Hugh Dive, Head of Listed Securities

Welcome to Philo Capital Advisers' Blog on portfolio construction and management issues. We welcome your comments and feedback.

  • Home
    Home This is where you can find all the blog posts throughout the site.
  • Categories
    Categories Displays a list of categories from this blog.
  • Bloggers
    Bloggers Search for your favorite blogger from this site.

Tales from the Trenches - Company changing events?

Posted by on in Market Commentary
  • Font size: Larger Smaller
  • Hits: 1974
  • 0 Comments
  • Subscribe to this entry
  • Print

Normally when a company announces a significant acquisition or major new investment it is trumpeted as a company-changing event that will dramatically boost earnings or change market perceptions of a company, both of which should be beneficial for shareholders. Whilst the valuation or market capitalisation of a company listed on the ASX can vary dramatically with market sentiment, in reality a company's business normally changes quite slowly and often the company-changing investment can actually be negative. In this piece we are going to look at recent company changing events that were both positive and negative for shareholders, along with a potentially company-changing event for a company we own in the Core Equity Portfolio; Origin Energy's APLNG project.

Company-changing-events.JPG

New acquisitions

When a company trumpets a new acquisition as being "company-changing or company-transforming", it is hard not to be skeptical. Historically, management teams both generally overpay for the asset and wildly overestimate the synergies they can extract. A classic example of this which still looms large in the minds of many investors is Rio Tinto's 2007 acquisition of Canada's Alcan. Rio Tinto paid US$38.1 billion for Alcan in a hotly contested bidding war and estimated at the time that it could extract US$600 million in costs per year. This acquisition ultimately turned out to be company-changing, but not in the way originally envisaged. The heavy debt load taken on to acquire Alcan resulted in a deeply discounted rights issue at $28.29 per share in 2009 to raise $19 billion. Further, the bulk of the aluminium assets acquired were eventually written off and all senior management involved including the chairman departed the company.

Rio Tinto was not the only Australian company making a company-changing acquisition in 2007. It takes a lot of guts to outbid some of the world's largest and most successful private equity firms, but in 2007 Wesfarmers did just that after stumping up a staggering $22bn to buy the beleaguered supermarket operator Coles. The price paid represented a breathtaking 29x earnings and necessitated a capital raising of $3.7 billion two years later to pay down debt. Whilst Wesfarmers' acquisition of Coles is not viewed in the same light as the Alcan acquisition, seven years later Coles has yet to return the cost of capital and Wesfarmers' earnings per share remain 30% below what it was prior to the purchase.

When acquisitions are company-changing?

Occasionally an open market purchase can be company-transforming, but this is rare and normally only occurs when the business being sold is a small part of a very large company and the seller has limited understanding of the business being sold. In 2006 BHP sold Southern Cross Fertilisers to Incitec Pivot for $155 million. BHP had acquired this asset as part of its takeover of WMC Resources. This proved to be a company-transforming event for Incitec Pivot, as the acquired business has delivered $1.7 billion in profits since 2006 and allowed Incitec to acquire Dyno Nobel to become the second largest supplier of explosives globally.

Similarly in 2009, Amcor acquired Rio Tinto's Alcan packaging business for A$2.5 billion which has since proved to be a company-changing acquisition for Amcor. As with BHP in the above example, Rio Tinto had acquired a business as part of a larger acquisition and the miner had very little interest in running a global packaging company. Amcor not only acquired their major European packaging at a very attractive price from a motivated seller, but the acquisition moved Amcor to become the largest global packaging company in healthcare, food and tobacco. Further, Amcor was able to double the profit margins of the acquired business which has led to the company growing earnings per share by +128%, despite facing increases in raw materials and unfriendly moves in the Australian dollar.

New projects

Management teams also seek to deliver a step-change in a company's earnings by making a major investment that may involve a few years of reduced dividends and higher debt levels as the project is built, but with a significant payout promised upon completion. In 2007 uranium producer Paladin embarked on a major expansion project at their existing mines in Nambia along with a the Kayalekera mine in Malawi. These were envisaged to be company transforming projects for Paladin Energy that had a market capitalisation of $5 billion. Cost overruns and production shortfalls, combined with a collapse in the uranium price post the Fukushima Daiichi nuclear disaster has seen Paladin's share price fall from $10.44 to $0.39!

Woodside Petroleum's recently completed Pluto offshore LNG project is an example of a project that is actually company transforming. Pluto began construction in 2008 and was completed in 2011 at a cost of $15 billion. During this period Woodside shareholders saw no growth in their dividends. Pluto LNG was successfully commissioned and has since proved to be a company-changing event. Woodside has sharply increased their earnings per share by 94% and has used the cash flows generated by the new project to rapidly pay down debt, with the company moving from a net debt to equity ratio in 2011 of 42% in 2011 to a net cash position today. Woodside shareholders are enjoying not only the doubling of dividends but the additional financial flexibility that these additional cash flows bring.

Future company transforming projects

As Origin Energy's APLNG project nears completion of the first LNG train in 2015, we consider the company will begin a major transformation of its earnings profile. The project, located in Queensland, converts coal seam gas from gas fields North West of Brisbane, into liquid nitrogen gas for transport to Chinese and Japanese customers. By 2018 as production reaches full capacity the project could generate an additional $1bn of profits for Origin Energy. With current earnings for the integrated energy company totalling around $700m, we calculate that APLNG's contribution could more than double earnings and transform the stock.

The common theme around successful acquisitions that are actually company transforming, is that a larger disinterested company sells a non-core business to a smaller specialised company that can run the acquired businesses more efficiently. Rarely does a company transform itself by acquiring a business in a competitive bidding process. In a competitive process the acquiring company generally pays too much and takes on too much debt to fund the acquisition. Looking forward we still believe that Origin Energy's APLNG project could well be the next company transforming project, when shareholders start to see the positive impacts of steeply increasing cashflows from LNG shipments to their Asian clients. We see that this should not only sharply reduce Origin Energy's debt but also allow the company to reward its patient shareholders.

Disclaimer

This article has been prepared by Philo Capital Advisers Pty Ltd ABN 70 119 185 974 AFSL 301808 (Philo) and contains general investment advice only. The information in this article does not take account of your objectives, financial situation or needs or those of your client. Before acting on this information readers should consider whether it is appropriate to their situation. We recommend obtaining financial, legal and taxation advice before making any financial investment decision. To the extent permitted by law, neither Philo nor any of its related entities accepts any responsibility for errors or misstatements of any nature, irrespective of how these may arise, nor will it be liable for any loss or damage suffered as a result of any reliance on the information included in this article. The information in this article is based on information obtained from sources believed to be reliable and accurate at the time of publication but we do not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. Past performance is not a reliable indicator of future performance. Any forecasts included in this article are predictive in character and may be affected by incorrect assumptions or by known or unknown risks and uncertainties. Nothing in this article shall be construed as a solicitation to make a financial investment.

Rate this blog entry:
0

Hugh Dive, Head of Listed Securities


Prior to joining Philo, Hugh was Head of Basic Materials Group Investment Research; covering the chemicals, building materials and steel sectors. In the 2011 Reuters StarMine Equity Analyst Awards, he was rated 5th overall in Australia for stock picking and first in the Diversified Industrials and Chemicals sectors. Hugh has extensive portfolio management experience gained at Investors Mutual, with a successful track record managing both small and large cap value funds. In 2009, one of the funds he helped manage, the IML Future Leaders Fund, won the AFR Smart Investor Award for the best Australian small cap fund.


Hugh started in funds management with CC&L Investment Management in Vancouver; Canada’s largest independent fund manager with C$37B under management. At CC&L he focused on asset allocation and then Canadian equity analysis. Hugh holds bachelor’s degrees in both Economics and Law from Sydney University and the University of British Columbia, Canadian Securities Course (Honours) and is a CFA charter holder.

Comments

  • No comments yet

Leave your comment

Guest Monday, 19 November 2018
Powered by EasyBlog for Joomla!

Privacy Statement 

Background

We may hold personal information about you, principally because you are a client of ours or give us information through this website. Personal information means information we hold about you from which your identity is either apparent or can be reasonably determined.

We respect your rights to privacy concerning your personal information which we hold. Our privacy policy is consistent with Australia's legal requirements.

Things change

If you think our records about you might be wrong or out of date - particularly your name, address, phone, email address or financial adviser - it’s important that you contact us and they will be corrected free of charge. 

Why is personal information collected?

Broadly, we use personal information you provide only for purposes consistent with the reason you provided it, or for a related purpose, for example to:

  • Subscribe to research or another service using this website;
  • Contact you regarding our services ~ you can opt out of these communications of course, just contact us;
  • Comply with legal obligations such as identifying you if you become a client; and
  • Administer your account (should you be a client).

If you do not provide us with the information which we ask for, we (or others) may not be able to provide you with some or all of the services available through us. 

How we collect

Most information is collected when you become a client of one of the financial services which we make available, often a managed discretionary account. But there may be other ways we collect personal information such as through contact with you and from this website and your advisers. We will collect personal information from you only by lawful and fair means and not in an unreasonably intrusive way.

What we collect

The kinds of personal information collected can include the following:

  • Name, gender and date of birth;
  • Contact details;
  • Bank account details;
  • Tax file number;
  • Any access and use details for this website; and
  • Other information you or others for you (for example, your financial adviser) might tell us.

Disclosure of personal information

We will not disclose personal information we hold about you unless:

  • This policy allows or with your other express or implied consent;
  • It is to joint account holders;
  • It is to companies within our group;
  • It is to those who help our business to run;
  • It is in the public interest (for example where a breach of law is committed or suspected, and we consider that disclosure against your rights to confidentiality is justified);
  • We consider that law requires disclosure, or a regulator requests (for example, to various government departments and agencies such as the Australian Taxation Office, CentreLink, the Child Support Agency, or disclosure to courts under subpoena or to ASIC or AUSTRAC if asked);
  • We consider someone relevant to you needs the information, for example your financial adviser or someone who we have no reason to doubt is acting for you; or
  • It is to administer your account.

What about security?

We are committed to ensuring that your personal information is kept secure. We have a number of physical access and technology policies and procedures in place designed to provide a robust security environment. No personal data is stored on our web site.

In those instances where we secure your personal information in transit to us and on receipt, we use the industry standard encryption software, Secured Socket Layer (SSL) 128 bit encryption. The URL in your browser will change to "HTTPS" instead of "HTTP" when this security feature is invoked. Your browser may also display a lock symbol on its bottom task bar line to indicate this secure transmission is in place. But the internet is not a secure environment and we cannot guarantee the security of information we exchange electronically.

Website use

Our internet server logs certain information which is provided by your browser:

  • The type of browser and operating system you are using;
  • Your Internet Service Provider and top level domain name (for example - .com, .gov, .au, .uk etc);
  • The address of any referring web site (for example - the previous web site you visited); and
  • Your computer's IP (Internet Protocol) address (a number which is unique to the machine through which you are connected to the internet).

We may use cookies to obtain information with regards to web site activity (such as the type of browser used, the number of pages viewed, time of the site and navigation patterns) and to help you use this site when you visit again. This information on its own does not identify an individual but it does provide us with statistics that can help us with design of the web site. You can configure your browser to accept or reject cookies. If you reject all cookies you may not be able to use some or all of our web site.

Telephone services

We may monitor or record telephone calls for training, record or security purposes. If we do so, we will tell you at the time.

Access to personal information

In most circumstances, you have the right to access any personal information we collect and hold about you. In certain circumstances, the law permits us to refuse your request to provide you with access to your personal information, such as when:

  • We reasonably believe that access would pose a serious threat to the life or health of any individual;
  • Giving access would have an unreasonable impact on the privacy of others;
  • The request is frivolous or vexatious;
  • The information relates to a commercially sensitive decision making process;
  • Access would be unlawful; or
  • Giving access may prejudice enforcement activities, a security function or commercial negotiations.

Please contact our Privacy Officer at the address below if you wish to access, update or correct your personal information, or if you have a complaint about how we have handled your details. We have a compliance process for dealing with complaints and we undertake to deal with your complaint as quickly as possible, and to keep you informed of its progress. 

Further information

You can obtain further general information about your privacy rights and privacy law from the Office of the Australian Information Commissioner by:

  • Calling their Privacy Hotline on 1300 363 992; or
  • visiting their web site at www.privacy.gov.au, or
  • by writing to:

The Australian Information Commissioner
GPO Box 5218
Sydney NSW 1042

or

The Australian Information Commissioner
enquiries @ oaic.gov.au 

Changes

We may make changes to information handling and privacy policies and practices and this privacy policy. We will publish important changes on our web site and if necessary update this policy.   

Privacy Officer

Attention: the Privacy Officer
Philo Group

Level 11

37 York Street
Sydney NSW 2000

Tel: 1300 303 323

or send a message on Contact Us page

 

Terms of use 

This website is published by Philo Capital Services Pty Ltd ABN 91 154 859 284 and is operated by Philo Capital Services Limited and other companies that are associates of Philo Capital Services Pty Ltd including Philo Capital Advisers Pty Ltd ABN 70 119 185 974 AFSL 301808  (referred to collectively as the Philo Group).

Using this website is your agreement to these terms as amended from time to time. Please take the time to read them. Contact us if you have any suggestions or complaints.

We do not promise that this website is always up to date, always available or virus or third party cookie free.

We take reasonable care in the maintenance of information on this website. However, to the extent permitted by Australian law, all obligations which might otherwise be implied or imposed on us by law or equity in relation to this website are expressly excluded to the extent permitted by law. Loss arising to you from use of this site is limited to resupply by us of the services. Under no circumstances will we be liable for any special or consequential damages.

We may amend this site or any part of its contents without telling you. You must not modify this site. Contact us if you wish to link to this site. We are not responsible for links to outside this site.

Unless otherwise expressly stated to the contrary, this website is not designed for the purpose of providing personal financial or investment advice. Information provided does not take into account your particular investment objectives, financial situation or investment needs.

You should assess whether the information on this website is appropriate to your particular investment objectives, financial situation and investment needs. We recommend you seek financial, legal and taxation advice. You should do this before making an investment decision on the basis of the information on this website.

Opinions expressed are subject to change without notice. Past performance is not a reliable indicator of future performance. Any forecasts included on this website are predictive in character and may be affected by incorrect assumptions or by known or unknown risks and uncertainties. Actual results may differ substantially from the forecasts.

Unless otherwise expressly stated to the contrary, the information on this website is not a recommendation to invest or refrain from investing in any investments, securities or financial products, including those which may be offered by any member of the Philo Group.

This website and all it displays are the property of Philo Capital Holdings Pty Ltd and related entities and are protected by copyright, trade mark and other intellectual property laws. You may reproduce information for your personal use only. We reserve all other rights.

Unless otherwise stated, all figures are in Australian dollars and include GST. Examples used on this website are not exhaustive.

This website is for persons located in, and is designed to meet only the laws of, Australia. This website is not for use by people not located in Australia. It is very likely that it does not comply with all foreign laws. In any dispute arising from this site, New South Wales laws apply. You consent to the exclusive jurisdiction of the courts of New South Wales.