SCT - Scott Tech

[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 '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.

Time to revisit the four full years of results considered by Northington partners. The table below is derived from Table 6 on page 22 of the Northington report.

	FY2011	FY2012	FY2013	FY2014	FY2015
EBITDA (Northingtons) (A)	$5.043m	$8.941m	$8.223m	$6.021m	$10.904m
SCT term borrowing rate	N/A	N/A	N/A	5.21%	4.78%
Net hidden associate debt	$7.241m	$7.089m	$5.368m	$5.540m	$5.972m
Net hidden interest (@5%)(B)	$0.362m	$0.354m	$0.268m	$0.277m	$0.299m
Govt R&D Grant	$1.877m	$2.558m	$2.509m	$1.498m	$0.673m
2 x Govt R&D Grant (C)	$3.754m	$5.166m	$5.018m	$2.996m	$1.346m
EBITDA (Snoopy) (A+B+C)	$9.159m	$14.411m	$13.509m	$9.294m	$12.549m

So the adjusted EBITDA average over the last 5 years has been $11.784m.

Note: Assuming the R&D expenditure was capitalised rather than expensed has produced the biggest change from the 'two' Northington Partner's approach. How much the capitalisation should be is a matter of judgement. I am assuming that the Callagahan R&D cover half of the 'real' R&D spend (so real spend was $18.28m over 5 years). I think that assumption is generally conservative.

SNOOPY NORTHINGTON (the third 'partner' from the Northington kennel)

[Snoopy]

So the adjusted EBITDA average over the last 5 years has been $11.784m.

Note: Assuming the R&D expenditure was capitalised rather than expensed has prodiuced the biggest change from the 'two' Northington Partner's approach. How much the capitalisation should be is a matter of judgement. I am assuming that the Callagahan R&D cover half of the 'real' R&D spend (so real spend was $18.28m over 5 years). I think that assumption is generally conservative.

I now move onto table 9 in the Northington report

	Low	High
Maintainable EBITDA	$11.800m	$12.300m
Valuation Multiple	7.5x	8.0x
Enterprise Value (000s)	$88.500m	$98.400m
less Net Debt (000s)	$18.200m	$18.200m
Aggregate Equity Value (000s)	$70.300m	$80.200m
No. shares on issue	48.474m	48.474m
Value Per Share	$1.45	$1.65

Note that the above figures do not include a premium for control. This is in contrast to the statement on page 7 of the 'original' Northington report which states:

"Our valuation is based on 100% of equity in Scott and therefore includes a premium for control"

(my emphasis on the italics). The statement 'that analyzing 100% of a company automatically includes a premium for control' is not true, and represents a serious error of judgement in the original Northington report IMO!

A modest premium for control of 10% would see a fair value takeover price between $1.60 and $1.82.

Thus my conclusion: A $1.39 bid for control is well outside the fair value range of SCT as determined by the 'three' Northington partners. Shareholders should reject the JBS bid

SNOOPY

[Under Surveillance]

A modest premium for control of 10% would see a fair value takeover price between $1.60 and $1.82.

Thus my conclusion: A $1.39 bid for control is well outside the fair value range of SCT as determined by the 'three' Northington partners. Shareholders should reject the JBS bid

Good work, Snoopy.
You've arrived at much the conclusion I came to a month back, post #456, when I reckoned JBS if serious would need to bump the offer price up 30%. 1.39 x 1.3 = 1.81.

[Under Surveillance]

1) SCT directors have raised no disagreement with the Northington Partners valuation of SCT shares at $1.08 to $1.26.

SCT directors unanimously recommend SCT shareholders support a deal with JBS whereby the shareholders may buy new SCT shares for $1.39, i.e. 110% to 129% of the Northington valuations. SCT directors have not attempted to justify the premium shareholders would pay.

Question arising: What does that say about the directors' exercising of their fiduciary responsibility to shareholders?

2) SCT directors have not challenged the Northington valuations, and have unanimously recommended a deal whereby JBS will pay SCT shareholders $1.39 for their shares, and SCT will issue new shares to JBS for $1.39.

Questions arising: Does it follow that the SCT directors are morally obligated to sell shares they hold personally to JBS at $1.39? Or is it do as we say but not as we do?

[Snoopy]

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.

Thanks for the heads up with your idea U.S. Bought a few more shares on market over the last few days to increase my (probable) 'no' vote to the scheme of arrangement. Meanwhile Scotts have wasted no time hungrily banking my rights cheque!

SNOOPY

[Snoopy]

1) SCT directors have raised no disagreement with the Northington Partners valuation of SCT shares at $1.08 to $1.26.

SCT directors unanimously recommend SCT shareholders support a deal with JBS whereby the shareholders may buy new SCT shares for $1.39, i.e. 110% to 129% of the Northington valuations. SCT directors have not attempted to justify the premium shareholders would pay.

Not quite true. Included in Statement 39a of the directors recommendation is the following text.

"The directors believe that the Company has developed and will continue to develop intellectual property which may create future value that is not fully incorporated into the Independent Adviser's valuation range. If the scheme of arrangement is approved, the directors suggest that shareholders need to be mindful of the Company's intellectual property and its possible value when considering their personal decision in relation to their shareholdings in the Compoany (for example in deciding whether to sell to JBS , hold or invest more by taking up the rights offer"

Translation: "You shareholders that prefer to 'sit back' really are getting a good deal by selling your shares to JBS." BUT "You shareholders that want to stay really are getting a good deal by buying new shares in the company at $1.39." "You see, we really can please everybody."

Question arising: What does that say about the directors' exercising of their fiduciary responsibility to shareholders?

Wash your mouth out with soap U.S. You really shouldn't be asking such a question of such nice people. Just start singing "everybody wins" and you will be fine.

2) SCT directors have not challenged the Northington valuations, and have unanimously recommended a deal whereby JBS will pay SCT shareholders $1.39 for their shares, and SCT will issue new shares to JBS for $1.39.

Questions arising: Does it follow that the SCT directors are morally obligated to sell shares they hold personally to JBS at $1.39? Or is it do as we say but not as we do?

The latter obviously. Now line up behind the nice man with the shepherd's crook and stop bleating.

SNOOPY

[GTM 3442]

I am a small shareholder in SCT. I think this sucks.

Speaking (as always) from a position of ignorance, it sucks because:


1) I don't like it from an "NZ Inc" perspective. The country loses more than it gains.

2) I don't believe that selling a diverse company such as SCT to a customer will lead to anything other than the atrophy and eventual divestment of the non-meat technology. I don't believe the stuff in the presentation about "business as usual". Come back in 5 years and see what's left.

3) From a personal financial perspective, the money offered isn't enough.

Not a happy holder.

[Snoopy]

2) I don't believe that selling a diverse company such as SCT to a customer will lead to anything other than the atrophy and eventual divestment of the non-meat technology. I don't believe the stuff in the presentation about "business as usual". Come back in 5 years and see what's left.

Interesting to read the JBS mission statement from the upcoming presentation (my emboldening):

"To be the best in what we set out to do, completely focused on our business, ensuring the best products and services for our customers, consistency for our suppliers, profitability for our shareholders and the opportunity of a better future for all our team members."

Then further on in the presentation look at what Scott hope to do if the scheme of arrangement is implemented (my emboldening).

Governance
• Scott will continue to pursue ambitions in all market sectors (not just meat);
• Scott will continue to service existing and new customers regardless of their competitive relationship with JBS;
•There are no plans by JBS to move or otherwise change any part of the business

To me this looks like a pretty serious clash of culture. It is almost as if Scott's and JBS's parts of the presentation were prepared completely separately, without any thought of the conflicting message sent.

SNOOPY

[Snoopy]

I see from Appendix 1 of the Northington report that JBS Australia has 11 processing facilities in Australia. From the presentation:

-----

Over the past two, JBS Australia and Scott have worked together installing an automated meat processing system for its lamb plant in Bordertown and elsewhere in Australia.

1/ The production line at Bordertown is running daily, at commercial line speeds (approx. 10 head of sheep per minute or approx. 8,000 per day). [Snoopy note: looks like two eight hour shifts per day]
2/ Rather than leading to redundancies, staff have been relocated to other parts of the plant, with consequent expansion in throughput.
3/Scott’s automation equipment is also operating at JBS’s Brooklyn plant (lamb) and beef plants at Dinmore and Beef City.

This reads as though Bordertown has 'full automation' and Brooklyn (lamb) and for Beef Dinmore and 'Beef City' (Toowoomba) are partially automated.

The JBS Australia Website lists the following processing sites:

Queensland: Dinmore, Beef City (near Toowoomba), Rockhampton, Townsville
NSW: Rivernia (rural NSW)
Victoria: Brooklyn, Cobram
Tasmania: Devonport, Longford
South Australia: Bordertown

Late in 2014, JBS acquired the 'Primo' group, specialising in smallgoods and bacon. Primo has two abbatoirs. One in Port Wakefield (South Australia) , and the other at Scone in the Hunter valley (NSW)

Nine of the above facilities process beef, and one pork. However JBS also processes lamb (Brooklyn) and goats.

SNOOPY

[Under Surveillance]

I am a small shareholder in SCT. I think this sucks.

Hey, GTM 3442, your angst is shared.

Like you, I would like to see SCT thrive for the benefit of employees, shareholders and NZ Inc.

I liked it that SCT had a large portion of their manufacturing in Dunedin and Christchurch, and are headquartered in Dunedin. Unfortunately with that comes a board of long-ensconced southern men - 4 from Otago and one from Canterbury. I hazard that only the latter could be considered in a national context to have outstanding corporate accomplishments. [I can’t help, as a shareholder in both SCT and SKL which have similarities, see huge disparities in the heft and governance skills of the boards, even allowing for SKL being 3x in size by revenue and NPAT.]

The SCT board was well-intentioned in helping SCT employees buy shares in 2012, the employees paying 10% less than market price, and getting interest free loans to buy if they wanted. Employees paid $1.53 for shares which Northington Partners now values at $1.06 to $1.28, which the board say are fairly priced at $1.39, and which traded at $1.55 immediately before the JBS scheme pack was mailed.

No doubt the board genuinely regrets the way the employee shareholders who still hold have fared with the value of their shares. When it comes to large shareholders, however, regret becomes obsession. The board is beside itself that large shareholders can’t sell down their holdings without knocking down the market price for SCT shares (meantime the existence of these overhangs itself places downwards pressure).

This obsession is, I think, at the core of the board’s motivation to cosy up with JBS in the proposed scheme, after large shareholders turned their backs on a regular rights issue and institutions didn’t want to deal, and the board had promised for months to be about to announce something. The JBS arrangement is set up for substantial holders, possibly including Oakwood Securities (Marsh) with 5.4 million shares and Urquhart estate with 3.4 million shares, to sell down or out at a guaranteed $1.39. No matter that Oakwood Securities rode their shares up to the mid $2.80s in early 2013, at which point large parcels might have been quit at a discount in a strong market. No matter that no-one forced the large shareholders to become so. No matter that no renounceable rights issue has been tried and failed.

The road show material released yesterday says if the JBS deal is not approved “Plan B” is for SCT to return to planning for a discounted rights issue for $15 - $20m, and there will be no liquidity event to sell shares. The stunning turnaround in NPAT in H2 2015 could see brighter prospects for a rights issue now than earlier (except from the constipated large holders). The board would have to come up with a convincing and optimistic outlook, and employ a valuation method selected to produce a result at the other extreme to the Northington product. It would help if the SCT board could quickly self-renew and bring aboard a David Mair (SKL) or two and fresh (to SCT) ideas.

There might be a case for SCT to go into the mode of funding expansion from NPAT for several years, paying no or token dividends. "Plan C" perhaps.

I don’t fault JBS for pursuing the deal which the SCT board proposed to them. If the SCT board believe that $1.39 is fair, and will get 75% voting support, why should JBS offer more? If the SCT board believe that the deal will be get 75% without JBS limiting its flexibility when in control, why should JBS tie itself in knots?

This is not an instance where a big multinational has used stealth or force to ravish a NZ company, rather one where a mediocre board has solicited action, consented to it, and bent the company over.