Alpha POWER Shares (Lonsec) Portfolio - April 2008
Lonsec comments on major out-performers:
ORG (+52.3%) On 30 April 2008, Origin announced that BG Group Plc, a global integrated gas major, had approached the company with a proposal to acquire all of the shares in Origin at a cash price of A$14.70 per share. The takeover offer is at a 40% premium to ORG’s last closing price before the offer. The proposal is subject to shareholder and regulatory approvals and other terms and conditions common to transaction of this type. Origin has not yet considered the proposal. Discussions between the parties will take place and shareholders will be advised of the outcome. Origin advised that shareholders should take no action with respect to their Origin shares, pending further announcement.
At first glance, the cash bid seems a fairly full valuation for the company given consensus earnings for FY08 are 50cps which implies a bid value of 29.4x FY08 earnings. However, Origin has valuable large Coal Seam Methane gas reserves in Queensland and has invested heavily in its future with strong earnings growth is expected in coming years. Australian and NZ Foreign investment approval is likely to be the main hurdle given the sensitivity of energy supply in each country. ORG shareholders should continue to HOLD pending further direction from the ORG board.
Origin is well placed in the Australian and NZ energy sector and is best viewed as a vertically integrated electricity and gas distributor. Origin is investing heavily in the production of gas to fire new electricity generation for the Australian market. Gas is cleaner burning than coal and is therefore expected to be a key fuel in future years.
BHP (+18.0%) BHP rallied strongly during April on a “perfect storm” of positive newsflow including rising iron-ore, coal, copper and oil prices and rumours of a Chinese Steel Consortium preparing to take a large interest in the company. BHP’s 3.4 for 1 scrip takeover offer for RIO is now in the money with the bid currently worth A$153 per RIO share compared to RIO’s current share price of A$144.30. Clearly, the pressure has increased on the RIO Board to engage BHP while the offer still stands. Investors should note that takeover negotiations are likely to be protracted as BHP is unlikely to increase pressure on RIO until it gains the necessary regulatory approvals. Any unacceptable conditions imposed by regulators could scuttle the bid. Lonsec believes that investors are better off in BHP than RIO as RIO could have greater downside risk if the BHP bid is withdrawn.
CBA (+7.3%) Sentiment towards Banks improved during April as Financial stocks on Wall Street rallied and locally ANZ and WBC delivered results that were generally better than the market’s overly cautious expectations. CBA announced that it planned further investment in its Core Banking System replacement project of $580m over the next four years. CBA expects to gradually lower its cost to income ratio below 40% as a result of the major IT project. Lonsec has selected CBA on its bias to retail banking (rather than Corporate Banking like ANZ and NAB), its strong retail deposit base (cheapest form of capital) and its superior positioning in the Australian Wealth Management sector via Cominsure, Comsec and Colonial/First Choice.
Lonsec comments on major under-performers:
TAH (-7.3%) The Victorian Government has announced significant changes to the Victorian Gaming and Wagering industry post 2012. The implications of the changes are:
Gaming – post 2012 pubs and clubs will be able to own, operate and maintain gaming machines directly effectively cutting out the operating licences of Tatttersall’s (Tatts) and Tabcorp. Pubs and clubs will be able to bid directly for gaming licences, with a 10 year term, subject to a limit of 35% market share.
The Vic Govt is also denying that it has to pay $1.2bn in compensation to Tatts and Tabcorp (about $600m each) under the terms of the original licencing agreement.
Post 2012, Tabcorp will lose about 28% of its EBIT from Vic gaming while Tatts stands to lose about 40%.
Wagering – a single wagering licence will be offered for tender post 2012. The current JV with the racing industry will be removed. The Vic Govt plans to compensate the Victorian Racing Industry for this change, under changes to the conditions of the new wagering licence post 2012.
Tabcorp currently holds the licence with the Vic racing industry and will have to re-tender for this licence. Vic wagering currently represents 10% of Tabcorp EBIT.
Keno – will be offered as a single, specific licence, with distribution to be expanded to include all venues with a liquor licence and wagering service.
Tabcorp’s current earnings base is:
Vic Gaming 28%
Wagering 29% (10% is Vic wagering)
Casinos 43%
Total 100%
By FY13 the Vic Gaming earnings will cease while the Vic wagering earnings will be subject to a successful outcome in tendering for the new wagering licence and the conditions of the new licence. The $687m in compensation for loss of licence is now likely to be subject to a legal battle with the Vic Government. These are the clear negatives of this announcement.
The positives are:
Tabcorp will continue to earn cashflow from Vic gaming until the end of FY12.
Tabcorp will likely reduce its capex in the Vic gaming business moving forward, as the business will most likely move into run-off mode.
Most analysts had Tabcorp bidding $1.2bn for the new licence, the need for that outlay will now be removed.
Tabcorp could get about $100m for the sale of its gaming machines, depending on its future strategy in the sector.
Without the gaming assets, Tabcorp becomes a more logical target for Crown which is looking for Casino acquisitions, or maybe Tabcorp and Tattersalls would consider merging?
S&P is maintaining a BBB+ rating on Tabcorp’s balance sheet given the $1.2bn payment for licence renewal is not required
S&P said: “While the loss of the licences are negative for Tabcorp’s earnings and business diversity beyond 2012, the company will now not have to fund a gaming licence renewal payment, and can manage its expenditure within that business with an eye to its 2012 closure. Tabcorp will need to decide whether it wants to remain involved in the Victorian gaming business beyond 2012 in some capacity. “The reduced earnings from Victorian gaming will slightly weaken the company’s business diversity, however, its impact is mitigated by the broader business base the company has developed over recent years.
“Standard & Poor’s will continue to monitor the impact of the Victorian Government’s announcement and will discuss Tabcorp’s business response with the company. We do not envisage that the ‘BBB+’ rating on Tabcorp will be affected by the announcement, although we cannot rule out a rating change as the situation unfolds and Tabcorp’s commercial reaction emerges.”
Conclusion
While the Tabcorp valuation is likely to fall by 15-20% as a result of the loss of Vic gaming earnings from FY13, there is the potential of high short-term dividend yields up to then. Tabcorp current dividend is 94cps, so its current yield is 8.9% fully franked. The level of future dividends will obviously depend on its future strategy.
Lonsec also feels that the Vic Govt’s hard-line on the $687m compensation payment maybe just an opening position, that it fully expects to be tested in the courts. It would look better, politically, if the Govt fights before handing over any money to Tatts and TAH. That being said, it shouldn’t be assumed that Tabcorp will eventually get the money either.
The vital question is; what does Tabcorp plan to do post FY12 when it loses the gaming revenue? The answer to this question will become clearer over the coming weeks. Lonsec feels investors will be in a better position to make an assessment then. Most of the damage is done for now, continue to HOLD.
 | Lonsec Limited ABN 56 061 751 102
Published by Participant of ASX Group
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© Alpha Structured Investments
Dr Tony Rumble
July 2007
