Ann: Skilled Group to be acquired by Programmed, page-20

Every now and then – maybe just once or twice a year - a situation pops up and, for whatever reason, the normally-efficient market fails to comprehend what’s happening.

When this sort of rare event occurs, it pays to be prepared, having done all the modelling of various scenarios, and to act with conviction.

This PRG-SEK transaction is such a case.

Now that the terms of the deal have been finalised, and there is negligible chance of the transaction not completing, it is a worthwhile exercise to look at the pro-forma numbers.

Based on the current PRG share price of $2.85 and the terms of the transaction, this theoretical SKE share price is $1.70.
[derived by: $2.85 x 0.55 (scrip component) plus $0.25 (cash component) less $0.115 (the PRG dividend to which SKE shareholders are not entitled)].

With the SKE share price already trading at that level, the market is effectively saying that the deal is 100% sure to go ahead.

My view on this is that finalising this deal will not be a problem, because the overwhelming majority of SKE shareholders, especially the financially literate, institutional ones, will understand that the alternative is not a particularly attractive one (i.e., a SKE share price closer to $1.00 and the company probably cum- a capital raising, to boot.), and the 75% required vote from shareholders will be forthcoming.

So let’s take a look at PRG post the acquisition of SKE:

Total Shares on Issue (SoI) will be 248m (PRG’s current 118.3m plus 0.55 x SKE’s current 235.9m SoI)
So, Market Cap = $707m

NIBD will be around $250m (SKE’s current $185m of NIBD less PRG’s $11m net cash plus $59m for the $0.25 cash component payout plus $14m for PRG’s full-year dividend)

So Enterprise Value = $950m, approximately.

Now:

Combined FY16 EBITDA will be $160m (PRG’s $61m plus SKE’s $80m plus $20m of synergies)

Combined FY16 EBIT will be $135m (PRG’s $49m plus SKE’s $65m plus $20m of synergies)

Combined FY16 NPAT will be $84m (PRG’s $29m plus SKE’s $17m plus tax-adjusted synergies of $14m)
On a per share basis, that’s around 34cps.

(Note: By way of conservativeness, I have not included the full synergies of $35m, as upgraded by today’s announcements)

And then, in valuation terms, it looks like this:

P/E = 8.4x
EV/EBITDA = 5.9x
DY = 6% (assuming a modest 50% payout ratio)

While this is not a great quality business, I still think investors will be happy to pay 12x P/E and 7.0x EV/EBITDA for the PRG once the market has digested the benefits of the deal and as the execution risks become diminished. (By way of referencing, those multiple are about where PRG has traded in the past.)

Assuming those multiples – which would still be at reassuring 25% to 30% discounts to the broader market – it implies a share price approaching $4.00 per share.

While it might not get there overnight, at the current valuation metrics (almost half the level of the broader market), there appears to me to be to be limited downside from here, with 30% to 40% upside.

Those are the sort of market odds I like to play.