Engineering and construction support services provider Downer EDI Limited (ASX:DOW) has nearly completed a hostile takeover of embattled catering and cleaning services company Spotless Group Limited (ASX:SPT). DOW now holds more than 70% of the company, and has offered minority shareholders an unconditional offer of $1.15 per share ($1.2 billion market capitalisation), a nearly 60% premium on the price prior to takeover news hit the wire in Mar’17.
Downer, a dominant $4 billion entity in the diversified support services space, is looking for new avenues to grow its earnings amid a stagnant top-line and a limited growth potential of some of its key end-markets: mining; rail; and technology and communications. With limited growth channels, Downer decided to at least grow in size and, to do that, it chose the most expensive method — an acquisition.
The deal is backed by CEO Grant Fenn’s narrative of high growth forecasts in the health and education industry, which DOW can capitalise through Spotless, along with plans to seek market-share gains in what he calls a “disaggregated industry”. Last month, Spotless signed its biggest public-private partnership deal with Royal Adelaide Hospital.
DOW shareholders completely rejected the idea in the beginning. Company shares fell more than 20% to $5.60-mark in a day when it announced the takeover-bid by raising $1 billion through equity offering ($5.95 per share) at a 20% discount to the then market price of over $7. A drop in acquirer’s share is common as investors are skeptical about value proposition, but this big a drop clearly indicated that Spotless was offered too high a price.
Mr Fenn took some time before making a statement last month that he miscalculated the extent of the unpopularity of Spotless among investors, who have some strong reasons for such an opinion. Spotless has a high debt to equity ratio of nearly 200% and a net debt to EBITDA (leverage) of 3.2 compared to DOW’s nearly zero net debt.
DOW shares have recovered since, although they are still down more than 10% against the price before the acquisition. Mr Fenn is optimistic about the future. DOW’s management has an impressive track record; however, the history of horizontal expansions in markets that grow in low-single digits doesn’t suggest a very bright outcome.