Rationale for voting against the deal
Philip Graves, Deputy Fund Manager of The Munro Fund, met senior management of ISS and G4S in Edinburgh on October 26th 2011 to hear the reasons behind G4S’s intention to buy ISS for £5.2bn (including the debt) and more than doubling the numbers of shares in issue through a 7:6 rights issue to raise £2bn. Whilst the industrial logic seems sound, and were well explained by management, the scale of the deal and the accompanying financial risks makes The Munro Fund unwilling to support it. The main concerns are as follows:
- The private equity sellers failed to get much support for an IPO earlier this year and the flotation had to be pulled suggesting the price was ambitious.
- The sheer scale of the deal- for example employee numbers double to over 1m and the number of shares in issue rise by 144%.
- The quality of the ISS management is uncertain. Over half the business is in cleaning services which helps explains labour turnover at a staggering 54% p.a., double the level at G4S.
- ISS has completed over 600 acquisitions over the last 10 years (approximately £2.5bn in total) which have led to extensive impairment charges for those underperforming businesses*. This degree of change can only add to the overall execution risk in the merger.
- Debt levels will remain high for the first few years. Initially net debt to EBITDA will rise to 3 times against about a sixth of this level at two comparative business service companies; Compass and MITIE.
- A large proportion of the debt (£2.5bn) has to be refinanced in 2013. There is the risk the bond market will be demanding much higher rates of interest than exist today.
- The vendors are taking an 11% stake in the enlarged business as part of their payment, but can sell this holding after only 9 months. This leaves the share price burdened by a large potential placing of stock in 9 months time.
- The valuation is demanding in comparison to similar companies. G4S are paying 8.5x EV/EBITDA which is higher than the valuation for similar business services companies such as MITIE, Serco and Compass**. Private equity vendors are renowned for their ability to achieve a full price for disposals.
As a consequence FTIM voted against the deal, though supported the rights issue. This gives the company opportunity to re-negotiate a lower price for the deal.
Philip Graves
Fundamental Tracker Investment Management Ltd
Exchange House,
50 Drymen Road,
Bearsden,
Glasgow
G61 2RH
Tel. 0141 931 7645
Mob. 0782 6424442
email: philip.graves@fundamentaltracker.com
www.fundamentaltracker.com
* Collins Stewart (20/10/11) calculate from figures in the prospectus that impairment charges represent about 15% of the total spent on acquisitions over the last 10 years. The management response is that the company is unable to book any offsetting goodwill “write-ups” that could have been applied to out-performing acquisitions. The value of these offsetting uplifts is not available.
** According to Collins Stewart these three companies presently trade on EV/EBITDA of 7.1-8.3x to year-end Dec. 2011.