Analysis: Brookfield offer for Asciano may not 'be in Australia's national interests'

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Australian port operator Asciano could be on the verge of being taken over by an infrastructure investor from Canada which owns a few port holdings and is no stranger to the market.

“Brookfield, the acquirer, is well positioned to secure the assets it is after,” a US banker told me.

Yet anyone who considers a fully-fledged takeover of Asciano as a done deal may be left with a bitter taste in his month.

The proposal

Asciano said on 1 July it had received “a confidential, indicative, non-binding and conditional proposal from Brookfield Infrastructure Group”, which valued its shares at A$9.05.

“The consideration payable under the proposal would comprise a combination of cash and units in Brookfield’s listed infrastructure fund, Brookfield Infrastructure Partners,” it added.

The deal structure may be first obstacle – who actually would want to hold units in Brookfield Infrastructure Partners? And that’s not to mention other, more serious issues such as the implied equity valuation of the target at A$9.05 a share, its forward growth rate and regulatory risk.

It’s not only a matter of price

Regulatory risk would likely require some kind of compromise on the resulting asset base and synergy forecasts. Another hot topic will be the location of the combined entity’s headquarters. Brookfield and Asciano may have similar views on these matters, but the would-be acquirer must also prove that the deal is in Australia’s national interest.

This could be a sticking point, if history is anything to go by.

On 28 November 2013, Chicago-based Archer Daniels Midland (ADM) said that it was disappointed to note that Joe Hockey, Australia’s Federal Treasurer, had made “an order prohibiting ADM’s proposed acquisition of GrainCorp” for A$2.2bn.

That GrainCorp deal was a much smaller, less strategic acquisition than the A$8.8bn proposed takeover of Asciano – which, including net debt, values the enterprise at about A$12bn.

Consider that, in 2013, ADM had even pledged an additional investment of A$200m only two days before the deal was pulled and, in a rather lengthy process, it had already received the green light from most authorities around the globe, including South Korea, Europe, Japan, South Africa and Canada.

ADM had also received the blessing of the Australian Competition and Consumer Commission, but strategic issues worked against the successful closing of the deal – with the ultimate result that the shares of GrainCorp have never fully recovered since. A lack of leadership ensued.

“GrainCorp, eastern Australia’s largest grain handler, said chief executive officer Alison Watkins resigned after a A$2.2bn takeover bid by ADM was blocked,” Bloomberg reported three days after the talks had collapsed, adding that the acquisition of the only “major publicly-traded grain merchant left in Australia after the country deregulated its wheat-export system, would have given ADM control of 280 storage sites and seven of the 10 ports that ship grain in bulk from the nation’s east coast.”

Joe Hockey, the Federal Treasurer, still holds his position today.

Moreover, if the Asciano deal goes through at the mooted price of A$9.05 a share, it might signal that Asciano is more troubled than many investors think it actually is, given that it could point to a lower growth rate for the port operator over the next few quarters.

After all, any proposal or formal offer indicates how much a buyer is willing to pay for the target’s growth rate – growth that could not be achieved by the acquirer on its own because it would likely cost more in terms of invested capital and associated returns.

On the one hand, Brookfield’s cash-and-stock proposal seems fair, given that it values Asciano’s equity at the highest level since late 2008.

On the other, Asciano’s equity should be considered fairly valued at A$8.8bn only under the assumption that its growth rate will be towards the low end of the recent growth-rate range for its underlying, adjusted earnings, at about 5%. In other words, if Asciano were expected to grow at a faster rate, say over 10% a year, its management would certainly try to negotiate a better deal for its shareholders than A$9.05 a share.

Asciano is expected to grow Ebit and Ebitda at between 5% and 10% over the next few years, according to market estimates from Thomson Reuters – a growth rate that is consistent with its recent track record.

Its stock trades on a one-year forward EV/Ebitda multiple of about 10x and on a one-year forward EV/Ebit multiple of about 14x.

Assuming that these trading multiples remain constant over time, and assuming a 10% growth rate for its core operating earnings, Brookfield’s proposal would represent just about 3.5 years of growth, which may or may not be enough to carry a formal offer over the finishing line.

If Asciano forecasts underlying earnings growth at 15% annually, the bidder will pay only for about two years of growth, but if the target’s core earnings grow at 5%, it will take about seven years for its shareholders to see their holdings appreciate above the A$9.05 mark, under a scenario that still assumes constant trading multiples over the period.

Also consider this: before the Brookfield’s approach emerged, the shares of Asciano traded at A$6.65. The A$9.05 take-out price implies an equity premium of 36% against Asciano’s unaffected stock price, yet the market is not convinced that such a valuation will be reached because no firm offer has been put forward, while a portion of the price will be paid in Brookfield Infrastructure Partners’ stock, which does look fully valued at present.

Unsurprisingly, Asciano’s share price currently implies a 13% discount (A$7.87) to the proposal that has emerged so far. The final cash/stock split will be important, too.

So, how will this saga likely end?

A bit of background on Asciano from the Loadstar Editorial Team: Asciano was originally known as Patrick Stevedores, and became famous for breaking the power of the Dockers unions in Australia in a series of particularly violent strikes. It was then acquired by Toll Group, before being spun off as an independent entity. It also has some quite big rail freight operations: all of which points to a formal offer that must be incredibly rich – say above A$10 a share – and one that is backed by the Australian government.