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API investor Andy Gracey wary of Sigma Healthcare merger


Australian Pharmaceutical Industries investor Andy Gracey says a proposal from the drug wholesaler to merge with Sigma Healthcare throws a lifeline to an under-pressure rival and is bad for shareholders.

The Australian Ethical portfolio manager, who controls about 3 per cent of the drug wholesaler and pharmacy marketing outfit, said he struggled to see how the $1 billion-plus merger benefited API investors.

"We're not particularly comfortable with the bid in terms of we think Sigma was in a tough situation and it feels like API is kind of handing them a pretty reasonable opportunity, and to the detriment of API shareholders," he said. "We feel like we're giving away more than we're getting."

API and Sigma are competitors in the $14 billion pharmaceutical wholesaling business alongside a third ASX-listed player, EBOS. The three operate in a highly regulated, government-subsidised sector, to deliver prescription and over-the-counter medicines to pharmacies around the country. Each wholesaler has exclusive distribution and support agreements with different brands – such as API and Priceline, or Sigma and Amcal.

Sigma investors got a shock in mid-2018 when the pharmacy industry gorilla Chemist Warehouse pulled its agreement in favour of a new exclusive distribution contract with EBOS.

API shares collapsed in the weeks after the proposed merger was announced on December 14, but are back trading at the $1.48 level they were at previously. The shares are flat over the year and at current levels are trading well below a 12-month high of $1.935 hit in September.

Earnings target

Sigma shares are down 32 per cent in the past year, mostly due to concerns about its earnings prospects after losing the Chemist Warehouse contract. They jumped 44 per cent to 58¢ on the merger news and have traded around that level since. The stock, however, has lost 32 per cent in the past year.

Given that change to its business Mr Gracey said he is concerned that Sigma's 2020 earnings target of $40 million to $50 million is "overly optimistic". Similarly, estimates from Sigma that losing the Chemist Warehouse contract will free up about $300 million in working capital may underestimate what's required to run the remaining business, he said.

Under the proposal API is seeking to buy out Sigma investors in a mixture of 0.31 API shares and 23¢ cash for each Sigma share.
Mr Gracey said he would prefer a pure-scrip merger that reflects a more equal sharing of synergies using a lower implied valuation for Sigma.
API will face investors in Sydney on Wednesday at its annual general meeting.

API director Robert Millner, who runs major shareholder Washington H. Soul Pattinson, said it was "a good deal for both companies".
"What's happening with Chemist Warehouse going to EBOS, they're going to have a vast majority of the market," he said. "It's a very low-margin business and by putting the two companies together you're going to get a lot of synergies."

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