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Henry Thornton - Economics: A discussion of economic, social and political issues Peter Kirby`s successors destroy his legacy Date 17/11/2008
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CSR - formerly Colonial Sugar Refining Company, is a business that has lost direction. To increase, or even retain, shareholder value, CSR must face the music and break-up, before the dispersed nature of its business causes more value destruction.
By Paul Kerin Email / Print

CEO denial is amazing. They grow empires, even when their bits are completely unrelated and break-ups can realise value.


Former CSR CEO Peter Kirby was an exception. His vigorous restructuring delivered enormous value. But his first successor wasted his legacy -- and his second successor is destroying it. CSR must be broken up before it's too late.


Kirby, an outsider hired to fix the mess following Geoff Kells' growth fixation and failure to deliver earnings, made 25 acquisitions and 22 divestments, focusing CSR on heavy construction materials (which became Rinker).


After five years, he demerged Rinker from the CSR rump (building materials, sugar and aluminium). Even this last act created substantial value.


CSR's price rose 21 per cent (over the market) - worth over $1 billion in shareholder value - in the four months between demerger proposal and approval.


Rinker shareholders later gained about $12 billion when Cemex acquired it.


Post-demerger, Alec Brennan ran the CSR conglomerate.


Its three businesses made no sense together. Investors expected a break-up, but Brennan was content to coast. As each business was a cash cow, he was under little pressure. He paid lip-service to the break-up proponents.


But at least he gave most of the cash back to shareholders rather than wasting it.


During Brennan's term, CSR shareholders enjoyed total annual returns about 1 per cent per annum below the ASX200 Industrials index. When CSR announced Brennan's retirement - and, later, under his successor Jerry Maycock - CSR's share price rose (relative to the index) by 1.6 and 3.1 per cent, respectively.


These announcements raised break-up hopes that had died under Brennan, particularly as Maycock was (like Kirby) an outsider with restructuring experience.


Like Brennan, Maycock paid lip-service to break-up proponents. Unlike Brennan - but like Kells - his growth fixation led him to spend shareholder cash freely and miss earnings targets.


Under Kirby's demerger proposal, CSR was to be a high-yield/low-growth stock, with a 60-70 per cent payout ratio, low gearing (25 per cent) and high interest cover (15 times).


It would pursue "low-risk growth options" that "didn't need big licks of capital". Brennan stuck to that strategy. In the year ended March 2007, Brennan's last year, dividend payout was 54.7 per cent, gearing 25.3 per cent and interest cover 15.4.


He also distributed substantial cash to shareholders through buybacks and a capital return.


In both 2007 and 2006, total distributions to shareholders exceeded after-tax profits.


Capital expenditure was tight and he spent only $13.4 million on acquisitions in his last two years. In four years, Brennan raised EPS 48.4 per cent to 27c -- partly by using buybacks to cut shares outstanding.


Maycock inherited Brennan's CSR on April Fool's Day last year.


His growth-fixation manifested itself quickly. Within three months, he paid $690 million for Pilkington Glass, saying "CSR needs a growth profile" and "we have no plans to break up".


This deal required "big licks" and wasn't low-risk: the price represented 23 per cent of CSR's market capitalisation.


Break-up proponents took heart when corporate raider Ron Brierley bought 6 per cent of CSR days later.


But when Maycock announced a second glass manufacturer acquisition (DMS) for $175 million and a capital raising to fund it, CSR dropped 6.9 per cent - more than DMS' entire acquisition price.


In Maycock's first year, EPS fell 22.6 per cent. There were no buybacks or capital returns. Instead of returning cash to shareholders, Maycock spent it. Acquisitions jumped from $7.7 million to $890 million in 08. Capital expenditure leapt from $241.1 million $379.6 million in 2008.


In 18 months, gearing went from 25.3 per cent to 44.5 per cent and interest cover from 15.4 to 5.2. While Brennan cut shares outstanding 7.2 per cent, Maycock grew them 16.6 per cent, further diluting EPS.


He did deliver a high payout (76.5 per cent in 2008), but only because EPS fell.


On November 5, Maycock trumpeted 12 per cent half-year EBIT growth. But that's easy to do -- just buy things! As his acquisitions added less to EBIT than they did to financing costs, profits fell.


Last Thursday. CSR called a trading halt, saying that "in light of market conditions" it was "reviewing capital management initiatives to strengthen its balance sheet".


Its market capitalisation had plummeted to $1.8 billion and rumours suggest it's looking for a $400 million equity injection.


This would come at a big discount, diluting shareholders even further.


CSR's predicament isn't bad luck due to tough financial markets. It reflects dumb strategy.


Brennan, Maycock and chairman Ian Blackburne have all wheeled out tired rationalisations - like "reduced earnings volatility" for keeping CSR intact.


But that adds no value - as Kirby's de-merger prospectus emphasised, "shareholders can achieve diversification through their own investments".


Maycock, like Brennan, has repeatedly used the well-worn "not now" rationalisation. Brennan said wait until "all businesses are firing". Maycock says share, building product and sugar prices are all down and the benefits from his capital/acquisition investments are yet to be reflected in CSR's share price.


None of these arguments stack up.


If we de-merge, shareholders in the sugar and building products businesses will still gain if/when their prices and/or the share market rises. Investments are business-specific, so those businesses will benefit if the market comes to think they're more valuable.


Trade sales shouldn't wait either.


Trade buyers can forecast commodity prices as well as Maycock can.


They can do due diligence on the future benefits of his investments. Even with a cash trade sale, shareholders could reinvest that cash in the market and therefore benefit from an upturn.


So breaking-up now isn't risky for shareholders. It's riskier for Maycock, as the market would realise that trade buyers see little value in his investment spree.


But delaying a break-up is costly. CSR's assets can earn better returns post-break-up. Delays reduce and defer those gains. Time is money.


Investors know that deferring break-ups is costly. On November 7, Orica deferred indefinitely its Consumer Products demerger. Orica's share price dropped 4.2 per cent (relative to the ASX200 Materials index), wiping $385 million off shareholder value.


Given CSR's plummeting share price, a raider could swoop, break it up and make a killing.


Shareholders should force a break-up now, rather than hand much of the potential value to a raider.


That's much better than letting Maycock dilute their stake even more in a vain attempt to maintain/grow a defunct conglomerate. Shareholders should put CSR out of its misery.


Paul Kerin is a Professorial Fellow, Strategy, at Melbourne Business School.


p.kerin@mbs.edu


As published in The Australian on November 17, 2008.

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