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Greencore Group plc (GNC:ID or GNC:LN)

  • Mkt Price:  EUR 0.635
  • Mkt Cap:  EUR 244.2 mio
  • P/E:  3.9   (well, sorta…based on 2011 Cont Adj EPS)
  • P/S:  0.19
  • Div Yield:  8.5%      

Continued from here… Before we look at Uniq, there’s two other acquisitions to tackle: First is the abortive (recommended) merger with Northern Foods. I was shocked when this was announced in Nov-2010. What the hell were they doing? Despite the management guff, clearly they already had enough on their plate. At least it was a nil premium merger, and promised GBP 40 mio of annual savings within 3 years. On that basis, things might not necessarily get any worse after the merger, and just might get better..! The market certainly shared this conclusion, with GNC’s share price actually rallying sharply.

For a short time, management basked in the glow of a potentially cheap deal that made (supposed) strategic sense. Unfortunately, their bubble soon burst when Ranjit Boparansurfaced with a potential interest. This crystallized into a knockout GBP 73p cash offer. Greencore scrambled for a few months, desperate to persuade their bankers/institutional investors to green light a significantly higher bid. To no avail, and they finally conceded defeat in March-2011. Bad luck, but it was always obvious that GNC had v little extra firepower if a rival bidder appeared.

Shareholders paid the price for this adventure, with almost EUR 13.6 mio spent on advisers. To be treated as an exceptional cost, of course. Fortunately, management highlighted that they had ‘…learnt an enormous amount from the process…’?! Surely, the cost of a f**king Corporate Finance MBA for all concerned would have been a lot cheaper and a lot more instructive?

During this debacle, a smaller (but far worse) acquisition actually did occur. The purchase of a small Boston fresh sandwich maker was announced in Dec-2010. Price wasn’t the problem, it’s the fact that this acquisition bulked up GNC’s US sales to a whopping 6% of Revenues. You gotta wonder about the true cost of this beach-head in terms of additional costs, trips and sheer waste of management time and focus? I shudder to think how much cash will be spent, if they’re given half a chance, on more capex and acquisitions in a vain attempt to become a US player…

After March, I mistakenly presumed management would feel suitably chastised. No such luck – a mere 4 months later, they were back with a recommended GBP 113.3 mio bid for Uniq plc, another convenience foods supplier. Uniq had already cleaned up its B/S and eliminated its Pension Deficit (by handing 90.2% of the company to its pensioners), but did I mention this was a Cash Offer?! God, I almost fell off my chair when I heard. For one naive moment, I thought: This is it, they’ll do a real kitchen sink rights issue to fund this and fix their own B/S… The share price will collapse, and finally it will be time to buy the shares. Nope – I read the announcement to learn they’re only raising 61% of the bid cost (a net GBP 68.9 mio, at a deeply discounted EUR 0.46). Unfortunately, this bid proved successful – surely empire building of the very worst sort.

The share price predictably collapsed. The company now has GBP 201.3 mio of year-end Net Debt (exc. Rights Issue proceeds). Year-end’s a seasonally low point, so true average Net Debt is about GBP 65 mio higher at GBP 266.3 mio. This cost the company GBP 19.8 mio in annual Net Interest. Btw I wouldn’t try to calculate an interest rate based on Net Debt, it’s often misleading. But we can estimate next year’s Net Interest: Since another GBP 44.4 mio of Debt is needed to complete the acquisition, we can assume average Net Debt of GBP 310.7 mio next year, costing GBP 23.1 mio of Net Interest.

How does this look vs. Operating Profit? As I’ve said, this is a distressed company and should only be evaluated on a Cashflow basis. But let’s be kind to the idiot child, and make some generous assumptions. First we’ll use GNC’s average Operating FCF of 4.3% (GBP 34.8 mio). Uniq was consistently Cashflow negative in the past few years, but I’ll use the LTM Op FCF of GBP (8.6) mio (exc. GBP 82.8 mio incremental Pension contribution). I’ll also assume the full net GBP 10 mio of annual savings (that GNC identified for this deal). This corresponds to, say, GBP 15 mio gross pa. We thereby arrive at, pro-forma, Op FCF of GBP 41.2 mio – a 3.7% Op FCF Margin on Revenues of GBP 1,111.6 mio. Damnit, let’s be even kinder, and assume GNC can return to a 4.3% Margin again, or GBP 48.0 mio.

Just to remind you, this is an extraordinarily generous assumption. Greencore touts a 6.4% Operating Profit Margin, the reality is their current Operating FCF Margin is only 1.8%! And doubtless there’ll be more exceptional/restructuring costs to come in the next couple of years. Against this, we have a GBP 23.1 mio Net Interest charge, equating to Interest Coverage of only 2.1 times. Clearly, GNC’s a woefully under-capitalized company, and terribly dangerous for shareholders. All shame on management for this!

As far as I’m concerned, I’ve v little interest in a company where Net Interest exceeds 15% of EBITA and/or Op FCF. Why? Well, this 15% amounts to 6.7 times Interest Coverage. Comfortable enough, perhaps – it’s still A credit rating territory. Go down to 3-4 times Coverage and you’re BBB. I’m just not keen on going there, or lower – after all, you already face a multitude of risks when investing in a stock. Why stack the deck even further against yourself by taking on a financially weak company? And I certainly wouldn’t expect an acquirer to assume Debt in excess of this metric.

Btw My apologies if you’re a fan of EV/EBITDA calculations, they’re not for me… EBITDA was obviously dreamed up by some I-Banker who wanted to lower a deal multiple just to get it done and collect his fee. Don’t underestimate the anchoring effect of this little trick. Charlie Munger sums it up best in his own inimitable style: ‘Every time you see the word EBITDA in a presentation, you should replace it with BULLSHIT EARNINGS, because that’s what they are!’.

So what would an acquirer pay for GNC? Well, the best I’d estimate is a 0.4 P/S multiple for a financially clean company with a 4.3% Op FCF margin. This equates to GBP 444.6 mio. But we need to adjust for excessive Debt. Why? Because an acquirer i) will refuse to assume some/all of the Debt, or ii) knows they’ll have to commit further Cash post-closing to improve Equity and/or Debt, or iii) they’ll take a flyer on the Leverage but haircut the purchase price to compensate. Based on my rule of thumb, GNC can (reasonably) comfortably support a GBP 7.205 mio Net Interest bill. This is only 31% of the 2012 Net Interest estimate! And implies a Net Debt haircut of GBP 213.9 mio to the purchase price (GNP 310.7 mio Average Net Debt * (1 – 31.1%)).

Unfortunately, I haven’t even gotten around to their significant Pension Deficit yet… Yes, I told you Greencore was distressed! Years ago, acquirers would blithely assume significant Pension Liabilities, but those days are long gone… We need to chop this GBP 105.7 mio Deficit (net of Deferred Tax) off the price also. This leads to an all-in price of GBP 125.0 mio. This is equivalent to EUR 146.4 mio or EUR 0.38 per share. You think this is cheap? Well, using the figures above, I arrive at a pro-forma FCF (i.e. after Interest & Taxes) estimate of EUR 24.5 mio. There are plenty of distressed businesses out there trading on a 6.0 P/E multiple or less…

I did try another approach: Let’s assume management finally gets religion, and properly fixes the B/S. But to do this they’re going to have to launch a humungous Rights Issue, again at a deeply discounted price. This offers the prospect of a higher net valuation, as the market rewards the financially stronger business. The problem is the colossal dilution – with the huge increase in Shares Outstanding, I can’t come up with a much better valuation per share. And the trouble is management will probably never follow this path, and shareholders are faced with a painful and uncertain future. A sale’s the only real exit, or more likely the only available safety net if things get really rough for GNC. The v best hope is a trade buyer who’s feeling generous with a paper bid. All in all, to ensure a sufficient Margin of Safety, I’m only prepared to use my exit valuation as the basis for a Fair Value of EUR 0.38 per share for GNC. Based on the current EUR 0.635 share price, I estimate Greencore to be 67% over-valued, or a Downside Potential of 40%.

Finally, I didn’t want to ruin my day thinking of this…but I think the recent (and v quickly) abandoned GNC bid approach (from Clayton, Dubilier & Rice?) supports this conclusion and analysis. I’m usually a fan of Risk Arbitrage, but I always recommend you first perform this type of Cashflow analysis. It saved my ass from investing in IFG’s (IFP:ID) recent (and failed) EUR 1.80 bid – I couldn’t make the numbers stack up.

You just can’t escape the fact that most (smart) buyers don’t give a damn about EPS or Operating Profit. They’ll pretty much home in on a brass tacks DCF analysis in the end, AND heavily weight it towards current Cashflows. I’d be amazed if CDR were contemplating any type of premium for GNC. In fact, I suspect they may really have wanted to do some type of PIPE deal. I’m sure any suggested price was fairly unpalatable to GNC management. I’m also pretty sure management were the party to bring the Offer talks to an end, as announced on December 5th.

Finally, where does the board get off announcing that no acceptable proposal was forthcoming? To you, and all other company management, it’s NOT your company, and it’s NOT your decision! How dare you sir!

  • Tgt FCF:  6.0
  • Tgt P/S:  0.11
  • Tgt Div Yield:  14.2%   (may drop to 10.5% or less, based on recent Div cut)
  • Fair Value:  EUR 0.38
  • Downside Potential:  40%
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