Update: Fosters should sell, maybe

News is out that Fosters Group (FGL) just knocked back a buy-out bid by SABMiller worth $9.5billion, claiming it significantly undervalues the company.  That’s a big call by the beer barons; the bid represented a per-share value of $4.90 and Fosters is trading around $4.50.  Let’s see if it stacks up based on the fundamentals.

Fosters’ fundamentals

Fosters announced a demerger of its Treasury Wine Estates in February 2011.  This demerger, whilst getting rid of a troubled arm, also lowered the equity per share value of Fosters significantly.  In fact, the demerger booklet has Fosters net assets at negative $200million after the merger, although this should become positive after the reinvestment of some of FY11s profits.  Analyst’s reports I have read give current equity per share at only $0.04.  Such a low number also makes forecasting next year’s return on equity (ROE) difficult, but the same report gave a forecast of 70%.  A high number, but don’t forget the equity per share divider is very, very low.

For the sake of a quick valuation, let’s assume current equity per share is $0.10, normalised ROE (i.e. including franking credits) is 70% for FY12 and declines to 60% over 5 years.  Assuming one third of profits will be reinvested and our required return is 15%, I calculate a value for the demerged Fosters of about $1.30.

That is way, way below the current share price of $4.53 and even further below SABMiller’s bid of $4.90 per share.  So in my humble opinion, Fosters is mad for knocking back the offer.  On the flip side, I think SABMiller is overvaluing Fosters by a country mile – and that is just based on the numbers.  When you consider Fosters dominant market position (about 50% of the Australian beer market), 4 years of lacklustre ROE and the recent demerger indicate management is not performing well. 

While not discouting the possibilty that SABMiller will go higher, they may have just dodged a very expensive bullet.

If I was a poor value investor that owned shares in Fosters, I’d need a stiff drink to calm the nerves.

Update:  Maybe not so bad

The MSM is all over the Fosters-SABMiller deal this morning.  Most talk about the past demerger from treasury wines, and how this has opened Fosters up to a bid from a bigger player.  Gottis piece in Business Spectator is the best because he actually uses numbers – those things oft-neglected in the MSM – to take a shot at valuing Foster.

He comes up with about 33 cents per share in dividends over the next few years, boosted in part by a recent favourable tax ruling.  Which means the figures I borrowed for ROE yesterday would be way too low.

If we ditch the ROE analysis (due to the trouble in determining the equity base post-merger, as highlighted by Mining Man) and look at earnings multiples, we get about $650m in estimated NPAT for FY11 vs the $9.5b bid.  That’s an earnings multiple of just under 15.

Too high?  I still think so, but I could very well be wrong if SABMiller turns Fosters into the cash cow it should be with its current Australian market position.

Things will be a lot more clearer come the next earnings report.

Disclosure: The author is a Director of a private investment company (Empire Investing Pty Ltd), which has no interest in the businesses mentioned in this article.  The article is not to be taken as investment advice and the views expressed are opinions only.  Readers should seek advice from someone who claims to be qualified before considering allocating capital in any investment.

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Comments

  1. This is a perfect example where ROE analysis is meaningless. The E is just an accounting number that is the risidual of a lot of other calcs.

  2. Technically it’s the net of assets and liabilities, but you have a valid point when equity is in the realm of 4-5c. A small increase in equity will have a drastic affect on ROE. FGL will need several years of competent operation before we’d upgrade it to investable. FGL will need several years of stellar ROE even from this low equity base (about 125%) to justify its self-declared value.
    However, when a long term (supposedly stable business) has a major restructure that removes some 2.9 billion in assets, ROE analysis really isn’t required. The risk associated with bad corporate managers should scare off most value investors until things become stable.

  3. Alex Heyworth

    Fosters closed at $5.14, suggesting the market is expecting a revised bid. What this implies to me is that the brand names on Fosters’ books are grossly undervalued.

    • Or the market is grossly over valuing them – wouldn’t be the first time. I’ll be watching FGL with interest over the next few years to see if earnings can justify the current market price.
      Intangibles aren’t worth much if they don’t produce the NPAT goods.

      • Alex Heyworth

        On reflection, I’m pretty sure you are right. Personally, I wouldn’t touch FGL with a ten-foot pole. What does the market see in it? Surely there are better alternatives.

      • The “market” has to buy it Alex – its a major weighting in index funds and most active managed funds as an ASX20 stock, where there are other dogs like Suncorp and AMP as well.