Why Invocare should say yes to TPG’s takeover offer
On 7 March, funeral services provider, Invocare (ASX:IVC), received an unsolicited, non-binding indicative offer from giant U.S. private equity firm, TPG Global. TPG offered to buy all the shares in IVC through a scheme of arrangement for $12.65 per share – a 40 per cent premium to its previous close. Based on a quick calculation, I think this is a pretty good deal for IVC shareholders.
The offer would be adjusted for any additional dividends or capital returns made by IVC prior to the completion of the proposed transaction.
There were conditions; for example, the IVC board of directors are not permitted to engage with third parties on an alternative change of control transaction during the due diligence period. The bid is also conditional on the board supporting it and on regulatory (Foreign Investment Review Board) approval.
TPG initially acquired 17.8 per cent in a combination of direct shares and swap arrangements. A day later, TPG had taken itself to a 19.98 per cent interest, which is the level below which it would otherwise have been required to make a bid if it wanted a larger stake.
While investors might think a 40 per cent premium to the last traded price of $8.95 should be incentive enough for the board to support the bid on behalf of shareholders, the reality is IVC shares only traded below $9.00 for three days. The average traded price for IVC this year has been $10.78. So the bid price is only 17 per cent above the average traded price of IVC this year.
Post reporting
The fall in the share price to below $9.00 for three days followed the company reporting its full-year 2022 results. The company reported 12 per cent growth in revenue and nine per cent growth in operating EBIT (earnings before interest and tax), but it missed analyst expectations. In fact, net profit after-tax estimates were missed by around 15 per cent. The results were attributed to an inability to meet demand during peak months due to tight labour markets impacting capacity and efficiency, as well as supply chain pressures inflating the CODB (cost of doing business) and inclement weather impacting memorialisation development and park maintenance costs. IVC’s Funerals Australia margin was flat at 25.9 per cent. Margins, however, were lower in Cemeteries & Crematoria, driven by the higher weather-related maintenance costs and materially lower margins in Pet Cremations due to increased staffing levels.
Most of these factors appear temporary, so to assess whether TPG’s bid has merit, investors must first understand the estimated intrinsic value of their company. Only then can they determine whether the acquirer is dealing them a fair hand.
Here’s how I have estimated the intrinsic value of Invocare
Based on its 2022 financial results and some assumptions about future return on equity and payout ratio:
Assuming the company sustains its after-tax return on equity of about 14 per cent on its current equity per share of about $3.80, and assuming its long-term dividend payout ratio is 75 per cent, I estimate the intrinsic value of IVC is $8.72.
I adopted a relatively low discount rate of 7.5 per cent, giving the company some points for being in a relatively stable and predictable industry. The predictability stems from the fact that baby boomers (aged 55-74 years) represent 21.5 per cent of the Australian population, according to the 2021 Census, and accounted for more than one-third (34.2 per cent) of all Australians who had at least one long-term health condition. More than half of baby boomers (50.4 per cent) had a long-term health condition reported in the 2021 Census.
Nevertheless, some may say a 7.5 per cent required return is too low in a rising interest rate environment. If you agree, then Invocare’s intrinsic value is something less than $8.72, rendering TPG’s bid relatively more attractive.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
