Straggle Muster 162 - 8/7/2005
Mark Lister - ABN Amro Craigs
WHOLE LOTTA WRIGHTSON
WRI and Pyne Gould Guinness (PGG) this week announced their intention to merge. The merged company, to be called PGG Wrightson, is proposed to be formed via a scheme of arrangement that will need to be approved by shareholders at a meeting likely to take place in September, at which 75% of voting shareholders must vote in favour. Other conditions will also need to be satisfied, such as Commerce Commission, Takeovers Panel and Securities Commission approval. PGG and WRI are confident that there will be no issues surrounding gaining of the necessary Commerce Commission approvals.
The merger will see PGG as the surviving entity, and WRI shareholders issued with shares in the new company at a ratio of 1.028 new shares per existing WRI share. The new entity is likely to be an NZX top 20 company with assets in excess of NZ$900m and revenue of NZ$1.1bn. No pro-forma financial information has been released yet as both PGG and WRI are due to report the results for the year ended 30 June 2005 over the next few weeks. The proposed merger timetable is outlined below.
+++ PROPOSED MERGER TIMETABLE +++
2005 financial year results announced July 2005
Investment statement and prospectus issued to shareholders Early August Independent experts reports available August Shareholder meetings Early September Legal completion of merger September
EFFEST ON MAJOR SHAREHOLDINGS
The cornerstone shareholders in PGG and WRI are both supportive of the proposal in principle. Pyne Gould Corporation (PGC), 55.4% owner of PGG is likely to own approximately 22.5% of PGG Wrightson and Rural Portfolio Investments (RPI), 50.01% owner of WRI is likely to own approximately 30.0% of the merged company. A shareholders agreement will be drafted between PGC and RPI with provisions for pre-emptive rights and standard governance and consultation.
PROPOSED MANAGEMENT AND BOARD STRUCTURE
The merged entity will have a Board consisting of twelve directors. Bill Baylis, current Chairman of PGG will be Chairman of the new entity. A search for a new CEO will begin immediately, with Hugh Martyn (current CEO of PGG) and Barry Brook (current CEO of WRI) the likely leading candidates. In the interim, Baird McConnon will be Interim Managing Director.
IMPACTS ON BRANDING AND STAFF
The Williams & Kettle brand will remain in place in the lower North Island. All other operations will be branded as 'PGG Wrightson'. All field staff will be retained. Both PGG and WRI recognise that the strength of their businesses is based on client relationships. There is likely to be some rationalisation of administrative and back office functions, however. WRI currently has approximately 2,100 staff and PGG approximately 600.
PGG Wrightson will be based in Christchurch (current headquarters of PGG). This is believed to be the optimum location for a rural servicing company in New Zealand. Regional administration centres will be based in Napier (Williams & Kettles traditional head office location) and Dunedin (where RPI is based). The WRI head office in Porirua (which employs approximately 100 staff) expected to close over time, with some staff relocated to other areas.
OPERATIONAL PROFILES
All businesses in the current PGG and WRI portfolios are to be retained. PGG Wrightson will hold a leading position in the areas of livestock, wool, rural supplies, grain, seeds, irrigation, finance, real estate, insurance, consultancy and training. WRI and PGG estimate the New Zealand rural sectors total gross revenue to be approximately NZ$15.0bn per annum, and total intermediate and input costs of the sector per annum to be NZ$7.0bn. With revenues of approximately NZ$1.1bn annually, PGG Wrightson would have a market share of approximately 15.7% across all rural related industry operations. The table below outlines an estimate of the rural supplies store network of the major players in New Zealand. There are a significant number of independents in addition to these. As a result of this merger, it is likely that some PGG and WRI stores will be merged in areas where there is crossover.
+++ RURAL SUPPLIES STORES +++
Company Number of Stores Geographical Presence
PGG Wrightson 144 National
RD1 51 Central and Northern North Island
Farmlands 27 North Island
Allied Farmers 14 Taranaki and Wanganui
CRT 26 South Island
Source: ABN AMRO estimates
PGG Wrightson will have approximately 500 livestock representatives and 25 Wool representatives. The combined real estate businesses will have the largest countrywide presence in rural real estate, with 60 offices and over 250 sales representatives. The merged finance division will be a full service specialised rural bank.
MERGER BENEFITS
PGG and WRI have identified the following key benefits of a merger:
- Improved leadership and innovation in the rural supply industry.
- Critical mass to invest in new products and services to improve on-farm productivity and profitability.
- Improved returns and ability to invest in expansion for shareholders.
- Strong business with enhanced career opportunities for staff.
IMPACTS ON EARNINGS AND VALUATION
In year one of the merger (FY06), the estimated synergy benefits are NZ$10.0m at the EBIT level, with these likely to be offset by a similar level of costs associated with the merger and restructure. The net effect on earnings for FY06 is expected to be neutral. From year two (FY07) onward, the merger benefits are expected to be NZ$20.0m per annum. This equates to an increase of approximately 5cps in forecast FY07 EPS from 15cps to 20cps.
With WRI and PGG due to announce results for the financial year ending 30 June 2005 within weeks, no prospective financials have been released in conjunction with this proposal. We have elected to maintain our current forecasts for WRI and PGG for the time being, and conduct a full review of our estimates and the earnings impacts of a merged vehicle once the FY05 results and following prospective financials have been released. We also will reserve judgement on whether we recommend investors accept the merger under current terms until an independent report has been released and more information provided. However, the proposal appears to be in the interests of both companies and is likely to provide shareholders with significant benefits. We have prepared an estimate of what the merged entity's earnings may look like from 2006 to 2008 based on our current forecasts for PGG and WRI plus NZ$20m of additional EBITDA to reflect the annual synergies expected to be gained from the merger, for the purposes of evaluating some common valuation parameters.
Based on our estimates of earnings in FY07, when the full-year impact of the merger will occur, earnings per share for PGG Wrightson will be 20cps, which equates to a PE ratio of 9.1x based on the WRI trading price of NZ$1.85 prior to the announcement. WRI historically has traded at a 30% discount to the market on a PE basis, and with the current forward PE of the NZSX50 at 15.4x, WRI theoretically should trade on a forward PE ratio of 10.8x. Based on FY07 earnings, this implies a share price of NZ$2.19. We have a DCF valuation for WRI of NZ$2.21, which has increased due to movements in the yield curve. This valuation assumes a successful rebuilding of the finance business (which begin to impact on forecasts from FY07), and NZ$4.0m per annum of synergy benefits at the NPAT level from the Williams & Kettle merger from FY06 onward. This valuation does not assume any benefits from a merger with PGG, but we estimate that our valuation could increase by up to NZ$0.40 per share potentially. We have previously applied a discount to our DCF valuation to determine our target price, primarily due to the fact that rural stocks traditionally trade at a discount to the market, and as a result of the majority benefits from growth in the finance business being delayed until post-FY07. These benefits are embedded in our DCF valuation but are unlikely to be reflected in the share price in the short term. As a result of the likelihood of this merger occurring and the significant positive benefits associated with it for WRI shareholders, we have elected to remove this discount and increase our target price to NZ$2.21, in line with our DCF valuation. We maintain our Add recommendation.
Based on the merger ratio and on our valuation for WRI, PGG is valued at NZ$2.15. The major risks to our target price are adverse movements in global rural commodity prices, further material appreciation of the New Zealand dollar, and change in trading conditions in New Zealand. With regard to our growth forecasts, the major risks are slower than expected growth in the finance business, lower than forecast synergies from the WKL integration, and regulatory hurdles that prevent the merger with PGG from occurring as planned.
For the full report including all graphs, tables and disclosure details click here. (PDF format only)
To sign-up for your weekly copy of the Straggle Muster newsletter click here, fill in your details and we'll add you to our list of "Musterers."
Return to the "Musterers' Archive" by clicking here.