The 44 management team at Clondalkin stands to make a bonanza if the proposed management buy-out (MBO) proves to be successful. It is not without its risks, but the potential prize is well worth going for. Like other MBOs, it is highly leveraged. First, in the joint venture company, Edgemead, making the offer, and second by the managers who have to raise funds to participate in the venture. Details on what the MBO team proposes to pay for the 19 per cent stake have not been released (the venture capitalist, Candover, is paying €122 million for its 81 per cent stake). As the management team is long-standing and, is, in effect, the company, it would be entitled to a considerable discount, of up to 50 per cent. On this basis, the payment will be around €15 million (u11.8 million).
The bulk of the €475 million payment, around 75 per cent, will, of course, be coming from senior debt and mezzanine finance, but the equity payment by the management team will come out at about €1.87 per share compared with the offer price of €9.10. If the MBO works out, and if the company were accorded the same low rating, the executives' effective purchase would be worth more than 10 times (u118 million) in five years time. But the potential is much greater.
Most of the executives will fund the purchase of shares in Edgemead, through the sale of their shares and options in Clondalkin, so they will not have any personal borrowings. But those who do borrow would be doubly geared.
The low effective price being paid shows the potential gains that can be made, particularly if the company more than doubled in size over the next five years. However, the price is only meaningful if the debt is reduced to a more normal level. The joint venture company faces a crucial question: is Clondalkin capable of generating sufficient free cash flow to reduce the debt substantially, without strangling its continuing ability to expand core operations and acquisitions?
Fortunately Clondalkin is a financially strong company. Cash flow from operations grew from €43.3 million to €50.3 million last year. This could rise to €55 million this year and to some €60 million next year. Reinvestment and working capital could take up €25 million so it could have $30 plus to play with. That, and the ability to separately finance large acquisitions, should allow it to continue to grow strongly. However, Clondalkin is not generating sufficient cash flow to substantially reduce the debt in the short-term; rather it looks like a five-year period, so there will be no instant bonanza, unless, of course, Clondalkin were to receive an attractive take-over bid over the next year or so.
There have been rumblings about the MBO bid price. John Lawrie, investment manager of Aberdeen Asset Managers which has a 5 per cent stake has described it as "remarkably cheap" at around 12 times historic earnings. "I remain to be convinced," said Martin Nolan, Norwich Union's investment manager. And Friends First fund manager, Pramti Ghose, remarked "It's hardly a racy price".
If the offer price is too cheap, why have these institutions not been buying the shares? Indeed, Norwich recently sold 100,000 of its Clondalkin shares at €6.30; an action that seems inconsistent with last Thursday's remark; "why should we sell if there's value there". Also, John Lawrie reduced his holding below 5 per cent last March when he sold 24,000 at €6.65 and is understood to have sold more since then.
The company's low rating has ironically been exacerbated by the institutions themselves as they shun small cap companies. Also the Irish institutions are reducing the Irish content of their portfolios, from 30 per cent to 25 per cent this year, to 20 per cent in 2000 and to 15 per cent in 2001.
When judged against the ratings of larger European packaging shares, their remarks are justified. That is particularly true when Clondalkin's expected growth is taken into account which would bring the prospective p/e in 2000 down to 10.5.
However, the reality is that its shares are not highly rated on the markets in which its shares are traded, and that is what counts. And the bid price is on a big premium to the net asset backing per share of €2.88. Admittedly the book value understates the true position because land and buildings were last revalued in 1989, or at existing use since 1989. It has surplus land of between 20 and 30 acres at Saggart which has been rezoned for housing and light industry. However, these are not material as they would probably add less than 25 cents to the NAV per share. The offer price represents a 48 per cent premium on the pre-announcement closing price.
The bid price does not compare unfavourably with the enterprise value of €475 million. That view is also backed up when the EBITDA (earnings before interest, tax, depreciation) multiple is compared with other recent takeover multiples. These (according to a table supplied by Clondalkin) varied from a low 4.4 for Crest to 8.2 for Sidlaw. Clondalkin's 7.5 multiple is higher than the 6.1 average.
On balance, in the absence of a better offer, Clondalkin shareholders (35 per cent have given irrevocable acceptances) should accept. Investors who fail to do so run the risk of seeing their shares falling back to their pre-bid levels.
