Our Equities Analyst, Ninus Kanna, makes a compelling argument as to why Saputo will win the battle for WCB. Below is a sneak preview of our research report:
The bidding war is on. The gloves are off. Warrnambool Cheese (WCB), the stock that has provided a rush to action-starved M&A junkies around the country, got even hotter. Its largest shareholder Bega Cheese raised its bid and said it would not attach conditions to its offer, unlike other suitors
Table 1 Warrnambool Cheese offer summary (as at 11am 15 November)
|
|
Saputo |
Murray Goulburn |
Bega |
|
Cash component |
$8 |
$9 |
$2 |
|
Scrip component |
nil |
nil |
1.5 for 1 |
|
Total Value (per share) |
$8 |
$9 |
$8.90 |
Hesitant on Bega’s mainly scrip offer, investors will look to Saputo and Murray Goulburn to cough up the cash. With an 18% stake in WCB and a scrip offer, Bega is playing the bluff card, looking to extract the most value from its stake. This leaves Saputo and Murray Goulburn the serious players on the table.
The end game is that Saputo will win. It has immense buying power compared with Bega and Murray Goulburn. From our analysis below, we believe that Saputo could potentially pay up to $15 for each Warrnambool share, just on interest rate differentials alone. By taking the Canadian 10-year bond rate of 2.59% as Saputo’s risk-free rate, it enjoys a 160bp interest rate advantage over Australian suitors.
A Canadian-Australian dollar exchange rate of 97 cents hardly detracts from this differential.
The net present value of Saputo’s lower required return translates into a 62% price advantage over Australian suitors. This means that Saputo can theoretically pay up to $15 per WCB share before it starts to detract from Saputo’s own return on equity. We have assumed the same beta and equity risk premium, as all companies operate in the same sector in similar stock markets.
Table 2 Saputo enjoys a cost of equity advantage
|
WCB FY14 EPS (¢) |
37.43 |
|
|
Perpetual growth rate |
5% |
|
|
|
Saputo |
Australian Company |
|
Risk-free rate (10-year bond yield) |
2.59% |
4.19% |
|
Beta |
1.00 |
1.00 |
|
Equity Risk Premium |
5.00% |
5.00% |
|
Cost of Equity |
7.59% |
9.19% |
|
Per-share valuation |
$15.17 |
$9.38 |
However, the analysis above comes with some hefty assumptions. The most pertinent is that WCB earnings grow by 5% until Kingdom come, and the equity risk premium over the risk-free rate is 5%. This essentially assumes that over the economic cycle, the expected return on equities in Canada is 7.59% and 9.19% in Australia. This is reasonable. However, it is possible Saputo could do a great job, allowing a higher growth rate. It is also possible Saputo make a mess of the operation, and achieve a lower perpetual growth rate. However, if Saputo believes it will improve profitability, it then has an even higher pricing edge over Australian suitors. We have conducted a sensitivity analysis, showing the pricing advantage Saputo enjoys over Australian companies for different levels of future earnings growth and equity risk premia.
Table 3 Saputo retains its price advantage in most scenarios
|
|
|
WCB earnings growth rate |
|
|
|
3% |
4% |
5% |
6% |
7% |
|
Equity risk premium (share market returns over 10-year bonds) |
5% |
35% |
45% |
62% |
101% |
271% |
|
6% |
29% |
35% |
45% |
62% |
101% |
|
7% |
24% |
29% |
35% |
45% |
62% |
In most cases, Saputo enjoys a winning hand. The effect of interest rates means its cost of capital is lower. Saputo can play its hand confidently, waiting for its Australian competitors to fold.
