The Security and Exchange Commission approved the purchase of 63% stake in Dangote Flour Mills by Tiger Brand (the South African Consumer food giant). I blogged about this potential acquisition some weeks back and explained how important it was for Dangote to sell down. This is Tiger Brand’s third acquisition in the sector, after acquiring major stakes in UAC and Deli Foods, and by far the most significant. Dangote Flour Mills fortunes have been on slide over the last few years as they face intense competition from smaller and major players in the industry.
According to reuters, Tiger Brand is paying $181.98m for a 63% stake in the company, valuing it at about $288.86m (N45b). The company currently has a market cap of about N38.55b as at Sep 24 2012 providing a control premium of 16.73%. On the surface, this looks like a good deal for Tiger Brand considering Dangote Flour Mills is thought to occupy about 30% of the market. However, the company has over the years posted declining profits and recently just announced a first quarter pre-tax loss of N90.4m. Its Post Tax earnings has declined 80% to N1.1 from it’s highs of N5.5b in 2009. What exactly happened? For both the company and group growth in Turnover has declined rapidly over the years as they remain stifled in competition. Selling General and Admin expenses has remained stubbornly high eating up 61% of Gross Profit in 2011 alone and 53% in 2010. The situation is even worse for the company as SG & A doubled to 42% of Gross Profit as against 27% in 2010. For a company like this it is important to grow revenues steadily at growth rates not less than 15% annually, however revenue growth over the last five years have come at a CAGR of 9% (for the Group). Thus reflecting the meagre 3% growth in revenue over the last three years. But was all this a reason for them to sell up to 63%? The cash flow situation of the group provides an insight into why .
The company generated ebitda of about N7.3b annually a figure that provides a margin of 11% indicating high operational cost. This leaves the company with very little room to fund itself organically and exposes it to internal shocks should trade debtors fail to pay up and suppliers refuse to give credit. It’s no surprise the company posted a negative operational cash flow N6.6b in the financial year ending December 2012. Whilst they paid suppliers and employees 42% more cash in 2011 when compared to 2011 they received just 6% more in payment from suppliers respectively. Thus cash equivalents for the end of the year was a whopping negative N20.8b with overdrafts accounting for all of it.
What is in it for Tiger Brand despite all the gloom? Tiger Brand is acquiring a controlling stake in the company at a price of 25X its trailing annual pre-tax profits (before exceptional items) a multiple that may have been just 9X in 2010. Basically, the acquisition is probably being consummated at the right time, at a time when the bottom line is caving in and threatening to drag the company into insolvency. Tiger Brand will now provide the company with the lifeline it requires, leveraging on its acquisition of Deli and UAC to reign in on competition and ensure price stability. The company gets to control of a strong reserve of N5.8b which will provide a good foundation for its revamp. It can kill off the noodles business of the group which has dragged the rest of its segments down in losses (N1.9b last year) as Deli foods probably provides a better platform to continue. This alone can save the company almost N2b annually in operating cost. The Pasta segment can be restructured to ensure better efficiency and repositioned for revenue growth as it has the brand presence to achieve both. Tiger Brand may also need to stump up another N20b in cash to ensure the company has the liquidity it so badly lacks. It owes over N50b in creditors with banks and owning N23b of that and suppliers N4.7b. The probability of its over N8b debtors coming up with the cash is very little reason why last year it wrote off over N1.4b in bad debts from its books.
For Investors, most will see this as an opportuity to buy, buy and buy. Their share price has risen 27% year to date despite reporting dismal results. This probably reflects optimism on the side of some. For me, the company will have to do better than the pre-tax 7% return on equity it posted last year and back to the 18% it churned out the year before and 19% in 2009. Those were the times.