SCT - Scott Tech

[Snoopy]

"Takeover Bid offers Premium"

Today I sent away my acceptance form to acquire more SCT shares at $1.39. I don't want to miss out on that! However, I have retained my voting form for the scheme of arrangement pending attending the Scott Technology investor roadshow.

There are a couple of major weaknesses in the Northington Partner's analysis that I am unhappy with. These are important because Northington's are using an EBITDA metric for valuation purposes. I believe both the 'I' and the 'DA' have not been adequately assessed by Northingtons. The result of these undervaluations is that true underlying EBITDA has been significantly undervalued by Northingtons and that in turn means their fair share valuation for SCT is too low.

SNOOPY

[Snoopy]

There are a couple of major weaknesses in the Northington Partner's analysis that I am unhappy with. These are important because Northington's are using an EBITDA metric for valuation purposes. I believe the 'I' has not been adequately assessed by Northingtons.

To provide the best example to understand this, shareholders need to go all the way back to AR2008 (Something Northingtons did not do) and look at the only clean set of accounts ever present for 'Robotic Technologies Limited' (RTL). RTL was Scott's first foray into robotic meat industry processing with Silver Fern farms. Under note 12 'Investments Under the Equity Method', the balance sheet for for RTL is presented like this:

Total Assets	$2.656m
Total Liabilities	$2.636m
Net Assets	$0.020m

(Note the above figures are for all of RTL . As a 50% owner, SCT have a half share in this debt as displayed)

As you can see RTL was leveraged to the hilt back in 2007. Not sure why. Perhaps is was because it was formed in one of those time periods when Silver Fern farms was short of capital to contribute? However, what is clear is that RTL as a stand alone business is not viable, and only exists in its heavily debt laden form because SCT is there to underwrite the risks.

Back in FY2007, just before SCT bought Rocklabs, SCT had no current or term debt. So where did the debt from the RTL balance sheet go? I contend it was hidden, because of the special accounting rules in conjunction with the introduction of IFRS that come with investment in associates. Quoting from AR2007 under 'Investments in Associates' p17

"Losses in an associate in excess of the groups interest (Snoopy comment: only $10,000 remember, and you can bet RTL cost more to get running that that) are recognised only to the extent that the group has incurred legal or constructive obligations or made payments on behalf of the associate."

I woudl be grateful if an actual accountant could verify if my interpretation is correct. But I can't see the SCT share of the RTL debt ( $2.636m/2= $1.318m ) on the SCT balance sheet for FY2007 anywhere.

So how much in interest charges in FY2007 were hidden? The bank interest rate for SCT in 2008 (when the acquired debt to fund the Rocklabs purchase p41, AR2007) was 9.81%

So: $1.318m x 0.0981 = $0.129m

Now $129,000 may not sound like much. But when you compare that to the loss (that's right loss) of $0.818m for the FY2007 financial year, it is not insignificant. Furthermore the number of associates has greatly increased since FY2007. And it appears that all of the newer associates are debt laden, like RTL, as well.

In summary, I contend that all 'hidden interest' should have been be added in to the EBITDA figures calculated by Northington's to give a more representative EBITDA figure. After all if the robotic technology was sold under the Scott Technology umbrella directly, they would have been added in. It was only the voluntary contruction of RTL by Scott that removed these interest costs from the equation

SNOOPY

[Snoopy]

There are a couple of major weaknesses in the Northington Partner's analysis that I am unhappy with. These are important because Northington's are using an EBITDA metric for valuation purposes. I believe both the 'DA' have not been adequately assessed by Northingtons.

Scott Technology have more many years had a policy of expensing all research and development costs. This is a conservative accounting policy and appropriate when you are unsure that the R&D expenditure you are making will be recovered in a clearly defined future project. I have no argument with the way SCT has implemented this policy.

The problem comes when as a result of the JBS bid, it now appears this investment will pay off big time. Total government grants or income tax credits relating to R&D add to $9.311m since FY2008. This means that on average the profit at SCT was:

0.72* ($9.311/8) = $840,000

less than it would have been if the R&D expenditure had instead been capitalised. To me the fact that JBS are prepared to spend an amount in the tens of millions of dollars to acquire this technology fully justifies giving it some value from hindsight perspective. Instead Northingtons have valued all this R&D spend as worthless (negative as it reducted EBIT) , and that is clearly wrong.

SNOOPY

[Carpenterjoe]

Scott Technology have more many years had a policy of expensing all research and development costs. This is a conservative accounting policy and appropriate when you are unsure that the R&D expenditure you are making will be recovered in a clearly defined future project. I have no argument with the way SCT has implemented this policy.

The problem comes when as a result of the JBS bid, it now appears this investment will pay off big time. Total government grants or income tax credits relating to R&D add to $9.311m since FY2008. This means that on average the profit at SCT was:

0.72* ($9.311/8) = $840,000

less than it would have been if the R&D expenditure had instead been capitalised. To me the fact that JBS are prepared to spend an amount in teh tens of millions of dollars to acquire this technology fully justifies giving it some value from hindsight perspective. Instead Northingtons have valued all this R&D spend as worthless (negative as it reducted EBIT) , and that is clearly wrong.

SNOOPY

To me the whole thing stinks of directors wanting to be the "big man" and "do" the big deal. I'm pretty sure if the small shareholders whom own 30% of this company had the opportunity to give a little, we might not been gifting half this company away!

[Sideshow Bob]

Farmers Weekly Article. Most major shareholders not selling.

http://viewer.zmags.com/publication/...d#/1e02a9ad/23

[Carpenterjoe]

Farmers Weekly Article. Most major shareholders not selling.

http://viewer.zmags.com/publication/...d#/1e02a9ad/23

Cheers mate,

[Snoopy]

Farmers Weekly Article. Most major shareholders not selling.

http://viewer.zmags.com/publication/...d#/1e02a9ad/23

Something doesn't quite add up here. From the above reference:

"Chairman Stuart Mclaughlin says that most larger sharehololders won't be selling their shares and they will take part in the planned capital raising."

Yet, what was the reason for the issue to be structured in the way it was?

http://www.odt.co.nz/news/business/3...-capital-boost

"Scott chairman Stuart McLauchlan said, when asked last Thursday why capital raising had been dropped, that some of the present larger shareholders were not prepared to inject more capital ''and would prefer to sit back''."

It hardly seems credible that both quotes have come from the same man, Stuart McLaughlin, the Chairman of the company!

Is some spin going on here? And if so to what end?

I would like to remind shareholders that the scheme is not a done deal (75% of shareholders need to vote for it) and if you want to vote against it, then you should. Personally I support a rights issue, but this rights issue seems far from ideal. So my inclination is to have a bob each way. Send in my cheque, in case the scheme of arrangement passes, but to vote against the rights issue in the hope that another will be drawn up on fairer terms to existing shareholders.

SNOOPY

[Under Surveillance]

I would like to remind shareholders that the scheme is not a done deal (75% of shareholders need to vote for it) and if you want to vote against it, then you should. Personally I support a rights issue, but this rights issue seems far from ideal. So my inclination is to have a bob each way. Send in my cheque, in case the scheme of arrangement passes, but to vote against the rights issue in the hope that another will be drawn up on fairer terms to existing shareholders.

SNOOPY

Certainly not a done deal, and I think highly unlikely to not become a done deal as it stands.

You get to vote full deal or no deal (i.e. can't vote for or against the rights component on its own).

If you send in your cheque and the full deal gets shot down you'll get your 139 cents back some time in December, no interest paid. If the deal as at present gets approved you might get the shares allocated by Christmas.

I've put my bob on the nose and bought more this morning at 140 (5.5 cent dividend attached). These shares get to vote against the scheme, whereas shares from the rights do not.

[Snoopy]

Certainly not a done deal, and I think highly unlikely to not become a done deal as it stands.

You may think the deal is highly unlikely to pass in its present form. But that doesn't mean you shouldn't plan for the possibility that it does pass.

You get to vote full deal or no deal (i.e. can't vote for or against the rights component on its own).

Quite right US. SCT can't have half this deal. It is all or nothing. Perhaps I should have been clearer in what I said. I will -probably- vote against the deal, although I feel I should hear the pre AGM Christchurch presentation at Deloitte's before finally deciding. If the deal is rejected, then I will not get the shares I asked for in the rights issue. However, if the deal goes through then I will be very happy to receive those rights issue shares bought at $1.39, accompanied by the certainty that the company will be well capitalised going forwards.

Also by subscribing the rights issue, if the deal goes through, then I am forcing JBS to stump up more capital on top of the stage one placement, to build their controlling share of 50.1%.

If you send in your cheque and the full deal gets shot down you'll get your 139 cents back some time in December, no interest paid. If the deal as at present gets approved you might get the shares allocated by Christmas.

I've put my bob on the nose and bought more this morning at 140 (5.5 cent dividend attached). These shares get to vote against the scheme, whereas shares from the rights do not.

I think a few weeks low interest on not that much amounts to not that much. So I won't lose any sleep over my lost interest. However I like your idea US of topping up cum dividend on market, and getting some more 'no' votes in the process. I might just do that too :-)

SNOOPY

[Snoopy]

Scott Technology have more many years had a policy of expensing all research and development costs. This is a conservative accounting policy and appropriate when you are unsure that the R&D expenditure you are making will be recovered in a clearly defined future project. I have no argument with the way SCT has implemented this policy.

<snip>
Total government grants or income tax credits relating to R&D add to $9.311m since FY2008.

Did a web search on these Callaghan Innovation R&D grants.

https://www.callaghaninnovation.govt.nz/grants

How does it work?

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Your business will receive:

20% of your eligible R&D expenditure, capped at $5m per annum
A two year extension after 3 years, subject to having met annual review requirements

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The government only reimburse 20% of R&D costs! So actual R&D is much higher than the government grant. Or is it? I would imagine pigeonholing just what is 'R&D' and what are 'normal business development expenses' is an area that has wriggle room. Any accountants (or others!) out there able to share some insights as to how this works in practice?

SNOOPY