For those interested in this sort of thing...
The Chairman of the Board of Directors
Monadelphous Group
59 Albany Way
Victoria Park
Western Australia
Dear Mr Rubino,
INTRODUCTION OF NEW SHAREHOLDER and ISSUED SHARE CAPITAL
As a long-time admirer of Monadelphous Group, I have for some years sought to become a shareholder of the company. Fortunately, the opportunity to do so finally presented itself earlier this year.
It therefore gives me great pleasure to introduce myself, and on behalf of my family members, to you as new shareholders via our family office entities.
I am usually disinclined to draft correspondence to company executives, preferring their precious time to be applied to the managing of the businesses under their charge. However, there is an issue with our company that, in my opinion, has an impact on long-term shareholder wealth creation, which I therefore wish to raise with you.
That issue is the stewardship of the company’s share capital, which I consider to be sub-optimal.
On the brazen assumption that our company’s directors welcome constructive criticism from the owners of the business, I respectfully offer my observation that, if there is one blot on the Monadelphous landscape of shareholder value creation, it is that there has been a meaningful increase over time in the company’s issued capital, which has been both unnecessary and – importantly – totally avoidable.
For context, as far back in time as I have researched our company’s Annual Reports (back to 2005), there has been an increase in the number of shares on issue (SoI) each year. The annual increases have not been material (an average increase of 1.5% per year) but, as you know, the compounding effect is a powerful one, resulting in SoI today being 20% higher than it was a little over a decade ago.
And, at the risk of stating the mathematically obvious, 20% higher SoI today means shareholders participate in 17% less of the company’s profits than would otherwise have been the case.
That is an undesirable outcome and, as I argue in the remainder of this letter, I believe it could have been circumvented. I will also later in this letter make an exhortation that capital management steps be put in place to prevent it recurring in the future.
For, juxtaposed against the increase in SoI is the fact that our company is a prolific generator of surplus capital: over the period under review (i.e., from the 2005 financial year), Monadelphous has generated $1.17bn in cumulative Operating Cash Flow (OCF). Out of this incoming cash flow, the business has consumed just $87m for purchasing Property, Plant and Equipment (PP&E). (Gross PP&E payments totaled $185m, and the sale of PP&E realized a total of $98m).
(One metric I use to discern the investment pedigree of a business is the ratio of OCF to Expenditure on PP&E. For Monadelphous, this figure has averaged around 13 times. You might be proud to learn that, as multi-decade student of corporate financial performance, I have encountered very few businesses that match MND’s ratio of OCF-to-PP&E Expenditure. This aspect of the business is truly a thing of beauty!)
Back to the numbers: before the servicing requirements of capital providers, the excess capital generated by the business over this period is a figure in excess of one billion dollars. Even if one adopted the prudent approach of accounting for Finance Lease payments (which total $148m over the review period) above the OCF line, the ratio of OCF-to-PP&E Spend is still a world-beating level a little under 12 times.
And our company also services its equity holders most generously (rightfully so), with four out of every five cents of Net Profits distributed as dividends, these cumulatively amounting to $794m.
So, by my reckoning, even after accounting for all the business’s ongoing funding needs, including servicing the servicing of off-balance sheet financing, and even after distributing the bulk of Net Profits to shareholders, our company has still generated a surplus of capital equal to around $140m over the period I reviewed.
(It warrants noting – I think – that this derived $140m surplus capital figure, exceeds the amount by which the company’s issued capital has increased over the same period, namely $100m.)
The upshot of all of this is that Net Cash position of our company is today at a record high:
NET CASH POSITION (Total Interest Bearing Loans & Borrowings, Less Cash & Cash Equivalents)
(At financial period-end, all figures in $m)
June, 2005: 4.7
June, 2006: 35.3
June, 2007: 73.9
June, 2008: 101.6
June, 2009: 127.3
June, 2010: 116.6
June, 2011: 129.5
June, 2012: 152.9
June, 2013: 140.2
June, 2014: 180.8
June, 2015: 186.6
December, 2016: 182.7
Unsurprisingly, this improving cash position is reflected in the Current Ratio today also being at record high level:
CURRENT RATIO (Current Assets divided by Current Liabilities)
(At financial period-end)
June, 2005: 1.36
June, 2006: 1.19
June, 2007: 1.19
June, 2008: 1.15
June, 2009: 1.19
June, 2010: 1.17
June, 2011: 1.19
June, 2012: 1.26
June, 2013: 1.40
June, 2014: 1.67
June, 2015: 1.63
December, 2016: 1.74
Of course, I am duly aware that the business has certain obligations that are not reflected in the published balance sheets, notably certain not-immaterial commitments that relate to Hire Purchase and Operating Lease arrangements.
But even if these are netted off against the cash resources of the business, the company’s financial health has never been better:
NET CASH LESS HIRE PURHCASE & OPERATING LEASE COMMITTMENTS
(At financial period-end, all figures in $m)
June, 2005: -20.1
June, 2006: -3.8
June, 2007: +29.1 [*]
June, 2008: +50.1 [*]
June, 2009: +62.5127.3
June, 2010: -5.3
June, 2011: -90.3
June, 2012: -5.7
June, 2013: -51.9
June, 2014: +42.9
June, 2015: +87.9
[*] Denotes periods in respect of which special dividends were declared
(Note: While they are duly noted, because of their highly contingent nature, performance guarantees are excluded from this exercise, a reasonable approach – I think – given the company’s operating history.)
Make no mistake; that our company finds itself in such pristine financial health, after the spectacular contraction in the markets serviced by it, is testimony to a number of things, most notably very prudent operational and fiscal management. This is a credit to our company’s board, management and employees.
However, as mentioned earlier, this fantastic achievement masks what I consider to be a dynamic of shareholder value leakage because the issued share capital base has been allowed to increase over time.
What makes this regrettable is that it has occurred despite the company being such a prolific generator of surplus capital, as has been demonstrated.
It is difficult to reconcile this juxtaposition.
Accordingly, as a shareholder who has an aversion to having his shareholdings diluted (especially when it can be easily avoided), my constructive requisition to you and to our company’s directors, is to put in place a capital management policy that, at the very least, guards against further unnecessary increases in issued capital.
Heaven knows, our company possesses the financial wherewithal to do so.
In fact, for a company with Mondadelphous’s financial prowess there is no reason why one the board’s strategic objectives for maximising shareholder value is not to reduce issued share capital over time.
Now, while my intention is not to solicit comment on it, but based on the company’s financial health, I have a suspicion that the board might be contemplating the declaration of a special dividend in respect of the 2016 financial year. Certainly, this would be a welcome acknowledgment of the company’s impeccable financial position, and it would serve well as a reward to long-term shareholders who have seen returns decline in recent years due to the contraction in the resources sector.
However, in my professional opinion, and in the context of the preceding discussion, what would be an even better long-term outcome for shareholders is moderation in the quantum of any special dividend that might be contemplated, in favour of the commencement of a share buyback program.
Indeed, a share buyback program, instead of a special dividend, would be eminently more sensible, I believe, from the standpoint of maximising long-term shareholder value.
As a new shareholder, I would appreciate it if our directors could afford this feedback due consideration.
In closing, I look forward to a long, constructive and prosperous association with Monadelphous.
For it is truly a most special company… which is why I would like to see its share count being guarded with a greater degree of vigilance.
Most Sincerely
Xxxxxx Xxxxxxx
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