As small shareholders in WA News contemplate double-digit capital losses courtesy of its board’s tolerance of an over-priced related party transaction put up by Kerry Stokes, the bean counters at Fairfax Media should be frenetically crunching the numbers on an alternative proposal.
A Fairfax deal with WA News has been talked about for decades but never come to fruition. It is the most logical newspaper merger in Australia given that competition regulators would never allow News Ltd to further extend its majority position.
While Greg Hywood is a babe in the wood as Fairfax CEO, the proposed $4.1 billion purchase of Seven Media Group presents a unique opportunity because truckloads of new WA News shares are being issued and the share price has tanked.
Fairfax is generating plenty of cash and has reduced its debt to $1.2 billion, so it has some capacity to move. It could comfortably snap up 20% of WAN on market for about $300 million. WAN is forecast to generate EBITDA of $175 million in 2010-11 and with low debt represents a relatively low-risk investment, albeit in a declining industry.
WA News is vulnerable. Its shares have badly underperformed from their recent peak of $8.44 in April 2010. On November 16 last year it was still trading as high as $7.30, but then steadily declined as the deal was negotiated over the past few months. It was down to $6.34 by the time we got an announcement and on Friday it closed at $5.58.
The whole SMG deal is off if shareholders vote it down on April 11 and Stokes can’t vote his 24% stake. It would be very easy for Fairfax to pick up a blocking stake big enough to vote down the deal. Perhaps it should simply stand in the market at $6.34 and offer to take WAN’s 26,700 retail shareholders back to the place they were at a week ago.
The brutal truth of this situation is that anyone who buys a business from KKR is probably paying over odds. Stokes doesn’t mind because for him there are additional benefits of retaining control and keeping his tax bill down.
When you exclude the existing 24% Stokes stake in WA News, the company is exactly 50-50% owned by institutional and retail investors. The institutions have already subscribed for 90% of their accelerated 4-for-7 entitlement offer at $5.20 and the $326 million retail offer opens this week.
Retail investors are being shafted because the offer is not renounceable, there is no bookbuild to sell any shortfall and there is no ability to apply for “overs” to take up the slack from investors who decline the offer.
When you look back at take-up rates in other comparable retail offers over the years, it is highly unlikely small investors will stump up more than $200 million.
This will allow the in-the-money shortfall to be allocated to the institutional clients of the two underwriters, UBS and JP Morgan, who will also be pocketing a tidy $26 million in fees. Retail investors currently own 38% of WAN but under this deal they will be diluted to below 20% in what constitutes a collective shafting while institutions, a billionaire media mogul, KKR and two global investment banks will benefit.
At some point retail investors need to take a stand to protect themselves from capital raisings that are deliberately structured to dilute them. Sure, they can always take up the offer but the board knows that a majority probably won’t. Who is looking after them?
This is precisely the argument that Fairfax should mount in snapping up a blocking stake and then potentially launching a scrip-based merger.
While Stokes would obviously rage against any spoiling tactic, the funny thing about a Fairfax bid for WAN is that Stokes probably wouldn’t mind rolling his existing 24% stake into a seat at the Fairfax table next to the Fairfax family with their 10% stake.
Greg Hywood is promising to be a more assertive Fairfax CEO who stands up for the company. There would be no better way to re-assert the Fairfax mojo than to enter the fray for WAN at a time when its share price is unusually slow and the non-Stokes shareholders are feeling shafted.