Australia | Jun 27 2006
By Chris Shaw
The announcement yesterday of an agreed scrip and cash bid by OneSteel (OST) for Smorgon Steel (SSX) that values the latter at $1.76 per share saw the price of Smorgon quickly increase to around the bid price.
With the price of both stocks settling today at levels around yesterday’s closing prices it suggests the market agrees with the JP Morgan assessment of the deal being a win-win scenario for both companies. The broker has gone as far as upgrading OneSteel to Overweight from Neutral, as in its view the deal will allow the company to expand its product range at lower cost, as it will be able to take advantage of the combination of production facilities resulting from the merger. Additionally, JP Morgan suggests the deal will provide the merged group with additional exposure to industries such as scrap metal, while also providing growth options such as expansion in LiteSteel Beams.
On the broker’s numbers the deal is slightly dilutive in FY07 and FY08, but adds about 5% to earnings in FY09. UBS is slightly more positive on the benefit to earnings, estimating it will be accretive in FY07 by about 3%, assuming $25m of the $70m in stated synergies are achieved in the first year.
It suggests Smorgon shareholders are getting slightly the better of the deal though, as in FY08 the earnings for OneSteel would be slightly diluted. Taking a longer-term view the broker suggests the deal should create a more efficient company that would likely rank in the S&P/ASX100, while also supplying the benefit of greater certainty of raw material supply.
The broker suggests BlueScope Steel (BSL) may look to counter the bid, particularly as the merger would make it increasingly difficult for the company to improve its weak position in distribution given the improved power OneSteel would have if the current proposal goes through. With that in mind, the broker suggests BlueScope would be more likely to target OneSteel than Smorgon.
Merrill Lynch continues to prefer BlueScope in the short-term, though notes OneSteel is effectively gaining access to long-term growth by sacrificing some of its short-term growth prospects, so the deal makes sense from that point of view.
On the broker’s numbers OneSteel would be getting Smorgon at an attractive price, as it had a pre-bid valuation on the company of $1.81, increasing to $2.28 when the growth prospects of Smorgon’s LiteSteel Beam product is included. While it means OneSteel is getting the upside cheaply, the broker points out it will be forced to wait for it as the earnings benefits will take some time to flow through.
While most in the market are in favour of the deal, Credit Suisse has gone out on a limb (or a beam) by suggesting while it is a fantastic outcome for Smorgon shareholders, the deal is a poor one for OneSteel. It argues the deal should actually be reversed, with Smorgon paying a premium to OneSteel given the greater growth prospects of that company.
In its view the deal provides Smorgon shareholders with a significant premium while strengthening the balance sheet and providing access to the growth to flow through from OneSteel’s Project Magnet, while all OneSteel holders get is a dilution of earnings in 2008-2010.
Credit Suisse also suggests OneSteel management is overpaying based on global benchmarks and may have been better served waiting a while as the valuation spread between the two companies should have widened further in OneSteel’s favour over time thanks to its stronger earnings growth outlook.
OneSteel shares today have risen 5c to $4.14, while Smorgon is up 2c to $1.79, putting it at a slight premium to the bid’s value of $1.76/share.