Is the Rexam Bid a Can of Worms?

By Robert Sutherland Smith.

It seems that British canning company Rexam (REX) is about to be grabbed by its US competitor the Balls Corporation of Colorado. There is none of the history and social role regarding the company’s history of the UK that was associated with the bid for Cadbury’s. So this is a bid that will get far less media coverage and provoke less public emotion. A can of soft drink does not have the emotive appeal of a Cadbury’s bar of fruit and nut.  

The Rexam share price last seen was 518p – a goodly discount to the reported bid value of 610p.

So is this an opportunity for canny investors (my last can joke I promise you) to buy the shares for a decent profit and, hopefully, an even bigger bid?

The 92p per share discrepancy between the reported bid price and the actual market price of a last seen 518p represents a 15% discount to the reported bid value. That is clearly not accounted for by the cost of being out of the money – the kind of nice calculations that institutions do when judging the financial opportunity cost of what they might lose by having money in the shares until the actual bid occurs, or keeping the money in an interest bearing deposit of some kind. The gap is too great to be explained in that way. Clearly the gap is indicative of something else.

The gap must be discounting the market’s belief that this is one bid too far, so far as the competition authorities in the USA and Europe are concerned. Reports suggest that the combined companies would have a market share of 70% in Europe and 60% in the USA. In other words, this a bid that is bound to rouse the sleeping dogs of competition regulators and a probable ultimate refusal to such an alliance.

In the UK it might also look bad politically with another chunk of corporation tax going off shore for ever. It seems likely at this stage that the newly merged company would be incorporated in the US to avoid the ire of US politicians who have even stronger feelings about corporation tax receipts. The Luton Head office would probably be closed to save costs and its functions, no doubt, moved to Broomfield in the Rocky Mountains of Colorado. Not the sort of stuff that the government will wish journalists to be turning over before a UK general election.    

Moreover, for competition reasons, this is not yet a formal bid. There have been talks and it looks as though the terms are agreeable to the Rexam Board. Newspapers say that Rexam thinks the bid has much logic – as well as the reported potential to enrich its CEO by some £10 million (a by no means trivial consideration). That logic probably includes the fact that Ball Corporation has no revenue growth with which to generate profits and its net margin is only 6% on a return to asset figure of 6.6%. This looks like an efficiently run business in a highly competitive market. However, Balls is highly geared. Debt was 256% of equity last year. So with low net margins, little in the way of sales growth – in fact a consensus estimated small decline – and very high gearing, Balls Corporation has little option but to seek an acquisition to achieve growth. Rexam would in all probability add an extra 40% of top line revenue on a slightly higher net margin of a reported 7.3% – and more besides if one knocks out the costs of independent operation.  

At 518p Rexam shares are valued at (according to market consensus earnings) a forecast PER 14.5 times earnings for the year just ended, 14.9 times for this year and 14.1 times for next year. That does not look good value in relation to earning growth estimates of 4.2% from historic 2013 earnings of 35.3p in 2013 to 36.8p in 2016.

There is of course a useful estimated 3.4% yield for the year just ended. But that has to be seen against a deteriorating cash position. In 2013 there was operating cash flow of £409 million to cover investment and dividend costs of £388 million. Year end cash in December 2013 was a mere £191 million contrasting with £1.2 billion in 2012. With a book value of attributable assets of a reported 188p the shares on that basis do not look attractive. Unless the corporate finance department can find some compelling arguments with which to wave through this bid on competition grounds – arguments that do not look likely – I would not chase Rexam shares at this level. If there is no bid, they might well crash back down to January’s pre bid price of 427p. They look more of a sell than a buy to me. There are better fish to fry, I think.