Brian Gaynor: Third time lucky for market veteran Skellerup

Skellerup is coming back to the sharemarket for the third time in the guise of Skellmax.

The new issue - 100 million shares at $1.15 each - is an exit strategy for Goldman Sachs, the Wall St investment banker badly burned by Murray Bolton's leveraged buy-out.

Skellmax will appeal to value-orientated investors, but to attract wider interest it needs to have a more aggressive growth strategy.

George Skellerup opened the first Para Rubber shop in Christchurch in 1910. Skellerup Industries was listed in 1947, but in the early 1980s it was a typical, old-fashioned New Zealand company, still dominated by family members and floundering in a deregulated environment.

In 1986, Brierley Investments acquired a 30 per cent stake and moved to 100 per cent the following year.

Skellerup reappeared again in 1993 when BIL sold 30 per cent to the public and 3 per cent to Murray Bolton at $1.50 a share. The new listing was a conglomerate of companies, including Skellerup, Cable Price Downer, Masport, Morrison-PIM and Lanes Industry (formerly Horticultural Industries), that BIL had acquired just before or after the 1987 sharemarket crash.

Bolton, who was in charge of Brierley's New Zealand operations from January 1991 until June 1993, was the driving force behind the float and was appointed chief executive.

At the end of 1993, BIL sold a further 25 million shares at $2.10 and in February 1994 a further 30 million shares at $2.62 to reduce its holding from 67 per cent to 30 per cent.

One of Bolton's main objectives was to grow the retailing arm of the group, and in September 1994 he acquired Levene for $74 million, including $35 million of goodwill. He also made an unsuccessful bid for Noel Leeming (now Pacific Retail) a month later.

Initially, Levene was a success, but on November 15, 1995, Skellerup told the Stock Exchange that trading had been difficult and its retail division had achieved little better than break-even for the September quarter.

Just five weeks later, Maine Investments - 83 per cent owned by funds managed by Goldman Sachs, 10 per cent by Bolton and 7 per cent by other senior managers of Skellerup - made a successful takeover offer for Skellerup at $390 million, or $2.45 a share.

Maine borrowed most of the purchase price against Skellerup's assets. Before the acquisition, Skellerup had $240 million of shareholders' equity and $182 million of long-term debt, but afterwards it had only $130 million of equity and long-term borrowings of $392 million.

The borrowings consisted of $315 million of secured bank finance and $77 million of Skellerup bonds sold to the public. The bonds had a coupon rate of 10 per cent a year and were quickly snapped up by eager investors.

The interest rate premium of just 2.5 per cent over five-year government stock was extremely low, given the junk-bond status of the new securities.

Skellerup sold several assets, but its overall performance fell well short of expectations and in 1997 Maine had to inject a further $40 million of equity. Later that year Levene was placed in receivership and the bonds plunged in value on the secondary market.

Bolton left and Goldman Sachs took control. In mid-1998 the Maine/Skellerup group was restructured and most of the assets transferred to Viking Pacific. In return the bondholders received:

* One free Viking share for every $13.9707 face value worth of bonds.

* A chance to subscribe for one Viking share at $1.05 for every $3.818087 face value of bonds.

* An offer from Goldman Sachs to buy the free shares issued to bondholders at $1.05 each.

Bondholders who accepted the Goldman Sachs offer would have received just 7.5c for every 100c originally invested.

Viking Pacific, under chairman Sir Selwyn Cushing, has performed much better than expected. It reported a net profit of $7.9 million for the June 2001 year and is on track to achieve more than $10 million in the current year.

The Skellmax float is the next stage in Viking's recovery and there are several important aspects to the issue:

* All $115 million raised will go to Viking.

* Skellerup and Flomax, the two Skellmax companies, have had a strong profit record and had nothing to do with the group's problems.

* Directors have not spelled out any clear growth strategy for the new listing.

The $115 million raised from the Skellmax float will be used to buy back Viking Pacific shares. The payment is estimated to be in the vicinity of $1.50 a share, leaving a residual value of about 50c a share.

Original bondholders who took up the $1.05 entitlement and a subsequent rights issue at 75c could eventually receive in the region of 68c for every 100c invested. Investors who purchased the bonds at a deep discount in 1997 will do particularly well.

It is more difficult to work out what Goldman Sachs, which owns 83 per cent of Viking Pacific, will receive, but it could get back about 50c for every 100c invested in Maine and Viking Pacific.

That is an excellent outcome, considering the conglomerate was on its knees and had little prospect of repaying any money to its shareholders or bondholders.

Skellerup, which is the world's third-largest dairy rubber producer, makes and supplies milking machine liners and tubing. Flomax makes vacuum pumps for the dairy industry.

Skellmax, which sells 51 per cent of its products overseas, is ideally suited to exploit New Zealand's dairy industry and be an important international company, but it has been restricted by its parent's financial problems. The float was a great opportunity to raise new growth equity but, as with so many other New Zealand companies, the funds will go to an outside party.

Only Tower and WestpacTrust have raised a large amount of new equity through initial public offerings in the past four years and it is not clear what WestpacTrust has done with its new equity.

Frucor was the last new listing to have strong overseas growth prospects, but struggled, partly because the funds raised did not go to the company.

Skellmax should be able to adopt a more aggressive growth strategy when its ties to Viking Pacific and Goldman Sachs are cut, but this approach would have been easier if at least half the money raised had gone to the company.

Don Stewart has done a good job running Skellerup, but the non-executive directors, Keith Smith (chairman), Arthur Young, Elizabeth Coutts, Leigh Davis and Graham Fraser, have limited experience of international manufacturing and distribution.

On the plus side, the company will have an open share registry and, like Frucor, will be vulnerable to a takeover offer if it does not achieve its full potential.

Directors are forecasting a net profit of $11.1 million, on a pro forma basis, for the June 2002 year and $12.4 million for 2003. Based on these forecasts, the company has prospective price/earnings multiples of 10.4 and 9.3 respectively at the $1.15 a share issue price. Its projected 2003 year dividend yield is 6.1 per cent (9.1 per cent gross), but the first dividend will not be paid until next April.

Skellmax does not think it will suffer from the rise in the New Zealand dollar because its international operations offer a natural currency hedge and it has a financial hedging policy in place.

The new issue will appeal to value-oriented investors. But it is a pity that Skellmax is being promoted from a low price/earnings ratio and high dividend yield perspective and that a greater emphasis has not been placed on its international growth potential.

* bgaynor@xtra.co.nz