Australia | Apr 19 2007
By Greg Peel
It’s often fun to read back through old stock analyst reports when one has the benefit of hindsight. An undertaking of this exercise reveals that only one broker appears to have suggested that explosives and chemical major Orica (ORI) might be considered a takeover target, but even then the suggestion was from a “competitor”.
That broker was Credit Suisse, who unfortunately downgraded Orica to Neutral from Outperform just two days ago (ouch).
It’s also hard to find any mention of the fact that Orica is undergeared, although there has been some suggestion made it was in a good position to make further acquisitions. Yet undergearing is one of the reasons analysts are today suddenly deciding that a private equity bid of $32.00 for the company is not enough.
My favourite comment this morning also comes from Credit Suisse. The analysts suggest the $32.00 bid should place a floor under the Orica price (as does everyone else) and “again highlight the market’s reluctance to value under-leveraged balance sheets across basic industries”. First it was Rinker, say the analysts, and now Orica.
The market’s reluctance?
Yesterday’s CS target price was $28.75 and today’s is $33.30. On Tuesday CS downgraded Orica because the share price had outperformed the index by 14% to 8%.
It is unfair, however, to single out Credit Suisse. For across the analyst community the focus up to yesterday had been on environmental costs and competition from Dyno Nobel’s (DXL) expansion plans. While five out of nine brokers held a Buy rating on Orica, their target prices averaged out to $26.97. Today that average is $34.70. And the private equity bid was only $32.00.
Merrill Lynch only provides target prices when it places Buy recommendations. Its rating on Orica yesterday was a lone Sell (double ouch). Merrills downgraded Orica to Sell in November when the stock price was about $24.00.
The analysts have now moved to “No Rating”, which is Merrill Lynch standard practise when a stock is “in play”. The implication is that that stock is no longer trading on fundamentals, and thus is not beholden to a normal rating measurement. And therein lies the crux of the matter.
Stock analysts’ ratings are usually for six months hence. Target prices are for twelve. A stock analyst is focused on earnings growth and the immediate accretive/dilutive effect of acquisitions or initiatives. By contrast, a privateer focuses on internal rate of return over, usually, a three to five year time frame. Privateers are happy with J-curves, that is, they are not fussed if the value of the company they have purchased initially falls below the value of their purchase price. They are looking to extract a higher value over a longer time frame. Stock analysts are only interested in IRRs when a privateer puts in a bid.
And they were certainly all interested this morning, as IRR formed the basis of analyst calculations that suggested the Orica board was right to dismiss the $32.00 bid.
While the bid was only 15% above Tuesday’s closing price (most private equity deals succeed at 30-35%), more importantly it represents an IRR in excess of 20%. As privateers are usually content with a 15% IRR, there must still be upside.
Similarly analysts focused on earnings multiples, which is a bit more their cup of tea, and again decided either the bid could be raised, or another player could emerge.
Thus it is that suddenly analysts decided Orica is really worth $35.00. At least that is the view of Macquarie, ABN Amro, Deutsche Bank, JP Morgan, Credit Suisse and Merrill Lynch. Citigroup has been very positive on the company’s prospects up to now and has set its new target way up at $38.20 (it was $27.00 yesterday). Only GSJB Were lacked any real enthusiasm, suggesting the Orica suitors might even struggle to achieve its required IRR at $32.00. Weres reiterates the ongoing legacy issues of environmental clean-up costs and an outstanding ATO tax dispute which are not reflected in the company’s P&L.
For the last twelve months or more stock analysts have been adding takeover premiums to their media stock valuations, or at least recognising takeover potential despite some poor fundamentals. Sure – new media laws provided a lay-down misere, but as the great private equity explosion rages on, why haven’t other industrials been afforded the same consideration?
Oh that’s right – market reluctance. But who is leading who?
Anyway, you can now rest assured that the Orica bid has provided a wake-up call for analysis of Dyno Nobel (DXL), with some analysts suggesting its equivalent valuation should now be placed at around $3.05-3.15. JP Morgan even recommends Dyno as a better play from here on in. Credit Suisse also wonders if James Hardie (JHX) might be next.
Anyone else guys, before we miss out again?