all that will be left. The portfolio of listed stocks has been almost entirely liquidated and cash is being returned via debt repayments and buybacks, with capital returns likely to follow soon.

Coats isn’t a great business but we were willing to bet it was worth more than almost nothing. With GPG’s share price up 26% since that recommendation, it’s time for a reassessment.

The liquidation process has been proceeding apace. One of the group’s largest holdings, Clearview Wealth, was sold for a full price late last year. Numerous small holdings were also offloaded in the second half of 2012. As a result, the balance sheet at 31 December 2012 showed net cash of £243m.

Disposals aplenty

Since then, the Capral stake was sold for the equivalent of £27m, PrimeAg was sold for £26m, Tandou for £9.7m, the remaining Metals X shares for £7m and AVJennings for £5m. The company also received NZD$40m, or £22m, when Tower Limited executed a capital reduction.

To be added to this is the £36m that will soon be received from the sale of the stake in Ridley Corp. We've also added £37m for its stake in CIC Australia, currently under takeover offer from Peet. GPG have accepted for their 73% holding and any remaining conditions that might unrail the deal are minimal.

Total cash inflows since 31 December total about £182m. Through buybacks, GPG has reduced its shares on issue by 13% since mid-last year, spending about £48m since the 31 December 2012 balance date. So the pro forma estimate of the current cash balance is £377m.

GPG’s only remaining listed investment is a stake in NZ insurer Tower, with a current market value of £66m, although we’ve deducted 25% for the ‘discounted market valuation’. That leads to a full market valuation of A$0.34 for the non-Coats part of GPG and A$0.32 for the discounted valuation.

The full market valuation of A$0.34 is a fair bit lower than the A$0.43 cents in our initial review. In part, the fall is real. About 1 cent comes from the recent fall Ridley’s share price just before GPG cashed out. Another 5 cents by a change in how we’ve accounted for GPG’s parent-level pension liabilities.

Pension set-aside

This requires some explanation. As discussed in GPG: Interim result 2012 on 30 Aug 12 (Hold – $0.40), the company is responsible for the viability of the Brunel and Staveley pension schemes at the parent company level. Pensionholders are rightly concerned that the liquidation and eventual return of capital by the parent weakens their own financial position. To ensure their viability, the company will set aside an additional £50m from the liquidation process to bolster pension assets.

So while the balance sheet shows liabilities of £74m, there’s a further £50m that won’t be available to return to shareholders for many years, if ever. We’ve now deducted that amount, in full.

Another reason for the fall is somewhat illusory. The company has been buying back stock at around A$0.45 cents per share – a premium to the value of the cash and share portfolio alone. That implies some value for Coats.

Investment mix shifted to Coats

As a result, those who didn’t sell into the buyback are effectively having their investment mix shifted away from cash and shares and more towards Coats. So some of the fall in the non-Coats value is offset by each share now owning a bigger part of Coats.

The combination of liquidation and buyback leaves us in the vicinity of A$0.34 per share for the liquid, non-Coats portion of GPG (now mostly cash). That vindicates our original view: at the price we paid last July, Coats was almost free.

But at the current price of A$0.46, Coats is being valued at about A$0.12 per GPG share, which translates to A$170m or £112m.

Let’s now look at Coats. After subtracting Coats' debt of £226m and other liabilities of £207m (mostly employee benefit obligations on a third pension scheme, which is the responsibility of Coats and is non-recourse to the parent entity), Coats had net assets of about £50m at 31 December 2012. This almost certainly undervalues the company.

Smart money sticks

An alternative approach would be to look past numerous one-offs, including last year’s €110m fine from the European Commission in relation to anti-competitive practices in the 1980s and 1990s and derive a valuation from underlying profit.

Underlying net profit was £34m in 2012, down from £50m in 2011 and significantly down from the glory days. If we put 2012’s modest earnings on a lowly multiple of six, Coats is worth at least £200m (A$304m). If a genuine turnaround could be engineered (as a standalone business the chances of that increase) it would be worth significantly more.

The smart money seems to be betting that it will be. Soros Fund Management, George Soros’s hedge fund management business, owns more than 9% of GPG, having invested more than £35m in August 2012 at prices around 40 cents (Australian). They still hold the stock.

Two directors, Rob Campbell and Scott Malcolm, have spent a combined £230,000 buying shares in recent months at prices similar to today's. That doesn’t offset the significant selling by former captain Ron Brierley, who’s sold about £9m worth of shares over the past six months, but Brierley’s sales could be as much an indicator of his waning influence as his opinions on value.

For our money, the current price still undervalues Coats. But we’re getting closer to the point at which we’ll take our profit and Sell. At about 55 Australian cents, that’s what we’re most likely to do. For now, with the share price basically unchanged since GPG: Under the hammer from 05 Nov 12 (Hold – $0.45), HOLD.

Note: The model Growth Portfolio owns shares in GPG.