Australia | Sep 05 2006
By Chris Shaw
When diversified finance company MFS (MFS) announced its surprise merger proposal with S8 (SEL) yesterday the reaction was understandable, as MFS shares fell and S8 shares rose to reflect the terms of the merger.
But the market has reassessed the bid overnight and can see the potential benefits it offers, with MFS shares recovering some of yesterday’s losses that can be attributed to the company issuing more scrip as part of the merger. The merger terms are one MFS share plus 70c or 1.15 MFS shares for every S8 share, which valued the company at between $4.60-$4.72 based on yesterday’s closing price for MFS of $3.87.
ABN Amro has assessed the move as a positive for both companies, initiating coverage on MFS with a Buy rating and a pre-takeover price target of $5.15. In its view the deal will see the company lift its assets under management from current levels of about $3bn to around $5bn, the merger creating a company capitalised at around $1.7bn, enough to see it likely to be added to the S&P/ASX200 index.
For those unfamiliar with the MFS story, the company has three main divisions – funds management, structured finance and tourism, the last division being where S8 fits in. MFS currently has about 9,000 holiday accommodation rooms under management, the S8 deal expected to add a further 5,000 rooms to this total.
The benefits of this are twofold, SB Citigroup noting there is the potential for cost savings and economies of scale from having a larger operation. Secondly and perhaps more importantly, the broker points out the deal will provide an increase in the number of agents MFS has for cross-selling other products such as credit cards and holiday financing.
This becomes significant as the company’s structure is one where capital and capex costs are reasonably low, while the annuity income from the management structure is growing. The merger proposal should see the pace of this growth step up, particularly as there is the potential for the leisure assets to be placed into a new vehicle and floated off sometime in the next 12 months or so.
There are additional benefits as well, as S8 itself had a strong earnings outlook. ABN Amro forecasts profit to grow from this year’s $20.9m to $44m in FY07 and $60m in FY08, so it estimates the deal for MFS will be earnings accretive by about 4% in FY07.
MFS management had forecast earnings for FY07 of 30c per share, but the broker sees upside risk to this number and is forecasting 31.9c on a pre-merger basis. In contrast, Macquarie had forecast earnings of 33.25c, while Thomson one Analytics shows the median earnings forecast was 32c.
MFS was not broadly covered in the Australian market prior to the merger proposal, but this may change given S8 had been a recent broker favourite. The FN Arena database shows MFS is rated as Buy by the three brokers who follow the stock, while S8 was rated as Buy five times prior to the merger offer. Subsequently Citigroup has downgraded its rating to Hold.
The average price target for S8 is $4.77, which is broadly in line with the merger offer though above the current market price of $4.20, down 10c today. The lack of a premium on the stock suggests the market sees the bid as likely to succeed, particularly as MFS has been granted an option over 19.9% of the issued capital of S8. MFS has an average target price of $5.26 and is trading higher today, as at 1.10pm the stock was up 11c at $3.98 after trading around $4.40 prior to the merger being announced.