Reckon (RKN.AX) – Business Sale – 40% upside

Current Price – A$1.21

Acquisition Price – A$1.69

Upside – 40%

Expiration Date – Q2 2018

Business Sale Announcement

This idea was shared by Hugh.

 

In November 2017 RKN agreed to sell the Accountant Practice Management division to MYOB (another Australian business software provider) for A$180M. This sale is continuation of RKN management’s strategy to fully realize sum of parts valuation.

The stock rallied to a A$1.58 per share high on the news, but gradually declined after critical response from regulators in Australia and New Zealand. Currently RKN trades at pre-announcement levels. As the business has not deteriorated in the meantime, I would assume the downside from the sale falling apart is minimal.

EV for the whole company stands at A$185 (A$135m market cap + A$50m debt), meaning that if the sale goes through investors would be getting the remaining business ($A48m in annual revenues) on the cheap.

If transaction closes on current terms I would expect RKN to trade up to A$1.69/share – 40% upside.

A good overview of both companies as well as whether current transaction makes sense from the business perspective can be found here.

 

Key uncertainties

Regulatory response – See the next section

Exit costs and taxes on sale proceeds

Management so far has not shared details on this, but assuming 20% effective tax rate on the difference to the BV of sold assets and A$5m exit costs still leaves c. A$150m in net proceeds (or A$1.33/share), suggesting the unsold business is currently valued at A$35m only.

The value of the retained business

Continuing operations represent c. 50% of combined revenues and are profitable – although historical profitability is lower relative to the sold assets mainly due to corporate overhead.

Guidance for 2018 is for A$48m-A$49m in revenues and A$15m-A$16m in EBITDA (zero growth in both metrics). Deducting ‘Development Spend’ (which is capitalized ongoing expenses) leaves us with cash EBITDA guidance of $7m.

For comparison, the combined company generated A$14.4m in cash EBITDA and was trading at EV=A$185m pre-announcement. At similar EV/EBITDA multiple the continuing operations (i.e. unsold assets) would be valued at A$90m, or A$0.8/share.

Putting it all together:

–          Net sales proceeds – A$1.33/share;

–          Value of retained business – A$0.8/share;

–          Less $50m of debt – A$0.44/share;

–          RKN value if transaction completes – A$1.69/share – which is quite similar to where the shares traded post announcement.

Downside if transaction falls apart

RKN is currently trading at pre-announcement levels and business seems to have performed in line with the guidance. Recent share price declines have coincided with critical responses from regulators. Thus I would expect minimal downside if transaction falls apart.

At the same time the value of the underlying assets has already been revealed and company is run by pro-active management who have clearly stated the strategy of realizing value through asset sales and demergers. Thus if the current transaction is prevented by regulators, management should be able to find other ways deliver value to shareholders (e.g. spin-off).

 

Business Background

RKN is software company selling desktop and cloud-based accounting software for accountants and small/medium businesses. 75% of revenues are subscription based and company recently started migrating to business to the cloud (both subscription and cloud revenues are growing).

RKN stated that since pursuing cloud based solutions “we sensed that the market perhaps began undervaluing the overall business…It was apparent that the valuation of the whole was less than the sum of the parts. We embarked on a different strategy to unlock value.”

That strategy has been to sell and spin off the business’ assets. In August 2017, management demerged the Document Management Group, which provided shareholders with an in-specie distribution in a new listed entity (GetBusy Plc – GETB in London AIM market).

Sale of Accountant Practice Management Group is the second step in this direction.

 

Regulatory Response

The ACCC and NZCC (the public regulators dealing with market competition / antitrust issues in Australia and New Zealnd) have delayed their decision on the deal. This is not in itself fatal, as delayed decisions have in the past resulted in approvals. However the ACCC has released a statement of issues, which raises concerns that transaction will not be approved.

The ACCC’s preliminary view is that the proposed acquisition is likely to substantially lessen competition in the supply of practice software to medium-to large accounting firms. However, the statement of issues is not a final decision; instead it gives the preliminary views of the ACCC and identifies areas of further inquiry.

This post provides a good critical overview on regulators actions towards RKN/MYOB:

“In short, I find the media release ridiculous, poorly worded and off-point. The Statement of Issues, whilst not without some substance, shows a lack of genuine investigation, understanding of competition and technical wherewithal.”

Few stats and historical examples of regulatory response:

– In 2016-17, the ACCC considered 288 mergers. In 13, a statement of issues was released. It did not oppose any mergers, but eight were withdrawn. That means there was a 38.5% success rate.

– In 2015-16, the ACCC considered 319 mergers. In 10, a statement of issues was released. Six were approved (60% success rate). One was opposed (10%) and another was withdrawn. It is unclear what happened to the remaining two.

– For example in Saputo Dairy, the regulator stated: “The ACCC is concerned that the proposed acquisition would be likely to substantially lessen competition in the market for the acquisition of raw milk in south west Victoria and south east South Australia (together, Western Victoria)”. This deal was later approved.

– Similarly, in Iron Mountain the regulator stated: “The ACCC is concerned that the proposed acquisition would be likely to lead to a substantial lessening of competition in a national market for the supply of physical document management services (PDMS)”. This deal was later approved.

Both regulators are set to decide the matter by 21 June 2018 (see ACCC and NZCC announcements). It is reasonable to assume that both regulators will arrive at the same decision, given the similarity in legal systems, and the (apparent) coordination on the release date for their decisions.