MNK cashing up again?, page-2

@The Yankee,

Thanks for posting this media article.

In terms of your thread header, I would have thought that, instead of "cashing up again", "debt-ing down again" would have been more appropriate, because cashing up connotes having ample cash, and then adding to it. Which is clearly not MNK's situation.

That MNK needs to sell off more assets in order to repair its balance sheet should come as no surprise, because doing nothing given the deteriorating solvency trends would clearly not have been palatable, especially not to MNK's creditors.

The only trouble is, what MNK are now doing in terms of selling off businesses to reduce debt is the exact reverse of what they had been doing in preceding two or three years, when they were undertaking acquisitions fueled by cheap debt.

And, while debt-funded acquisition strategies at times of low interest rates are usually easily accretive to earnings (due to the acquired earnings easily exceeding the resulting modest interest expense), the opposite applies when companies de-gear, i.e., disproportionately more earnings are foregone when businesses are sold than interest is saved, the result being earnings dilutive.

For example, MNK's Nuclear Imaging business ($690m healdine sales price, of which $574m received upfront), even if it was sold for a very generous EV/EBIT multiple of 20 times, this would still have been dilutive, since the company will have foregone EBIT of $690m divided by 20, which equals $35m, which is more than the $21m of interest (3% interest rate applied to $690m sale consideration) of interest the company would have saved.

(And this is a generous assessment of the situation because, in reality, MNK received cash for the sale of only $574m and the debt that was repaid was short-term debt which attracted an interest rate of less than 2%, so really the interest saving is closer to 2% of $574m, i.e, $11.5m)

We already saw the impact of this dynamic of dis-synergies in MN'K's last quarter result, where EBIT fell a lost faster that interest expense after the sale of the Nuclear Imaging business during the period.


Similarly with the possible sale of MNK's Generics business (which accounts for $1.0bn of MNK's total annual sales of $3.0bn) for a figure reported to be ~$2.0bn .

So, a case of MNK selling one-third of its revenues for a consideration equivalent to just one-fifth of its Enterprise Value.

Interesting proposition, to say the least.
And not something that would naturally be done out of choice, you wouldn't think.


So let's look at a possible scenario of what would happen to MNK's financials (and - importantly - its solvency metrics of Net Debt to EBITDA).

Currently, MNK's salient financials look as follows (P&L figures annualised, based on the company's MQ2017 result, and before non-recurring items) :

EBITDA = $1.25bn,
EBIT = $440m
Interest Expense = $370m
Net Debt = $5.67bn.
(So, NIBD-to-EBITDA = 4.5x and EBIT-to-Net Interest = 1.2x).


Now let's assume they sell the Generics business for a generous 15 times EV/EBIT (which would be a big multiple for such a business, especially one which MNK's own management conceded was somewhat challenged structurally viz. "We expect continued pressure on the generics segment from competitive entrants and market pricing in coming quarters"):


After the sale, the company's financials would look something like this:

EBITDA = $870m (assumes proportional depreciation ratios apply before and after the sale)
EBIT = $310m ($133m EBIT reduction, derived from $2.0bn sale price divided by 15x sale multiple)
Interest Expense = $290m ($80m reduction in interest bill from $2.0bn lower debt @4% rate)
Net Debt = $3.67bn ($2.0bn reduction).
(Now, the resulting solvency metrics: NIBD-to-EBITDA = 4.2x and EBIT-to-Net Interest = 1.05x).


So, even if they are able to sell the generics business for 15x EBIT, it will still not bring about any meaningful improvement in their overall solvency metrics.

Net Debt-to-EBITDA would improve, but not to the point of bringing it under the company's covenant limit of 4.0x. And EBIT interest coverage will be virtually at parity, meaning the business becomes one of zero profit (a $4.3bn market cap company based on zero profits... interesting study in corporate levitation, I think.)

Based on my modelling, it would require a sale multiple of around 20x EBIT for the generics business, in order for it to get MNK's solvency metrics to a level where they would be within covenants (only just though: Net Debt-to-EBITDA would be 3.8x and EBIT-to-Net Interest would reach 1.16x. Which would provide some temporary breathing space, but not much.)


Feel free to let me know where I've made any errors, calculation or otherwise.