Soul Patts and Brickworks: The great unwinding - Part 2

Washington H Soul Pattinson started life in 1872 as a single pharmacy in Sydney’s CBD. Thirty-one years later it listed on the Sydney Stock Exchange, making it one of Australia’s oldest listed businesses after Elders, AGL Energy and Westpac.

A further 110 years down the track, it has transformed into a $4bn holding company, with interests reaching from coal and copper to telecommunications and property – there’s even an odd chemist still amongst the mix.

To get a handle on the value of this diverse mix, we need to unpick the underlying investments. So let’s start with the biggest, its 59.7% stake in coal miner New Hope Group (see Table 1).

New Hope is a Queensland-based coalminer, which we recently covered in New Hope prepares for the worst from 14 Nov 13 (Sell – $3.77).

As Gaurav Sodhi explained in that review, a combination of slowing Chinese demand and increased supply from Indonesia, Mongolia and the US has seen coal prices fall from over US$125 per tonne to less than US$80 in just over two years.

As a result, New Hope’s mining profits have tumbled from over $200m in 2009 to $60m in 2013. Even if we assume coal price stay low – something we, and management, think is very likely – the New Acland mine should be worth at least $500m, or 60 cents per New Hope share.

More than a miner

However, New Hope isn’t just a miner. Most of its value comes from its $1.2bn cash hoard – the spoils of a timely sale of its Saraji mine to BHP in 2009. This cash has been carefully managed, and much of it has already been fed back to shareholders via special dividends. This is New Hope’s largest asset, worth $1.45 New Hope per share.

Elsewhere the company owns Queensland Bulk Handling, an export terminal at the Port of Brisbane with a capacity to export 10m tonnes of coal a year. This gives New Hope an easy way to export its own production, while making a nice profit by doing the same for its peers. Assuming profits of $40m a year, it’s easily worth $400m, or about 50 cents New Hope per share.

Adding it up, New Hope would be cheap at less than $2.50 a share (corresponding to our Buy trigger for the stock), and that’s the value we’ve used for our ‘cheap’ valuation, giving a value for Soul Patts’ stake of $1,250m. For our ‘fair’ valuation we’ve increased the value of the mine and port slightly, giving us a value of $3.00 per share (the middle of our Hold range for New Hope), and $1,500m for Soul Patts’ stake. Note that these prices are a long way below New Hope’s current share price of $3.77 (which explains our Sell recommendation on the stock).

TPG’s outstanding success

Soul Patts’ second-largest investment (excluding its 44.3% stake in Brickworks) is its 26.9% stake in internet-service-provider-come-full-service-telco TPG Telecom.

This has been a spectacularly successful investment. At the time of TPG and SP Telemedia’s $277m merger in 2008, the value of Soul Patts’ 46% holding in the latter was about $65m. Skip forward five years and Souls’ stake is now worth $940m. You don’t need many TPGs in your investing life to do very handsomely. It’s another example of the shrewd, long-term focused investing style that has made Souls such as success (a point we’ll return to in Part 3).

We’ve spent a lot of time researching the telecommunications sector this year and we’ve been able to get a much better understanding of the value of TPG. As we explained in TPG vs iiNet: Battle of the ISPs on 14 Oct 13 (Hold – $4.26), through ownership of its network and strict cost control – a trait likely inherited from the famously frugal Millners who run Souls – TPG has been able to offer cheaper prices than incumbents Telstra and Optus, while generating higher profit margins. This has helped it win 10% of the broadband market and increase earnings threefold in five years.

As with New Hope, we’re taking our Buy price of $3.20 as our ‘cheap’ valuation and the middle of our Hold range ($4.20) as our ‘fair’ valuation. These figures are between 27% and 4% below the current market price and give us a range for Souls’ holding of $680m-$900m.

Portfolio of blue chips ...

Soul Patts owns minority stakes in numerous blue-chip companies such as BHP Billiton, Telstra and Commonwealth Bank (see Table 2). This direct equity portfolio was worth $388m at the end of July. Again, we’ve derived our own valuation for this portfolio by using our Buy prices for the underlying investment as our ‘cheap’ valuation and the middle of our Hold range for our ‘fair valuation’, giving values of $290m and $370m respectively.

Soul Patts also owns a $91m stake in BKI Investment Company and a $133m stake in Milton – which, like Soul Patts, own a basket of listed investments (see Table 2). Both portfolios are similarly focused on large blue-chip companies and we’ve applied the same treatments as with Souls’ other direct equities giving us values of $65m-$82m for BKI and $90m-$120m for Milton, after accounting for management fees within these vehicles. 

... and second liners

Other significant investments include its wholly owned copper mines CopperChem and Exco Resources, both based in Western Queensland. CopperChem is currently loss making, although ruthless cost cutting is reducing the losses. We’ve valued the investment at zero.

Exco has been far more successful and, with profits flowing, $50m of net cash and scope to increase production by integrating CopperChem’s output we’ve conservatively valued this asset at $65m-$100m.

Souls’ remaining assets include electronic product manufacturer and service provider Ampcontrol, pharmaceutical wholesaler and retailer Australian Pharmaceutical Industries (API), nutraceutical and medical products company Clover Corp (which, to the layman, recycles tuna oil for use in infant formula), Malaysian-listed API-equivalent Apex, in-house corporate advisory firm Pitt St Capital Partners, the new Australian Logistics Property Fund which is building logistic centres in NSW and Queensland, as well a stake in Rural Co.

For each we’ve estimated ‘cheap’ and ‘fair’ valuations, which we’ve set out in Table 1. There are some good businesses in here – and some not so good – but their combined impact is dwarfed by Souls’ larger investments in TPG and New Hope.

Hint of a bargain

Finally, we need to take account of net cash of $174m, outstanding tax liabilities of $193m and make an allowance of $70m for head office costs.

Adding it all up we get a valuation range of $2,583m-$3,315m, or $10.79-$13.85 per share, excluding the company’s 44.3% stake in Brickworks. That’s the second piece of the valuation puzzle, and compared to a market price of $14.20 it hints at a possible bargain on offer.

An investment decision is imminent: tomorrow, we’ll pull it all together to extract a final valuation for both Brickworks and Soul Patts. Until then, both Brickworks and Soul Patts are UNDER REVIEW. 

Note: Our model Growth Portfolio owns shares in Brickworks, while our model Income Portfolio owns shares in Washington H Soul Pattinson.