Stock for discussion:
Household Goods (Steinhoff)
“Throwing Darts”
Share price: 8515 cents
Shares in issue: 3,737 billion
Market cap: R318,2 billion
Fair value: 7500 cents
Target price: 8500 cents
Trading Sell and Portfolio Buy
Steinhoff is upping the ante for Darty at 160 pence per share, now 28% more than the original offer. The equity value based on 527,5 million shares in issue plus outstanding share options is around £860 million versus £673 million.
This is the third increased cash offer and after buying 4,8 million more shares Steinhoff has taken its holding to 108 million shares or 20.4% of the issued share capital.
Darty stock in London closed 163 pence on Friday – suggesting this could get more pricey. It is already double the original Groupe Fnac SA proposal.
Steinhoff is keen to neuter the impact of two key competitors joining up as one.
Groupe Fnac SA is keen to get its hands on the €3,5 billion turnover European electrical retailing group with outlets predominantly in France and with a smaller presence in Belgium and Netherlands. There are 415 stores as at October 2015 of which 56 are franchise. This gives it the diversity it need. To some extent, Fnac would probably want Darty more than Steinhoff.
The original Fnac offer was in shares with a partial cash alternative valued at 105 pence per share. This was a 33% premium to the closing price of 81 pence on 29 September 2015. The plan was for Darty shareholders to own 46% of the enlarged group.
In the three months to 31 January, sales in France grew by 4.4% and the group is generally trading ahead of the market.
The year end is April so the books will close off shortly. An EBITDA of approximately €120 million is likely. Net debt should fall from €195 million as at October 2015 to €145 million in April 2016 based on cash flow. Adjusted clean earnings going forward are likely to be in the region of €35 million or 6,6 euro cents per share.
The offer by Steinhoff therefore has an enterprise value of close to £1 billion or €1,3 billion. That implies an EV/EBITDA multiple of just under 11x. The earnings multiple on the total purchase price of the deal is over 36x.
The deal is therefore expensive. But that does not mean Steinhoff can’t or won’t pay up further. Strategically, in a few years, the price would be a distant memory and Steinhoff would have consolidated its hold in France.
Synergy is a word deployed in the lexicon of mergers & acquisitions. Cost savings premised on heroic assumptions seemingly don’t quite materialise months after the selling shareholders have laughed all the way to the bank and the acquirer is digesting the expense.
Fnac originally came out with €85 million in cost savings. This figure then grew to €130 million, including assumed extra sales of €45 million. I don’t see that €45 million dropping straight to the bottom line so would rather ignore it. The €85 million seems rather large and would have to come out of distribution, selling and administration expenses, well controlled at Darty thanks to the Nouvelle Confiance business improvement programme.
Furthermore, caution remains necessary. There is no further clarity on the German tax investigation. The outcome is unknowable but it could have potential negative valuation consequences. I’ve cautioned about this since 2014 and have given detailed analysis previously on it.
There are also valuation consequences should the Darty deal go through, as further debt will need to be taken on. I remain satisfied this represents more opportunity than hard risk and is arguably positive for the longer term investment case.
Steinhoff as at 31 December 2015 had gross borrowings of €5 256 million of which €4 445 million was longer than a year. Net of cash in the amount of €3 068 million that gives us net borrowings of €2 188 million. Unutilised borrowings came to €2 428 million.
With EBITDA interest cover exceeding 10x and with borrowing powers unlimited, subject to certain servicing covenants, there is amply funding headroom to pay cash for Darty. Steinhoff has in any event bought over 20% of Darty stock, which would have set it back over £150 million or €200 million. The company has a vested interest and pre-purchased part of the total deal value.
Furthermore, on 2 October 2015 special purpose entities of Steinhoff International Holdings Limited purchased 150 million Steinhoff ordinary shares for €758 million or €5,05 each. These shares are accounted for as treasury shares but treasury shares are also currency.
On the trading front, Steinhoff had a pleasing first half, seasonally the better half. Given the trend in operating margin, up to 12.0% in the first six months from 10.5%, the group should have a good finish to the year.
Pepkor contributed since 1 April 2015 and reflected for the full six months with turnover increasing 19.2% to €1 845 million (25% at constant currency) and with profit increasing by 25.5% to €197 million, taking margin to 10.7%.
Kika-Leiner is consolidated effective 1 December 2015 following a reverse takeover and will add slightly to the result for the full year.
Pepkor helped boost group revenue, up 47% to €6 700 million and operating profit, up 65% to €802 million. Headline earnings increased by 46.5% and headline EPS from continuing operations decreased by 2% to 16,9 cents.
Largely due to Pepkor, weighted average shares in issue increased by 50% in H1 to 3 700 million. Investors should remember that shares in issue are approximately 3 737 million net of treasury shares compared with 2 158 million shares as at 31 December 2014.
I estimate headline earnings from continuing operations for the year ending 30 June 2016 of €1 300 million. Assuming an average rate of exchange of R15,50/EUR this is R20 billion.
This translates to EPS for the year of 35 cents in euro or 542 SA cents. On a 3x dividend cover that means a dividend of about 12 euro cents or 186 SA cents.
I mentioned in my last note on 7 March that any froth in the share price associated with deal activity, including Home Retail Group and Darty, was a good opportunity to take money off the table.
The decline in the share price to 8515 cents is in line with my call and getting back to a level that I am more comfortable with and which squares with my currency view. The stock reached a high of 9700 cents at the end of March. I have had a fair value of 7500 cents and target price of 8500 cents for a while now.
At 8515 cents on the JSE, the stock is on a 15,7x forward price earnings ratio and a gross yield of 2.2%. This is at an historic premium to what Steinhoff has historically traded.
The stock register is predominantly in South Africa and the price largely made on the JSE for the time being.
I retain a Trading Sell and a Portfolio Buy recommendation and I leave fair value at 7500 cents and the target price at 8500 cents.