Foster's Group Limited (Foster's) has objectively reviewed the valuation report of Southcorp Limited (Southcorp) prepared by Lonergan Edwards & Associates Limited (Lonergan).
Foster's believes the Lonergan valuation is fundamentally flawed for four main reasons:
1. Incorrect base earnings in 2006;
2. Double counting of earnings beyond 2006;
3. Double counting of premium for control; and
4. Flawed assessment of reasonableness in relation to comparable transactions.
Addressing issues 1 to 3 above would result in a corrected:
On this basis, Foster's offer of $4.14 cash per share represents a premium of 57 - 67% over the stand alone valuation and significantly exceeds even the top-end of the control valuation (Attachment 1 illustrates this in more detail).
Even if no adjustment is made for the double counting of the control premium (i.e. only issues 1 and 2 above are corrected), the result would be a control valuation of only $3.92 - $4.13 per share. Foster's offer still exceeds even the top-end of this range (Attachment 2 illustrates this in more detail).
Whether or not an adjustment is made for double counting of the control premium, Lonergan should conclude that the Foster's offer of $4.14 cash per share is both fair and reasonable and Southcorp should recommend that shareholders accept the Foster's offer, in the absence of a higher offer.
Foster's main concerns with the Lonergan valuation are outlined below and are consistent with that of the broker research community (Attachment 3 demonstrates this point).
Foster's has always maintained that its offer of $4.14 cash per share is an outstanding price for Southcorp shareholders. A proper assessment of Southcorp's first half results and Target's Statement as well as the Lonergan valuation report supports this view.
1. Incorrect base earnings in 2006
Lonergan has incorrectly included SGARA1 in the normalised earnings forecast to value Southcorp. SGARA is a non-cash accounting charge that fluctuates depending on yields and market prices and is unique to Australia. SGARA should be excluded when valuing a company (as is amortisation), especially when comparing to a universe including international companies. If SGARA is excluded, the 2006 base EBITAS2 number reduces by $7m to $193m (consistent with broker consensus) and the Lonergan valuation would be 13 cents per share lower. Separately, Foster's also notes that the forecasts underpinning the normalised earnings employed exhibit dramatic growth in 2006 and are heavily dependent on the realisation of major cost reductions from the Southcorp Asset Review and Veraison, lower grape costs, USD / AUD exchange rate below current spot levels and 11% volume growth which is well above forecast category growth.
2. Double counting of earnings beyond 2006
Lonergan has double counted earnings beyond 2006 by capitalising 2006 earnings using a multiple which already reflects similar 'post 2006 benefits' and then adding a separate NPV3 of those benefits. These benefits are already captured in the multiple and should not be added again. By definition, share prices and multiples reflect expectations of future performance. Every one of the Australian companies and the majority of the international companies that Lonergan refers to have announced similar major cost, operational, asset and/or acquisition reviews. These reviews are forecast to generate benefits into the future which are reflected in the current share prices and trading multiples of these companies. So, applying these trading multiples to Southcorp means that any expected benefits from the Southcorp Asset Review and Veraison are already covered. If the impact of the 'post 2006 benefits' double counting is removed, the Lonergan valuation would be another 52 - 54 cents per share lower.
3. Double counting of premium for control
Lonergan has double counted the control premium by adding bidder-specific synergies to a valuation that already includes a significant control premium. The result is a takeover premium that is nearly double the average stated by Lonergan itself. Lonergan also did not independently assess the value of these synergies - it merely used those that were speculatively calculated by Southcorp. In arriving at a per share value of the synergies, Lonergan did use a more realistic discount rate of 9% post-tax (as opposed to Southcorp's 10% pre-tax) but, without explanation, it arrived at a very similar per share value as Southcorp. No details regarding growth rates or terminal value assumptions have been provided, nor has there been any sensitivity analysis around key assumptions.
Lonergan then erroneously added this value for synergies to a valuation that already includes a significant control premium. This in isolation results in a total premium of 57 - 58% compared to the corrected stand alone valuation. Cumulatively, Lonergan's valuation range implies a total premium of 82 - 84% to the corrected stand alone valuation. Both of these premium ranges significantly exceed the 30 - 35% range Lonergan itself says is normal (Foster's notes that Lonergan has increased the bottom end of this average takeover premium range from the 25% it used in the Burswood, TAB and OPSM valuation reports). If a premium range of 30 - 35% is used, the Lonergan control valuation would be another 58 - 70 cents per share lower.
4. Flawed assessment of reasonableness in relation to comparable transactions
Lonergan's reasonableness comparison of the implied multiples from its valuation range with previous transactions is flawed and therefore does not highlight the double counting errors - it refers to a universe that includes several less relevant transactions and excludes several of the most relevant transactions, and it incorrectly compares forward multiples with historical multiples.
Reference to selective and incomplete universe of transactions
Erroneous and misleading comparison of forecast multiples with historical multiples
1 Net profit from self generating and regenerating assets.
2 Earnings before interest, tax, amortisation and SGARA.
3 Net present value.
Media
Lisa Keenan
Tel: +61 3 9633 2265
Mob: 0409 150 771
Investors
Chris Knorr
Tel: +61 3 9633 2685
Mob: 0417 033 623
Attachments 1 and 2 (PDF, 242 Kb)
