Qantas’s revised profit outlook can’t force a more generous offer for the company

In today’s Australian, Bryan Frith writes that speculation Airline Partners Australia will be pressured by Qantas Airways’ upgrade of its 2007 profit forecast into increasing its $5.60 a share offer price overlooks the fact that the bidding consortium is unable to go higher.

On a number of occasions, including in the bidder’s statement, APA has categorically stated that, in the absence of an alternative offer being announced, the $5.60 a share offer price “will not be increased”.

As a result, APA is bound to that statement under the “truth in takeovers” policy of the corporate regulator ASIC. In the absence of a rival bid, it cannot lift the offer price, even if it wants to.

ASIC in the distant past has allowed a bidder to lift its bid despite having stated that it wouldn’t do so – on condition that the bidder compensated all investors who sold shares in the target between the time the initial bid price was announced and offer price was increased.

However, ASIC has made it clear it doesn’t favour such a compromise, preferring to hold bidders accountable for their statements on the bid price.

Qantas earned $480 million in 2006 and had previously forecast that its earnings for 2007 would improve by 25 per cent to 30 per cent. It has now upped that to an increase in the range of 30 per cent to 40 per cent, or $624 million to $670 million.

Some observers have suggested that the improved profit forecast is likely to boost the value range which the independent expert Grant Samuel will put on Qantas in the target’s statement, which is due out within the next two weeks.

That may well be so, but what needs to be kept in mind is the price Qantas shares were selling at before the bid, and just how hefty a control premium APA is offering.

Qantas shares were selling as low as $2.90 last July. The 12-month VWAP (volume weighted average price) is $3.61, the 6-month VWAP is $3.48, the 3-month VWAP is $3.73. Therefore, at $5.60 a share APA is offering a 55 per cent premium to the 12-month VWAP, 61 per cent to 6-month VWAP and 50 per cent to the 3-month VWAP.

That compares with an average takeover premium of 33 per cent, and on that basis is demonstrably generous.

In terms of multiples, the $5.60 offer price equalled a price/earnings ratio of 16 times the forecast 2007 profit and 14.1 times the forecast 2008 profit.

Allowing for the new profit forecast this would produce a p/e ratio of 15.4 times the 2007 forecast and 12.7 times the forecast 2008 earnings.

It’s possible that the higher profit forecast will cause Grant Samuel to revise upwards its value range for Qantas shares. But it’s highly unlikely that the bottom of its range will start above the offer price. The almost certain outcome is that the offer price will be within the value range, probably still towards the upper end and, by definition, anywhere within the value range would mean the offer is fair and reasonable as far as Grant Samuel is concerned.

As it is, the bid price will be adjusted next week. Qantas yesterday declared a fully franked special dividend of 15c a share, which compares with last year’s interim dividend of 11c. The special dividend will use up of all of Qantas’s franking credits and will benefit the Australian shareholders who own 54 per cent of the airline.

The APA offer will be adjusted downwards to $5.45 a share, to allow for the dividend payment. Qantas shares will be quoted ex-dividend as from next Tuesday.

The speculation on the need for an increase in the offer price wasn’t reflected in the share market where Qantas shares closed 1c lower at $5.35 – 25c, or 4.5 per cent below the present offer price.

It remains to be seen whether the market adjusts to the same discount level, which would equate to a price for Qantas shares of $5.21, or whether, as is often the case, the market doesn’t fall to the full extent of the dividend payment.

When the FIRB is conducting its scrutiny of the Qantas bid it will no doubt take particular note of the equity funding arrangements for APA. APA comprises three Australian participants, Allco Finance, Allco Equity Partners and Macquarie Bank, two foreign private equity funds, Texas Pacific Group, and Onex Partners, and a number of unidentified foreign investors which are expected to comprise one or more institutional and/or private investors.

Allco Finance is to have a voting interest of 35 per cent and economic interest of 27 per cent; AEP 11 per cent equity, 8 per cent economic; Macquarie 15 per cent on both counts; TPG 15 per cent voting, 25 per cent economic; Onex 9 per cent voting, 12.5 per cent economic; with the other foreigners having 15 per cent voting and 11.5 per cent economic.

The voting interest is designed to ensure that the foreign interest doesn’t exceed the limits under the Foreign Acquisitions & Takeovers Act (15 per cent for an individual foreigner and 40 per cent in aggregate) and that the economic interest does not breach the foreign limits under the Qantas Sale Act (25 per cent for an individual foreigner and 49 per cent in aggregate).

The bid document shows that the APA consortium will put up just over $3.5 billion in equity funding. Of that Allco Finance will contribute $300 million, AEP $956.1 million, TPG $891 million, Onex $445.5 million and Macquarie $525.5 million.

TPG has also agreed to ensure that the other foreign investors will provide $409.9 million of equity. If there is a funding shortfall, either because TPG is unable to procure sufficient take-up or because one, or more, of those foreign investors fail to put up their money, then TPG will be liable for the shortfall.

The bid document says that any TPG funding shortfall is to be provided as an increase in the subscription monies payable by TPG for its shares in the bid structure.

FIRB will want to satisfy itself, but that doesn’t mean that TPG’s voting and economic interest would rise if it’s forced to pump in extra money to make up for any shortfall. That couldn’t be allowed to happen because it would breach FATA’s 15 per cent limit for an individual foreigner and the Qantas Sale Act’s 25 per cent limit for an individual foreigner.

Instead, TPG’s voting and economic interest would remain the same and it would cost the private equity fund more for its stake than was originally to be the case. TPG would just have to wear it, which should encourage it to find parties to join the bidding team.

Report by The Mole with material from The Australian