There’s a rule of thumb around the market that says “beware when Kerry Packer sells”. So why, if Packer wants to sell Hoyts, is it such a compelling deal for PBL?

As expected all the “non-associated directors” of PBL have stuck their hands up and recommended to non-Packer shareholders that the deal to buy 50% of Hoyts movie business from Consolidated Press, should go ahead.

The non-associated directors of PBL (not associated with Kerry Packer and his private group, Consolidated Press Holdings) have recommended that PBL shareholders vote in favour of the deal at a meeting of shareholders in early March. And, of course, they will.

PBL announced last month that it was joining with West Australian Newspapers to do the deal. WAN will put in just over $173 million in cash, while PBL will issue shares to the same value to CPH. That will result in the CPH-Packer stake in PBL rising around one per cent to 38.4%.

The recommendation and independent report is available here.

But nowhere in the report does anyone explain why, after several years of very mixed financial results, Kerry Packer wants to quit Hoyts. And, why, if Packer wants to sell Hoyts, is it such a compelling deal for PBL?

That question was not raised in anyway or addressed in the independent report or by directors. A big omission!

It hasn’t been the greatest of deals since CPH bought it in the late 80s. Underperforming international businesses in the US, Europe and South America have been sold off leaving only the cinemas in Australia and New Zealand, plus the Val Morgan advertising business, some distribution and DVD producing operations.

Under the influence of Kerry Packer and his CPH group of managers, Hoyts has become a much smaller company in the past seven years.

It takes special talent to take a company private and shrink it. The whole idea of buyouts by private equity is to grow the business and sell it for more down the track, like Pacific Brands or Repco, for example.

But not in the case of Hoyts and no explanation as to why CPH and Packer want to quit this investment now.

There’s a rule of thumb around the market that says “beware when Kerry Packer sells”. Investors say he has a habit of trying to buy low and sell high and extract the most value out of an investment.

The rationale behind PBL is simple. It is an in-house outlet for Packer to quit this investment. West Australian Newspapers’ involvement is simply roping in the largest and most profitable and important media business in Perth, where PBL has just spent more than $700 million buying Burswood casino.

Hoyts has movie screens in the West and PBL’s Nine Network has a franchised outlet in NWS 9 owned by Sunraysia TV.

There is one dodgy part about the deal, it is valued and being sold to investors on a valuation that’s based on earnings before interest, tax and depreciation, or EBITDA.

That’s a phoney baloney valuation. It assumes businesses do not pay tax or have to provide depreciation. Both are required to be paid(unless losses or other claims reduce the tax bill, a specialty of the Packer interests).

In all respects it’s really a valuation based on cash flow, because essentially that’s what EBITDA measures (with one or two writebacks). Alan Kohler had a very good column on the use of EBITDA valuations in the Fosters takeover of Southcorp. His comments are equally as valid in this transaction about the use of EBITDA multiples to value transactions.

They give a misleading multiple that understates the true cost to the company or companies doing the acquiring.

Kohler writes:

“One of the most insidious and dangerous developments in modern business analysis is the creeping use of EBITDA instead of net profit. EBITDA stands for earnings before interest, tax, depreciation and amortisation”.

Cashflow greases the wheels of business and is essential, profits enable investors to be paid and profits plus depreciation and amortisation allow capital expenditure to be maintained to enable the business to grow. Cashflow is not available to the owners of the business, they have profits, but only after depreciation, amortisation and tax are charged.

According to the independent report Hoyts earnings fell in 2004 (the accounts are unaudited) compared to 2003. The year to December say EBITDA of only $48.495 million, compared to $99.427 million in 2003(that was boosted by writebacks and other provisions).

Operating profit after tax though was only $27.4 million, compared to $74.47 million.

Tax in 2003 related to a net positive claim to Hoyts of $1.755 million, while in 2004 Hoyts had to pay a mere $683,000 in tax.

I told you the Cons Press businesses are specials in reducing their tax bills.

A more normal tax bill would have cut net earnings by around $6 million or so to only $20 million.

Now the 2003 result was boosted by provisions and “normalised” earnings (a great word normalised, that’s how PBL describes its half yearly and annual results to try and take account of the impact of the high rollers business at Crown. It sounds like accounting ledger main) would see 2004 earnings of around $51.9 million compared to $50.2 million last year. Those adjustments would have slashed 2003’s EBITDA by $49.22 million and boosted 2004’s by $3.4 million.

Convenient. But a “normalised after tax result was not given”.

Using a multiple based on the after tax profit would produce a price that was more than 14 times earnings (not EBITDA).

PBL itself is valued on a multiple using net earnings as the base, not EBITDA.

Its P/E is more than 14 times earnings at the moment, meaning that the Hoyts deal is valued the same as PBL(using net earnings) or slightly more.

That makes it a very expensive deal to shareholders.

Probably the most important figure in the brief financials was not discussed by the Independent Experts.

It was the small fall in revenue, from $284.54 million in 2003, to $284.28 million last year.

That’s pretty appalling and yet the independent report and directors chat talk a lot about boosting food sales, sales of DVDs, improving returns from existing business, ‘cross platform synergies” with PBL and WAN.

But not why revenue(from movie tickets, Val Morgan food sales etc slipped in 2004)

Other revenue and joint venture profits, none of which was operational, boosted the total revenue figure to $305.887 million, up marginally from 2003’s $304.6 million.

Pie in the sky stuff when Hoyts management couldn’t drive topline revenue. In fact the earnings picture was made to look better by a reduction in what Hoyts paid to suppliers and employees.

According to the cash flow analysis, that payment fell from $265.3 million in 2003 to $247.18 million.

So earnings were maintained by chiseling suppliers and employees (and employment levels in all reality). Hoyts isn’t the healthiest of businesses.

Another justification from directors for approving the deal is to expand in WA, but a breakdown on where Hoyts operates shows that WA is one of its major markets. Hoyts is grossly underrepresented in the growing Queensland market where Amalgamated Holdings has a strong base.

That would have been far more sensible a reason than the silly one trotted out:

“The Joint Venture represents an opportunity to partner with WAN…..to further improve the performance of the Hoyts business generally and specifically in Western Australia.”

Gee, the same document says Hoyts has “significant presence in NSW, Victoria, the ACT and Western Australia”. Where will the future benefits come from?

Finally the non-associated directors.

Chris Anderson is a newbie on the board and was the lead director for this deal. But also named were Robert Whyte, Rowena Danziger, Rowen Craigie, who runs the gambling business for PBL and John Alexander, the $25 million man. Sam Chisholm is also listed.

All are associated with Packer (except Anderson) by previous or present board service, some lengthy.

Craigie and Alexander are the most senior executives of PBL on the board.

Alexander’s bonus component and his deferred bonus component of his package (they could total up to and more than $3 million a year) depend in part on this deal going through and helping to maintain the PBL share price at its current high level (around $16.40).

That’s hardly the stuff of an independent thinking, non-associated director.

If this deal was knocked back, earnings in 2006 could be lower and the share price would fall and his bonus payments might not be as large.

So he has every incentive to want this deal to go through.

Peter Fray

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