Christopher Niesche
Downer’s takeover bid a risky move for CEO
Grant Fenn is either very, very clever or very, very brave. It’s possible he is both. Fenn is chief executive of contractor Downer EDI and has just launched a A$1.3 billion hostile takeover for the Spotless Group.
The move has left Spotless shareholders elated and many others scratching their heads.
Downer is offering A$1.15 a share — a premium of close to 60 per cent over the last traded price of Spotless.
Many Spotless shareholders are planning to take the money and run, because the catering and cleaning services group has been a huge underperformer since it was floated by private equity a couple of years ago.
Spotless was listed on the share market by Pacific Equity Partners in August 2012 for about A$2 billion after the private equity firm bought it for about A$720 million a couple of years earlier.
After a series of profit downgrades, A$1.15 a share is more than most investors would have dared hope for, even if they did pay A$1.60 in the float, so the takeover is a huge get out of jail card for them. The rest of the market isn’t so sure. Firstly, there is Spotless itself and questions about how strong it is.
Fenn is defending his target, saying it is “sound” despite its recent poor first-half results and close to half a billion dollars of asset writedowns. It’s the latest in a series of problems, but Fenn says the services group appeared to have “made an effort” to address its issues over the past few years and that it would be a “good fit” with Downer.
Downer shareholders might want more than a company that has “made an effort” to fix its problems.
And we’d have to question how Fenn can be so confident about his tepid endorsement. Because this is a hostile takeover bid, it hasn’t been able to do due diligence, and who knows what other surprises are buried in the company’s books. Fenn is relying on disclosure laws which require companies to release material information to the market as soon as they learn about it, but these laws don’t always work as they should.
The one piece of insurance Fenn has is that the bid is conditional on there being no further earnings downgrades at Spotless.
Then there is the size of the acquisition. At A$1.3 billion, it’s hardly a mammoth takeover, but it’s a huge acquisition for a company with a market cap of less than A$2.4 billion like Downer. The company is funding the purchase with A$1b it plans to raise by issuing and selling new shares. Add the A$840m in Spotless debt that Downer will also become responsible for, and it’s an ever bigger acquisition.
Then there is the question of how well the two businesses will fit together.
Founded in New Zealand in 1933, Downer provides engineering and infrastructure management services to the public and private transport, energy, infrastructure, communications and resources sectors, across Australia, New Zealand and the Asia Pacific.
Spotless provides services such as catering, cleaning, laundry and security to industries such as defence, leisure and health.
Fenn’s rationale for the purchase is to get away from reliance on mining, which is a major buyer of the company’s services and is in decline in Australia as the mining investment boom tails off.
While they are both services companies, Spotless and Downer are very different, which is revealed in the fairly modest synergies Downer is expecting from the merger — A$20m to A$40m a year “over time”.
Against all of this are two things that might just make the takeover a very smart buy on the part of Fenn, if it is successful.
First, Spotless is in the midst of a turnaround.
It has been struggling with a lot of low-margin, short term contracts for its services. These are coming to an end and are being placed with longer term, multi-services and highermargin deals with bigger customers. This should put Spotless on a much firmer footing in the coming years.
Secondly, there is the price Fenn is paying for Spotless.
Spotless’ earnings base is about double what it was when it was bought by Pacific Equity Partners for A$720m yet in the days before the Downer takeover offer, its market capitalisation (the amount the total company was worth on the stock market) was also about A$700m.
This is what was attractive about the company for Downer.
Fenn has proved adept at turnarounds, as he has got Downer out of its own difficulties from a few years ago, which has seen its share price more than double over the past year.
If the takeover is successful and he has the same sort of success with Spotless, then Fenn will have proved to be not only very brave, but also very clever.