The Spanish have set sail and rescued long suffering Leighton shareholders! And in the process, squeezed the professional short sellers!
Well, that’s the way I look at the Spanish-controlled Hochtief’s proportionate offer for Leighton Holdings. I have been one of the few bulls on the stock (see here [1] and here [2]) and while I didn’t forecast the offer, I did note that the major shareholder kept using the creep provisions to add to their holding. Betting against the interests of a majority shareholder seemed like a pretty risky business, however that’s what the so-called professionals were doing.
And boy, were they short. According to ASIC data, some 7.33% of Leighton’s ordinary shares were short sold when the initial bid was announced last Monday. Given that Hochtief owned 58.77% of the shares, the short component represented almost one in five of all other shares held.
Why was the market short?
Before coming to the question every Leighton shareholder has – should I accept or reject the offer or alternatively, sell my shares into the market now? – it is worth recapping on why the market has been short.
The market has been betting against Leighton for more than 12 months. The main reason the analysts cite is the value of Leighton’s trade receivables – monies owed by some of Leighton’s major construction clients – and so called under claims – “work variations that have been performed for clients but have not yet been billed”. They fear that some of these under claims won’t be realised, and Leighton will be forced to make material write-downs.
Then there is Leighton’s exposure to the resources sector through contract mining, which makes up 35% of Leighton’s work in hand. Add in the Fairfax allegations about bribery and corruption in the international business division in 2010 and 2011, and the usual beat-up about corporate governance and you have four reasons to be short on Leighton.
As an aside, I have never understood why there is something wrong about a majority shareholder driving a company to further its objectives. That doesn’t mean we don’t need to be careful about who we get into bed with, however no one forces us to be minority shareholders. Maybe I am just used to being a retail shareholder with no influence and no rights, so agitating about the rights of minority shareholders seems like a nonsense from grumbling institutional investors fanned by a press that thirsts on conflict.
On the plus side, Leighton’s revenue rose by 6% in CY 2013, compared with 2012, EBIT rose by 27% and Underlying Net Profit After Tax rose 30% to $584 million. Gearing fell from 31.9% to 29.2%, and at 31 December 2013, work in hand was a very healthy $42.2 billion, down 3% from December 2012. For shareholders, earnings per share increased by 13% to 150.9c, and dividends increased by 30% to 105c per share.
By most valuation metrics, Leighton looked pretty cheap.
The offer
While the timing of the offer was a surprise, Hochtief (and its parent ACS) had well and truly telegraphed that it wanted more. Under the creep provisions, it had been buying more shares in Leighton and had taken its holding prior to the offer to 58.77%. If the offer is successful and all shareholders accept, Hochtief’s interest in Leighton will increase to 73.82%. The key details of the offer are:
- proportionate offer to acquire three out of every eight shares for $22.50 in cash;
- shareholders on the register on 21 March will also receive the dividend of 60c (50% franked);
- offer closes on 9 May;
- shareholders will receive payment within 21 days of the offer closing;
- the offer is conditional upon there being no objection from the FIRB.
The offer price of $22.50 is pitched at a premium of 35.1% to the average Leighton ASX price over the last three months of $16.66, 26.4% to the average price over the last month of $17.80 and 20.6% to the average price in the week immediately prior to the offer of $18.65.
What now?
As it is a proportionate offer, shareholders have three choices: (i) accept the offer – sell three shares and keep five; (ii) reject the offer – keep all eight shares; or (iii) sell their shares now on the ASX. Like all offers, it really comes down to a view on what the price of Leighton shares will be after the offer has finished.
The market is expecting the Leighton share price to fall. Using Friday’s closing price of $21.37, it expects a “post offer” price of $19.73 (excluding any time value of money). [This is calculated by assuming three shares are sold at $22.50, the dividend on all eight shares of 60c is received, and the remaining five shares are sold on market after the offer closes].
According to FN Arena, the broker analysts expect EPS for Leighton in 2014 of 164c. At $19.73, this would see Leighton trading on a PE multiple of 12, and with a forecast dividend of 105c, a yield of 5.3%. Their consensus target price is $20.33.
On the downside, if Hochtief’s offer is successful, Leighton will most likely drop out of the major indices as its free float will fall below 30%. This means that index-based funds (including the ETFs) will be forced sellers, and over time, some other active managers will choose not to consider Leighton as an eligible security to invest in.
So while the valuation metrics look okay, liquidity (and institutional demand) for Leighton’s shares will be reduced.
And there will be lots of noise and stories in the media to say how far the share price will fall (at least in the next two months) – the short sellers are still short!
My sense is that there is still value in Leighton up to $20.00 (on a post offer basis), so I am not inclined to sell now. I am not going to look a gift horse in the mouth either, so my plan is to take some profit and accept. If the Leighton price gets creamed, then I might just buy them back. And at the back of my mind is the old truism that a majority shareholder rarely sits on a holding of 73.82% – the probability says that rather than put up with pesky minority shareholders, there will be another bid. It might be 18 months away, in three years, in five years – but I can afford to be patient.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report:
- Peter Switzer – Profitable Dirty Harry moment to buy BHP and Rio [3]
- James Dunn – Potential M&A targets are to buy [4]
- Penny Pryor – Shortlisted [5]
- Roger Montgomery – The next chapter in the Sirtex story [6]
- Rudi Filapek-Vandyck – Buy, Sell, Hold – what the brokers say [7]
- Staff Reporter – Property continues to rise [8]