Brian Gaynor: The good, the bad and the outright ugly

Fletcher Building's fantastic result for the six months to December 31 is a great boost for the sharemarket and corporate confidence.

Although the group's New Zealand operations performed extremely well, the two recent Australian acquisitions, Laminex Group and Tasman Products, contributed 29 per cent of operating earnings (earnings before interest and tax) compared with nothing a few years ago.

The result demonstrates that New Zealand companies can make wealth-creating acquisitions across the Tasman although it is an Australian, chief executive, Ralph Waters, who is the main architect of the group's successful acquisition strategy.

Waters joined Fletcher Building on June 1, 2001, when its share price was only $2.31. His first major acquisition was the Laminex Group, an Australian manufacturer of laminates and decorated woodpanels, in November 2002.

The purchase price was A$645 million ($709 million) but a provision in the agreement said an additional amount would be paid if Laminex exceeded a predetermined earnings figure for the June 2003 year.

Laminex exceeded this target and Fletcher ended up paying A$660 million ($725 million).

The new acquisition achieved operating earnings of $44 million for the seven-and-a-half months to June 2003, $95 million for the June 2004 year and $56 million for the six months to December 2004 (Laminex earned $65 million in its last full year under the previous owners).

These figures have been boosted by the inclusion of Fletcher Wood Panels and Scott Panel and Hardware for the past 18 months but it is still a remarkable performance by a New Zealand acquisition in Australia. Since the purchase, Laminex has achieved average 12 months operating earnings of $92 million, an annual return of 12.7 per cent on the original purchase price and 15 per cent return for the 12 months ended December 2004.

Waters' next big acquisition was Tasman Building Products for A$230 million ($253 million) in September 2003. Tasman Products, which has a strong market position in insulation (Pink Batts), roofing (Gerard Roofs), sinkware and flooring, has about 48 per cent of its revenue in Australia, 31 per cent in New Zealand and 21 per cent outside Australasia.

This purchase has been an even greater success than Laminex. In the 15 months under Fletcher Building ownership, it has produced operating earnings of $60 million, which represents an annualised return of 19 per cent on the purchase price (Tasman Products had operating earnings of $30 million in the last full year under the previous owners).

Waters' recipe for success is not revolutionary. He purchases good assets that are complementary to his existing businesses and doesn't become involved in bidding wars for listed companies.

Fletcher Building now has its eye on Amatek, the Australian building products company with annual revenue of about A$750 million. The target is owned by CVC Capital Partners, one of the UK's largest private investment partnerships, and Waters has indicated he will walk away from the $500 million deal if it is not completed by the end of the month.

In view of the success of Laminex and Tasman Products, investors will look at an Amatek deal in a favourable light, particularly if the purchase price is seen as reasonable.

In contrast, Telecom's acquisition of AAPT was one of the worst transactions in recent New Zealand corporate history.

The initial 19.8 per cent was acquired in the June 1999 quarter after Dr Roderick Deane had revealed he was resigning as chief executive and would replace Peter Shirtcliffe as chairman. The full takeover offer was announced before Theresa Gattung replaced Dean as chief executive on October 1, 1999.

What was the Telecom board thinking when it launched a high-risk acquisition while at the same time appointing a new and inexperienced CEO? This dreadful board decision, and others like it, have destroyed huge amounts of shareholder wealth in New Zealand.

The AAPT purchase has been a disaster, with the Australian company achieving an average operating return of only 1.9 per cent per annum on the $1.6 billion purchase price.

The meagre return is before interest costs and does not take into account a substantial capital expenditure programme at AAPT.

The good news is that Deane is finally taking a back-seat role at Telecom while Gattung is gaining in confidence and beginning to stamp her authority on the group (Deane is also chairman of Fletcher Building but Waters calls the shots).

Although AAPT continues to be a huge burden, Telecom's result for the six months to December was encouraging. The company is now reinvesting in its business, instead of focusing on cost cutting, and this is beginning to produce results in mobile phones and internet connections.

As the accompanying table shows, the worst Australian acquisition by a NZSX 10 index company in recent years has been The Warehouse's purchase of Clint's Crazy Bargains and Silly Solly's, effective August 1, 2000. The purchase price was A$105 million ($115 million).

The problem with Clint's Crazy Bargains and Silly Solly's is that their stores were too small and poorly located. The two acquisitions were bargain chains whereas The Warehouse is a discount variety operator and Australian retailing is very different to New Zealand.

Ian Morrice and his executive team still have a long way to go before they achieve an acceptable return in Australia.

Sky City's purchase of the Adelaide Casino in 2000 has been more successful but it still falls far short of Fletcher Building's performance across the Tasman.

The South Australian casino cost A$185.4 million ($202 million) and has produced average operating earnings of $14 million per annum. This is an average annual return of just 6.9 per cent before financing costs, although the good news is the casino's operating earnings are steadily growing and reached A$15.7 million ($17.2 million) for the June 2004 year.

Finally there is Fonterra and its quest to acquire 100 per cent of National Foods. The Australian dairy company achieved operating earnings of A$112 million in the June 2004 year. If Fonterra, which already owns 19.9 per cent, is to achieve full control it will probably have to pay A$6.20 a share and, at that price, the outstanding 80 per cent will cost nearly A$1.5 billion.

As this will have to be borrowed, Fonterra should be looking for a pre-funding return of at least 12 per cent on the purchase price of the remaining 80 per cent to justify the acquisition. This means that Fonterra will have to raise National Foods earnings from A$112 million to A$180 million or from A$112 million to A$220 million if the full 100 per cent value of National Foods at A$6.20 a share is taken into account.

Given the acquisition record of New Zealand companies in Australia, with the notable exception of Fletcher Building, it is doubtful if Fonterra has either the board or management expertise to achieve operating earnings of A$180 million at National Foods, at least in the short term.

Disclosure of interest; Brian Gaynor is an executive director of Milford Asset Management and a Fletcher Building and Telecom shareholder.

mailto:bgaynor@milfordasset.com