The Warrnambool Cheese and Butter Factory Takeover

Yesterday we promised to take a look at the Warrnambool Cheese and Butter Factory (WCB) takeover. It’s one of Australia’s largest listed dairy companies and it’s the subject of a bidding war between Canadian, New Zealand and Australian dairy interests. (Nick Hubble’s Money for Life Letter did quite nicely out of a pre-bidding war WCB tip.)

Let’s have a look at the numbers and see who is getting the best deal from all this…

In 2013, WCB made a net profit of just $7.5 million dollars. According to forecasts, it should make a profit of around $14.5 million this year (2014). That’s a big improvement, but considering the stock now has a market capitalisation of around $510 million, it puts it on a price-to-earnings multiple of 35 times.

Looked at another way, WCB should generate a return on equity of 9% in 2014. As a business investor (which is what the acquiring companies are) you wouldn’t want to pay more than the company’s equity value to achieve that 9% return.

But the current equity per share is $2.93. The current share price is $9.25. That means the potential acquirer of WCB is paying 3.16 times the equity value. It also means the acquirer is guaranteeing themselves a return of just 2.84% on the deal, given the forecast earnings.

You can get this number by dividing the forecast earnings ($14.5 million) by the market value ($510 million) or you can divide the forecast return on equity (9%) by the market value of the company’s equity (3.16).

Clearly, this is a lousy business return, and therefore those bidding for WCB obviously must see strong growth for the company. But how strong does the growth have to be ensure an adequate return?

Well, we consider a 12% return on shareholders’ equity to be a minimum requirement for a sound investment and account for the risk of investing in a volatile industry like dairy farming and production. To achieve such a return, WCB would have to increase profits to around $40 million to justify the current market price. That’s around a 180% increase on current forecasts, which isn’t going to happen in a hurry.

On these numbers, it seems to us that any buyer will have a lot of hard work to do to make the WCB acquisition pay off. More realistically, the buyer will guarantee themselves years of low returns, and will eventually write off some of the $350 million plus in goodwill it will pay to get control.

The lesson here is that competitive takeovers/auctions are nearly always good for the sellers and bad for the buyers. The buyers simply pay too high a price, which locks them into low long term business returns. We can see why the farmer owners of Warrnambool are of two minds…they’re both sellers and buyers.

The only competitive auctions that don’t seem to guarantee a low future return to buyers are residential property auctions. More on that tomorrow….


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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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