Surprise Bid Puts Spotlight On Treasury Wine’s Value

This story features TREASURY WINE ESTATES LIMITED. For more info SHARE ANALYSIS: TWE

-Bid appears generous
-Potential FY14 downgrade
-New strategy critical to outlook
 

By Eva Brocklehurst

The revelation of a takeover bid has astounded brokers and provoked a welter of commentary about the real value of Treasury Wine Estates ((TWE)). Private equity firm Kohlberg, Kravis and Roberts (KKR) has made a non-binding, conditional proposal at $4.70 a share.

Treasury Wine has rejected the bid as undervaluing the company and has refused due diligence. Macquarie thinks the bid is attractive, at 30 times FY14 earnings forecasts, and also believes the company's accompanying comments signal further risk of a downgrade to FY14 earnings guidance. The bid may not be the final word on a transaction but a material increase in KKR's proposition is far from certain. Macquarie notes another variable, and that is the board's willingness to sell. Further to whether the board is willing to sell is faith in the new CEO's turnaround strategy. Macquarie suspects that the board must be tempted to take the opportunity for a clean exit, after a prolonged period of trying to revive the company's fortunes. The broker thinks investors would be best served by taking profits now, rather than risking a generous offer falling through, especially given the market is pricing in an improved bid. Macquarie's rating is downgraded to Underperform from Neutral.

Deutsche Bank is puzzled. The share price is well above where fundamental valuation lies, even assuming a dramatic improvement in the company's business. The bid also seems to make no allowance for a long history of underperformance, and the risks associated with agricultural variability. There are no guarantees that a deal will be done but the presence of the bid provides valuation support and the broker does not rule out a bid from another similarly-focused financial entity. On this basis, Deutsche Bank has upgraded its recommendation to Hold from Sell. Management has announced a 50% increase in marketing spend in FY15, to be funded by $35m in cost savings. Deutsche Bank expects timing differences to constitute an earnings drag in FY15.

JP Morgan, in unravelling events that led up to the announcement of the proposal, suspects it may come to nothing. The broker found it strange the company decided to announce the proposal more than a month after receipt. Treasury Wine decided to publicise the offer, despite a request for confidentiality from KKR when the bid was made in April, because KKR approached some shareholders recently and there was a risk confidentiality would be breached. JP Morgan highlights the significant risk in the bid that, after extensive due diligence to determine the value of a potential break up, KKR would be able to walk away, or materially reduce the offer price. The broker also believes there is a high likelihood of a downgrade to FY14 guidance prior to reporting the results in August.

The company's marketing spending is to be consumer-based and allocated to the international brands such as Penfolds and Wolf Blass, as well as strong regional brands such as Chateau St Jean. These brands generate the strongest margins. The cost savings will come from a reduction in the workforce. Management is focused on the US business as a key growth platform and this suggests to JP Morgan this business is unlikely to be divested.

Morgan Stanley can envisage where KKR may be undervaluing Treasury Wine. The broker thinks the true value of the US business is $1.4bn with the inventory balance at $1.9bn. If these values are accurate, this implies the KKR bid values the Australasian assets at just $500m. In Morgan Stanley's analysis, KKR could afford to increase the bid. Wine assets tend to trade on high multiples, given their strategic nature, and Morgan Stanley suspects Treasury Wine is no different. Valuing Treasury Wine based on precedent transactions the broker comes up with $5.18 a share.

CIMB is of the view that a higher bid would be a challenge for KKR. Crucial to the bid was access to due diligence. There is increased probability that KKR walks away, as CIMB observes private equity firms are typically more disciplined than trade buyers. For KKR to increase the bid it would need to contemplate a more complex and risky asset sale process, in CIMB's opinion, and the appetite for many of the non core assets is likely to be low. UBS suspects the Treasury Wine board has not yet firmed up its view on the company's value, given the new CEO is yet to roll out his new strategy. The broker still thinks current guidance for earnings of $190-210m for FY14 is optimistic. UBS remains comfortable defending its valuation of Treasury Wine's US assets, noting speculation regarding global beverage player interest in these assets. Such speculation, combined with the KKR approach, is expected to support the share price for now, despite the challenging near-term outlook.

On the FNArena database the consensus price target is $4.44, suggesting 7.2% downside to the last share price. This target is up from $3.71 ahead of the announcement. There are one Buy, two Hold and five Sell ratings on the database.
 

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