Time for a trip down memory lane... The improvement in European...

Time for a trip down memory lane...

The improvement in European EBITDA was all due to M&A (and a bit of FX boost). Organically, the business went backwards at a rate of knots.

Here is why:

Transaction 1: (24-Oct-17) European Portfolio ’Century’ from Adama/ Syngenta
> Transaction closed 16-Mar-18
> Paid US$490m cash + US$21.8m inventory + transaction costs (total ~A$700m)
> Expected net sales of A$250m, EBITDA of A$95m-A$100m in FY19
> Note that this portfolio did net sales of A$286m in CY16
> Nufarm flagged potential reduction in sales due to regulation and competition
> Useful life for amortisation was estimated at 5-15 years
> Expected full-year amortisation charge of $47m

Transaction 2: (8-Nov-17) European Portfolio from FMC
> Transaction closed 8-Nov-17
> Paid US$85m cash + US$2.87m inventory (total est. ~A$121m)
> Expected net sales of A$30m, EBITDA of A$15m in FY19
> Useful life for amortisation was estimated at 15 years
> Expected full-year amortisation charge of $7m

Note how on both the transactions, the expectation of EPS accretion is on a pre-amortisation basis, meaning the economic decay of the IP purchased is not accounted for.

Together, for these two deals, NUF allocated A$25m to inventory, A$615m to identifiable intangibles, $132m for goodwill. The combined operating profit contribution for the first partial year (FY18) was an effective margin of 15.9%.

So, call it $800m paid for $280m in sales earning ~16% for $45m profit, or a profit multiple of approximately 18x.

Of course, when you look at the EBITDA multiple paid (800m/112.5m = 7.1x) they look like a decent pair of deals, but once you take out the amortisation of (47m+7m=54m), the economic earnings effectively halve, and the purchase multiple doubles.

With that background, go back and compare slide 15 of Nufarm’s ‘Century’ deal to Mayne Pharma’s (MYX) acquisition of the Teva generics portfolio in 2016 (slide 17 here) with passing reference to MYX’s share price performance from then until now.

The common points are that both:
1. Were big deals to essentially buy IP (i.e. almost all intangible assets)
2. Generated optically attractive EPSA accretion
a. But deal economics looked much worse when amortisation was included
3. Papered over weakness in underlying organic growth
4. Were funded by substantial equity raisings

Now, if you can’t make a deal stack up without recourse to accounting gymnastics (EPSA accretion), then you probably shouldn’t do the deal. In any highly competitive market, for instance crop protection chemicals or pharmaceuticals, where new IP from several large players is constantly producing better products and formulations, I would be very surprised if the competitive ‘shelf’ life of a whole portfolio of molecules would be 15 years. More likely what happens is that the sales of a purchased portfolio are eroded due to competitive decay to the extent embedded new launches are unable to offset the organic decline.

When you look at NUF Europe’s FY19 result released today, they did about +A$190 in sales and only +$9m in EBITDA (an incremental margin of <5%). If you look at when they did the deals, the residual contribution from FMC/Century in FY19 should have been about +A$210m sales and about +A$95m in EBITDA (per note 14 in FY18 annual report per business combinations. Where did all that supposed profit go? If that isn’t a convincing showing of why something isn’t quite right and that EBITDA is a rubbish measure, then I don’t know what is.