Looking for Value in “Mining Service” Takeover Targets

Shares of self-styled “professional infrastructure and environmental services company” Cardno Limited (CDD) closed the trading day of 19 May 2015 at $3.50 per share. On 20 May company management issued a profit warning.  Cardno expects NPAT (net profit after tax) to drop from last year’s $78.1 million to between $48 and $51 million.

The stock price hit a 12 year low intraday, closing at $2.50. Analysts at Macquarie, Deutsche Bank and UBS cut price targets. On 21 May the price fell further, closing at $2.36, but shot up to $2.86 the following day, continuing its rise to close at $3.05 on 28 May.  Here is the chart showing the moves.

Cardno is one of the Top Ten Shorted Stocks on the ASX and it is possible a rush of short-sellers covering their positions added to the price rise. The triggering event was rampant speculation CDD was now taking a place on the acquisition target list of beleaguered companies in the sector. What started the speculation was the confirmed news an unidentified investor had not only acquired a 10% stake in the business, but also was willing to pay $2.60 per share, roughly 10% more than the prior day’s closing price .

Why would an investor with such deep pockets step up and ignore market experts to stay away from “mining service providers?”

Note the discrepancy between Cardno’s self-description as an infrastructure and environmental service company and the perception of Cardno as a mining services company.

If you check the Cardno website you will find Energy and Resources is only one of ten market segments served by the company.  In addition, acquisitions have broadened the revenue base to the point Cardno now derives most of its business outside of Australia.  From the latest Cardno Annual Report, the following graph shows the breakdown of revenue by geographic segment.

•    58% Americas

•    32% Australia and New Zealand

•    10% Rest of the World

Here is another graph from the Annual Report that would certainly seem to support the view Cardno is more than a “mining services provider.”

•    Resources    12%

•    Oil and Gas    22%

•    Government    29%

•    Contractors    11%

•    Other Private    26%

Even if you factor in the problematic Oil and Gas business with Resources, you come up with about a third of revenue from these two segments, with only 12% from the mining segment.  This is not to suggest investors should ignore the downside in resources and oil and gas; only that the market perception of Cardno as a “mining services provider” is not totally accurate.

The willingness of an unknown investor to grab a substantial piece of Cardno suggests there is value in the company.  That value may stem from the company’s position in the infrastructure business.  Check the Cardno website and you will see the company is involved in key areas that should be addressed by the infrastructure spending in the recently released 2015 Federal Budget – rails, roads, bridges, ports, harbors, traffic, and civil engineering work across the board.

There are four other companies in the sector that have been the subject of takeover offers or speculation.  In the following table we will look at share price performance year over year and some measures acquiring companies most often consider when determining a target’s value.  Here is the table.

The table is a gross oversimplification of the things acquiring companies consider, but we have included some of the key concerns.  As a starting point, the most important measure is Enterprise Value.  Market Capitalisation is simply the company’s price per share multiplied by the shares outstanding.  There are no fundamental value indicators in that formula.  One could think of market cap as how investors value the company.

Enterprise Value starts with the market value of common stock; adds the market value of preferred equity and minority interests; adds total debt and then subtracts cash on hand and the value of investments.  A primary reason this is a better measure of value is the inclusion of both debt and cash.  The acquiring company will inherit both the target’s debt and its cash.

Although other factors come into play, generally speaking a company whose enterprise value exceeds its market cap might be a better buy, and in some cases a bargain.  Similarly, a company with a Book Value per Share greater than its share price might make for a better deal for the acquirer.

Return on Equity (ROE) and Return on Assets (ROA) are considered to be measures of how effectively company management is using its resources.  In many cases, private equity firms look for companies where poor management is part of the reason for the declining share price.

One could make a case that buying a stock strictly on speculation the company could get taken over is little more than punting.  The financial news regularly reports on deals delayed and deals that fall through.

However, we think the mere fact another company or a private equity firm shows interest in a target is enough of an indication of potential value for further investigation.  Many investors avoid embattled sectors completely and fail to differentiate companies within the troubled sector.  When bidders appear, that should be seen as a good sign.

Lumping firms that do some business in the mining and oil and gas sector with companies that do the majority of business in those sectors presents an opportunity when share prices drop across the board.  You can see from the table all these companies have seen substantial declines in share price over the past year.  Cardno is more than a mining services provider.  Now let’s see if any of the other companies that have been the subject of takeover bids or speculation are similar.

WorleyParsons Ltd (WOR) is a service provider with three customer sectors – Hydrocarbons; Metals & Minerals; and Infrastructure.  This company has a huge global presence that should cushion the impact of commodity price falls, but it is hard to ignore the fact two of the three sectors WOR serves are challenging at best. What’s more, if you dig into the company description of the Infrastructure Sector you find much of that business involves the resource and energy sector.

Like many companies in the sector WorleyParsons has been through a series of profit downgrades and disappointing financial results. Speculation from some is the company could be a target for a large Asian Oil and Gas Firm or, considering WOR’s market cap, a private equity firm with very deep pockets.

The troubles for shareholders of WOR and CDD have been ongoing for some time.  The following two year price  chart for the two tells the story.

UGL Ltd (UGL) proclaims it is “one of the most diverse service companies in Australia.”  That may be, with a global reach and six customer sectors – Rail, Power, Resources, Water, Defence, and Transport & Technology Systems.  Yet the company’s financial results have been sub-par, with the February release of the 2015 Half Year Results showing a revenue decline of 12% along with a profit decline of 41%.  UGL and WOR both join CDD as residents of the ASX Top Ten Short List.  UGL is the only stock in the table with an analyst consensus rating of Underperform.  Cardno and WorleyParsons are both rated a Hold.

Analysts cite a lack of transparency from UGL management and both the ROE and the ROE for the company suggest something less than 100% management effectiveness.  Yet the share price has been climbing since takeover rumours began to gain strength in mid-April, with the Australian Financial Review 20 May report that another engineering contractor and a private equity firm may be interested in acquiring the company adding fuel to the fire.  Here is a six month price movement chart for UGL showing the move.

Bradken Limited (BKN) got a takeover bid of $2.50 per share from Koch Industries and Pacific Equity Partners, which was quickly rejected as not representing the company’s fair value.  The offer came on 1 April when BKN was trading at $1.94.  Bradken had already turned down an offer of $5.10 per share from Bain Capital Asia and Pacific Equity Partners on 28 January when the share price was at $4.11.  The offer was made public in early December of 2014 sending the share price up, only to fall back to earth when the deal was rejected.  Here is a chart showing the moves.

The company is often described as a “supplier of mining equipment to miners in Australia.”  Looking at Bradken’s customer base suggests there is more to this company than mining.

Bradken serves four market segments – Mineral Processing; Mining Products; Transport & Industrial Products; Engineered Products; and Cast Metal Services with operating locations around the world.

However, if you dig into the product descriptions on the company website you find much of what is considered transport or engineered or cast metal products finds its way to the mining sector.  The Full Year 2014 Results showed a 14% drop in revenue with a 43% fall in profit.  Management attributes the decline to pressures on the mining industry.  An analysis of what Bradken provides suggests only a minimal benefit from contracts beyond the iron ore, coal, gold, and oil and gas sectors.

Given the Federal Government’s commitment to infrastructure spending it would seem investors should be looking for beaten down companies in this sector that have a chance to grab a piece of the pie.  The recently release Australian Infrastructure Audit found that “without action Australia’s productivity and quality of life will be tested, with population and economic growth set to cause increasing congestion and bottlenecks.”

This is not something that is going to happen overnight but retail investors should be watching for news of infrastructure projects and potential bidders.  Cardno and to a lesser extent UGL and WOR could be players here.  The final stock in the table may be the one to watch the closest.

Maca Limited (MLD) is a rare stock indeed, as it is the only one in the table to have an Analyst consensus Outperform rating.   The company operates in two segments – Mining Contracting and Civil Contracting.  This company is also running against the industry trend by reporting positive financial results and no lowered guidance warnings.

The Half Year 2015 Results showed a respectable 4.4% increase in revenue and a 6.4% rise in profit.  Full Year 2014 Results released back in August included a 25% revenue rise and a 12% jump in profit.  A few days after the report management rewarded shareholders with a special dividend of $0.25 per share.  However, it has been all downhill since, apparently due to the dire straits of some of Maca’s customers like Atlas Iron Ltd (AGO).  Here is a one year chart for MLD.

Given the profitability of the company this is somewhat surprising.  However, markets are forward looking and there is no denying Maca’s work in the mining industry is in decline without any substantial increase on the Civil Contracting business through more infrastructure projects.  Check the company website for its current projects in Civil Contracting.  There are four, and all are road-building projects.  Should road building get a boost from the budget, watch Maca.

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