The recently announced management buy out (MBO) of Adare Printing will once again cause investors to focus on the very low ratings afforded the majority of Irish small capitalisation stocks. The buyout price values Adare at €160 million and represents a 70 per cent premium to the closing dealt price of March 29th, 2000.
Compared with Adare's low price of the past year, it represents a more dramatic 100 per cent premium.
In contrast to 1999, activity on the buy-out front has been quite limited so far this year. Nevertheless, overall market conditions point to the likelihood that there will be a slow but steady flow of future deals.
Quoted small companies remain firmly out of favour and, if anything, already low valuations have continued to slide. Irish quoted companies are being further hampered by the fact that Irish financial institutions seem still to be trying to reduce their exposure to the domestic market.
Low valuations and low interest rates are the key ingredients of a successful MBO. Although euro interest rates are now on a gently rising trend, the cost of funding remains very low by historical standards. More importantly, the euro zone is likely to remain a low inflation/low interest rate bloc over the long term. Therefore, buy-out groups can put in place appropriate funding with a high degree of confidence regarding their estimates of the long-run cost of such finance.
Furthermore, the strong economic and financial environment domestically and internationally means that good projects have several funding options from both the banking system and the capital markets. The list of companies on the Irish Stock Exchange with single-digit price/earnings (p/e) ratios is quite long and the table presents a selection of just six of these. Their p/e range from a low of 4.9 in the case of IWP to a still lowly 7.8 for Greencore.
Most of these companies have strong balance sheets and are generating substantial cash flow.
Greencore's latest balance sheet statement, for example, showed it had a debt/equity ratio of 55 per cent, but this was forecast to reduce to 29 per cent by September 2001. The company is generating substantial free cashflow and could easily cope with much higher leverage on its balance sheet. Athlone Extrusions actually has a significant amount of cash on its balance sheet and is generating substantially more cash than it needs to invest in the business. Unless the company engages in a major acquisition, cash will continue to build up. Ultimately this cash will have to be returned to shareholders through share buybacks or by taking the company private.
In contrast, IWP International had a debt/equity ratio of 193 per cent at its last published balance sheet date and therefore is in a weaker position than either Athlone or Greencore. Nevertheless, it is in a strongly cash-flow positive situation and the company is rapidly reducing its debt burden.
These examples highlight that the prospects for corporate activity will be dependent on the particular circumstances of each individual company. A very low stock market rating and the relatively easy availability of cheap credit is not of itself sufficient to activate a management or leveraged buy out. However, the current ratings of the small capitalisation sector of the Irish market provide fertile ground for management or corporate investors who are prepared to take advantage of current market circumstances.
IRISH LOW P/E STOCKS
Price-Earnings Ratio 2000
Greencore - 7.8
Heiton Holdings - 7.8
Barlo - 7.6
Athlone Extrusions - 7.3
IWP International - 4.9
Donegal Creameries - 4.7
