revised independent valuation is next

Light at the end of the Toll/Patrick tunnel
By Stephen Bartholomeusz (The Age)
April 8, 2006

ANOTHER of those decisive moments — perhaps the decisive moment — is looming in the torrid eight-month battle by Toll Holdings to win control of Patrick Corp.

Next week, Patrick is likely to release its revised Target's Statement in response to the increased bid that Toll announced last month. That response will include a revised independent expert's report by Lonergan Edwards.

Whatever value the firm places on Patrick, it will inevitably be higher than the $7.75 to $8.31 a share valuation of the shares last year. If it just added the 7 per cent increase in the value of industrial shares over the period, the range would rise to between $8.30 and $8.90 a share.

Even if the 32¢ a share special dividend Patrick paid during the course of the bid is deducted, that would still be significantly higher than the maximum value of Toll's revised offer. That offer is just over $7.60 a share — if the 30¢ a share of cash conditional on Toll achieving 90 per cent ownership of Patrick's and Patrick not proceeding with its proposed FCL acquisition is included.

The risk for Toll, of course, is that the report puts a much higher value on Patrick and effectively makes it impossible for Toll to contemplate raising the offer to the bottom end of the revised range.

That is why Toll has been muttering in the past week about the possibility of putting its final offer on the table and declaring the offer final. That would make the Lonergan Edwards report, if not irrelevant, then significantly less influential in setting expectations about the final pricing. Patrick's directors and shareholders would have to decide whether to accept or reject the only offer on the table, an offer at that point incapable of being increased.

The risk for Toll in that kind of strategy is that it declares its bid final only to discover that the revised independent expert's report produces a range that would have been within Toll's capacity. Toll's Paul Little would kick himself if he denied himself the opportunity to get a recommendation from Patrick.

Chris Corrigan also, presumably, knows that the bid is delicately poised and that, while he has had a lot of fun developing a radical and creative defence, he and his shareholders have as much to lose as Toll if the bid doesn't ultimately succeed.

Corrigan has committed an independent Patrick to acquiring freight forwarding business to support the proposed break-up of the Pacific National rail freight joint venture with Toll. He knows breaking up PN would destroy value for both companies, that the handful of owners of significant freight forwarding operations would have him over a barrel if the Toll bid failed and he had to acquire their businesses, and that his strategy would ignite a ferocious tussle for customers with Toll in Toll's heartland. That might be good for competition but would be bad news for shareholders in both bidder and target.

As it stands, Corrigan's tactics have prised an extra $1 billion of cash out of Toll, more than if its own $225 million dividend is included. They have also, with the help of the hedge funds, kept the Toll share price under real pressure.

That's important because every time it has appeared that Toll might be gaining the upper hand in the bid, its share price has strengthened. While there is a big range of valuations of Toll in the market on the basis of the bid succeeding — the range is from just over $14 a share to nearly $18 a share, with an average of about $15.70 a share — the clear expectation is that Toll shares will be re-rated heavily if it succeeds.

Given that about 70 per cent of the consideration being offered is Toll scrip, there is potentially well over $1 a share of prospective value for Patrick shareholders that would flow from a re-rating of Toll post-bid.

The endgame in this bid has always been about that value. Corrigan wants more cash from Toll and he wants to keep the Toll share price under pressure until after its final price is on the table to prevent Toll from using the re-rating to help finance the increase. He wants to "double-dip", extracting as much extra cash as he can from Toll and maximising his shareholders' exposure to the subsequent re-rating.

That is, again, a delicate game. It is in Patrick shareholders' interests that, while the value of their shares is maximised through the terms of the bid, the re-rating of Toll occurs.

If Toll is seen to have paid too much for Patrick — if Corrigan is characterised as having played "rope a dope" with Toll's Paul Little — the re-rating and a lot of value for both Patrick and Toll shareholders will be jeopardised. It is in both companies' interests, and those of their shareholders, that if the Toll offer does succeed it is not seen to have overpaid.

Both Toll and Patrick have to finesse this endgame if their shareholders aren't to be burned. Ideally they would be trying to co-operate at this point but relations between the two camps have become poisonous and distrustful, creating a very real possibility that one or both will misjudge the other's resolve.

One of the perverse aspects of the protracted bid is that there is substantial, indeed overwhelming, common interest in striking a deal that unleashes the re-rating of Toll. Given that the alternative is mutually assured destruction, the risks that one of the protagonists overplays their hand ought to be tempered by self-interest and the size of the prize for both sets of shareholders.