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Shoeshine: Fletcher Building gets itself an Australian benchtop bargain

By Shoeshine

Friday 27th September 2002

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The market is taking a bit of time to warm up to Fletcher Building's buy of Australia's Laminex. But surely anything that irritates the Aussie financial media must be a good thing for New Zealand.

"Our nearest foreigners dominate more than dole queues and rugby games these days," the Sydney Morning Herald whined last week.

"With Fletcher Building buying Laminex for $A645 million it has become nigh on impossible for anyone to buy a bench top, wood panel, or piece of particleboard in this country that doesn't come from a New Zealand company."

Tongue-in-cheek though these comments might be they illustrate an important point about Fletcher Building's move.

The kneejerk reaction among some market commentators was to condemn Fletcher Building for overpaying in the Australian market, a "black hole for Kiwi corporates," at the top of the cycle.

That attitude might have been justified a few years ago but it's beginning to sound a bit tired. The Warehouse, Michael Hill, Nuplex, Baycorp, Tower and Mainfreight have all established profitable positions, either by organic growth or by acquisition.

The huge exceptions, of course, have been Air New Zealand and Telecom. In both cases the companies turned out to have overpaid for businesses facing cut-throat competition.

That isn't the case with Laminex, which has the number two position in a virtual duopoly.

Fletcher Building has already raised $129 million of the $754 million purchase price through a share placement to institutions. Along with approval for the deal shareholders will be asked to authorise an issue of capital notes to part-finance the remaining $625 million.

Chief executive Ralph Waters has a hard fight ahead of him to dispel ingrained cynicism about deals of this sort.

Only a few weeks ago shareholders in Fletcher Forests voted down the Central North Island Forest Partnership deal because it would have resulted in a company exposed to the vagaries of the commodities price cycle becoming very highly geared.

Fletcher Building's deal will see debt of about $157 million after the sale of the Bolivian operations increase fivefold to $782 million.

Revenue will rise 24% to $3.68 billion and earnings before interest, tax, and abnormals by 32% to $277 million, on last year's figures.

Extra payments for Laminex will be triggered if June 2003 ebitda (earnings before interest, tax, depreciation and amortisation) rise from $A88.1 million to $A95 million, and the full $A20 million top-up payment will be made if ebitda hits $A105 million.

The rise in debt looks scary but there are several factors that should give investors some comfort.

First, unlike Fletcher Forests, Laminex's industry position gives it considerable shelter from the downside of the Australian building cycle.

It operates in a different product sector from giants like Boral (mined and quarried materials) and CSR (plasterboard, concrete and heavy materials). Laminex and Carter Holt Harvey are unlikely to cut each others' throats for market share even when things get tough.

Second, the extra debt is paying for real assets and reliable earnings, not the "blue sky" Telecom bought with AAPT.

If the entire purchase price was debt-funded at, say, 8%, the pre-tax annual interest bill would be $60 million. As 2002 ebitda was $102 million the acquisition would still be cash eps (earnings per share) positive even if there was a huge fall in earnings.

And analysts estimate the company will have $80-100 million of cashflow available annually to reduce debt.

Third, Fletcher Building still has some asset sales up its sleeve. The Peruvian operation has a book value of $16 million. The upstream Pacific Steel and downstream steel divisions are both now profitable, although more work is being done on downstream.

Fourth, Waters has squeezed truckloads of lazy, Old Fletcher costs out of the company, so the earnings trough at the bottom of the cycle won't be nearly as deep as it has been.

And last, Laminex has put Fletcher Building ­ previously covered as a small company by Australia-based analysts ­ on to Australian institutions' radar screens.

By some estimates they now hold about 20% of the stock, compared with only 5% a year ago. Asian institutions have also shown an interest. In the longer term this will help to reduce Fletcher Building's cost of capital.

As a former chief executive of Email, Waters knows the Australian market. He is emphatically not interested in the other building products businesses Laminex owner Amatek has to sell: Rocla concrete products, Stramit Steel, and Insulation Solutions.

For the time being Fletcher Building's shares are trading sideways, although still above the $2.81 pre-Laminex level.

It will be interesting to see where they go once institutional investors digest their placements and get some more cash in the door.

United in existentialism

We live in strange times. The Stock Exchange market surveillance panel this week gave United Networks a waiver from listing rule 9.2.1(a) (footnote 1) to allow Vector, Powerco and Hawke's Bay Network to make a joint bid for United Networks' assets.

The panel's largesse is granted on condition "confirmation was received on the independence of United Networks' independent directors."

It also wants the independents ­ if, indeed, they are independents ­ to certify they are acting in the interests of all United Networks shareholders.

A third condition wants them to certify that majority shareholder Aquila is unable to influence them (that is, that they're independent).

Has the panel gone all existential on us? Or is there something about Mike Smith and Bob Stanic that we ought to know?

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