A few days ago, I mentioned UK based Severfield Rowen as a potential interesting “deeply discounted rights issue” special situation.
Problem is that I don’t know much about the company. So the problem is always: How do you start looking at a new company ?
That’s when I remembered a very good post of Geoff Gannnon a few days ago:
I recently mentioned something in an email that I’m not sure I’ve said before on this blog. I always read the newest and oldest 10-K for a company when I start analyzing it. Reading the oldest 10-K gives you perspective.
I have to confess that normally I would start with the latest report and then work my way back, but the approach of Geoff really makes a lot of intuitive sense to me. So why not try with Severfield-Rowen ?.
So let’s compare some key figures from 2000 against 2011:
The difference couldn’t be bigger. In 1999/2000 we have a completely unlevered company with OK margins but very nice ROE/ROCE because of a quite efficient capital/sales ratio.
The 2011 company however looks very different. Sales have doubled, but lower margins, significant goodwill and debt including a growing pension liability reduce ROE/ROCE into low single digits.
So what happened in between ? Well of course, acquisitions:
2005: Acquisition of Atlas Ward, however this looked like rather a small fish at a bargain price
But then the big bummer:
2007: Acquisition of Fisher Engineering for a whopping 90 mn GBP
Fisher Engineering seemed to have been a Northern Ireland based company at least, the seemed to have paid partly in new shares according to this article:
Severfield-Rowen has agreed to buy AML for a total consideration of approximately £90m, of which £36.6m will be satisfied by the issue of 1,750,000 new shares at approximately 2,089 pence each with the balance in cash.
The rational given now f course sounds like a big joke, but at that time Ireland was still “hot” (for another 6 months or so:
The Fisher acquisition will extend Severfield-Rowen’s leading market position in the UK and give Severfield-Rowen a stronger presence in the growing Irish steel fabrication market.
In 2010 finally, they started a JV in India, but more on that later.
SO let’s look at 2006 vs. 2007 :
We can see in 2006 a very very healthy company with lots of net cash on the balance sheet, no goodwill nothing. In 2007, profits still went up but didn’t really compensate for the increased invested capital.
Interestingly, 2008 and 2009 were quire ok, however in 2010 S-R was hit by the “Wile E. Coyote” moment:
I spare myself the details, but i think this table is quite telling:
|Republic of Ireland and mainland Europe||8.9||79.5||23.2||3.6|
The access to the “Fast growing Irish market” for which they paid 90 mn GBP in 2007 had completely “vaporized” in 2010. I have to confess that this seems to be one of the worst timed acquisitions I have seen in my life.
interestingly enough, the still carry proudly the whole acquisition goodwill on their balance sheet. I wonder how the auditors sign this on a subsidiary without sales ?
The rights issue
Propectuses for rights issues are a very good ssource of information, the one from S-r is no exception.
Especially the following paragraph makes clear, how severe the problems are:
Severfield-Rowen will be in breach of one or more covenants under the Existing Facilities on 18 March 2013, being the date of the General Meeting. A breach of any one of such covenants would be an event of default under the Existing Facilities entitling the Group’s lenders to demand immediate repayment of all outstanding amounts and cancel the facilities. As at 14 February 2013 the Group had net financial indebtedness of £44.0 million. In the event that Shareholders’ do not vote in favour of the Resolution and the Group’s lenders demanded repayment of all outstanding amounts and cancelled the Existing Facilities on 18 March 2013, the Group would have insufficient funds to repay the amounts outstanding. The Group would then immediately need to find alternative sources of funds to replace the funds that would have been made available pursuant to the Rights Issue and the Revised Facilities. The actions that the Group would then seek to take to make up the shortfall in its funding requirements (which the Directors believe would need to be pursued simultaneously and immediately), include seeking to negotiate a new facility agreement with its lenders; seeking to obtain a sufficient amount of alternative funding from other sources; seeking to dispose of some or all of its assets or businesses; and/or seeking to find a purchaser of the entire Group. The Directors are not confident that any of the above actions will be achievable. In the event that the alternative courses of action set out above fail, the Group
ultimately may have to cease trading at that time. As a result, Shareholders could lose their investment in the Company.
So it is pretty clear: A failure to get the rights issue approved will lead to a direct insolvency of the company.
Quick valuation exercise
We have seen that the business of S-R is clearly very cyclical. At the moment, the UK and S-R are clearly at a low part of the cycle. Also, years like 2006 and 2007 will not be repeated any time soon.
Over the full 1999-2012 cycle, S-R has an average net margin of 3.7%. The exactly same average is the result of the “Normal” years, taking out 2007-2009 and 2012.
So if S-R gets back to ~300 mn GBP sales, that could result in 11.1 mn GBP normalized earnings. After the capital increase,S-R will have 290 mn shares outstanding. This results ~ 3.7 cents normalized earnings per share or a “fair value per share” after the capital increase of around 37 pence.
In order to make this interesting, the price should be definitely cheaper than that, so I would only buy below 25 pence or so.
The rights have been split of on Tue, March 19th. The stocks are trading now around 0,37 GBP
Looking at Severfiled-Rowen in 1999 and 2011 is like looking at two different companies. Especially the misguided acquisition in 2007 lead the company in deep trouble. However, despite the very significant decrease in the share price, S-R is still not a real bargain due to the massive dilution of the rights issue.
Only if one believes in a short term recovery of the UK economy, S-R would be a “buy” right now. So for the time being “no action”.