McPherson’s (MCP.AX) – Expected Higher Bid – 20% Upside

Current Price: A$1.43

Target Price: A$1.71

Upside: 20%

Expected Closing: May 2021

Offer document

 

On the 9th of April, Melbourne billionaire family’s holding company Kin Group launched an on-the-market offer for a small Australian consumer beauty / personal care product marketer McPherson’s. Until the 10th of May shareholders can exchange their shares for a cash consideration of A$1.34/share. The offer is highly opportunistic and comes after a series of announcements (primarily lower than expected MCP sales in China), which over the last 6 months have beaten down MCP share price from A$3+/share to around A$1.20/share. Management has swiftly rejected the offer, recommending shareholders to take no action, and later released a detailed response to the offer detailing their arguments against it. Apparently, management is not against selling the company per se, but considers the current offer to be predatory and undervaluing the business relative to peers. Two major shareholders (combined 10%) have also rejected the offer calling it “unfair and shallow”. The buyer has not responded yet, however, their previous statements did not rule out the possibility of an improved price.

Shares are currently trading above the offer price indicating that shareholders are unlikely to tender and that the market is expecting an increased offer price. Overall, holding MCP for a month seems to have a limited downside as in the worst case you can just tender the shares at A$1.34/share (6% downside). Meanwhile, there is a good chance that something positive happens during this time, e.g. Kin bumps the proposal or a competing buyer shows up, potentially resulting in a significant short-term upside. Also the company is due to report Q1 results at the end of April. I’m setting a price target of at least A$1.71/share (9x TTM EBITDA and 13x P/E).

The buyer owns 5% of MCP – the stake was accumulated recently at an average price of A$1.30. The offer has no minimum target for acceptance, however, it seems that the buyer intends to acquire a substantial position in order to have a representation on the board and launch a deep operational and strategic review of the company. In order to get a seat in Australia, the unwritten rule requires owning at least 15%-20% of the company’s shares.

There are some further positive aspects suggesting likely favorable development of the situation:

• Management has stated that the recent lackluster performance in China – which is likely the main reason for the fall in MCP share price – is temporary and the company is expected to recover in the short/medium term. These management’s claims are further supported by MCP’s JV partner in China forecasts for CY21.
• MCP seems undervalued relative to peers. Larger peers trade at several times higher multiple valuations (20x+ TTM EBITDA) than MCP does at the moment (7.6x TTM EBITDA). This leaves plenty of room for an improved offer. Analysts’ price targets average A$1.48/share, however, the management notes that those figures do not include a control premium.
• Management has hinted at expectations of an improved offer either from Gallin (Kin’s vehicle) or a third party. Their response to the offer states that tendering shareholders “will not benefit from any subsequent superior offer from Gallin or another third party, should one emerge”. The recent media report also quotes MCP:

If another bidder emerges I wouldn’t be surprised. We have had a number of tentative approaches over the years [when the shares were trading above $2 and $3] but nothing has developed.

• MCP acquisition seems to have some operational synergies for Kin as the group also holds controlling/majority stakes in two prominent packaging firms and a discount retailer. MCP already supplies some of its products to Kin’s retail locations, so it’s likely that the buyer has a good understanding of MCP product appeal.
• Institutional investors participated in MCP private placements at $2.27/share and $2.15/share in Oct’20 and Nov’20. The second sale took place after MCP China sales underperformed expectations during Single’s Day (11th of Nov, a major online retailing event in China). However, it is not clear if private placement investors had been informed about this before the official quarterly results (ending Sep’20) were released in December halving the share price.
• Q1 update is expected by the end of April (in 2020 was the 23rd of April). Any positive updates on the business recovery/growth could act as an additional incentive for price appreciation/increased bid/emergence of competing buyers.

Risks:

• The main risk is that Kin Group will not raise the price and no other competing bids will emerge. This would result in a 6% loss if shares are tendered after a month at the current Kin’s offer.
• The buyer has made a similarly opportunistic offer before for The Reject Shop (TRS.AX) in 2019 at A$2.70/share. Only 12% of TRS shareholders tendered their shares, however, the buyer didn’t raise the price and made no subsequent offers. Worth mentioning, that currently, TRS trades at A$6.68/share. So although I’ve marked this as a separate risk, the interest from Kin by itself might be a decent indication that MCP is cheap.
• Visibility into the recently impacted Chinese division sales is limited. Although the company claims that sales should recover in the short-medium term, it is not clear why the 11/11 (Single’s Day) performance results were substantially below expectations. The only explanation provided was COVID’19 impact, whereas, MCP peer BKL, which also has sales channels in China has reported “robust performance in the important Double 11 e-commerce shopping festival”.
• On the 1st of April (before the Kin Group offer) one of the major shareholders, Lennox Capital (owned 5.8%) sold about 3m shares, 2% of MCP, and ceased to be a major shareholder. This seems strange as apparently, the volume of MCP shares was around only 500k on that day – potentially this was a private sale to another larger shareholder.
• Finally, I am not entirely sure how easy it would be for Kin Group to cancel/amend the existing offer and thus remove the downside protection from this situation. However, the language in the offer document seems to be rather strict – offer termination possible only if MCP carries out any capital structure changes or disposes of assets.

 

McPherson’s Business Background

In 2012 MCP demerged its printing business and focused on marketing health, wellness and beauty products in Australia, NZ and China. The company owns most of its brands within product divisions of skin, hair and body/essential beauty/household essentials and also distributes certain third-party brands (agency brands and private label divisions). Manufacturing is outsourced.

The core six brands of the company are Dr. LeWinn’s (skin, hair & body), Manicare (beauty), Lady Jayne (Beauty), A’kin (skin, hair, body), Multix (household), and Swisspers (beauty).

One of the Kin Group’s arguments for the low offer price is that MCP revenues have been declining for several years now. However, the performance wasn’t that dim as the decline in revenues was largely the result of the business transformation strategy – refocusing towards owned brand growth, closure of unprofitable operations, exit from multiple agency brands, and overall brand consolidation (fewer, larger brands). The company was able to materially increase its margins – despite 37% drop in revenues, earnings remained stable and even started increasing during 2020. MCP also cleaned its balance sheet with net debt reduced to A$3.8m (H1 FY21) from A$75m in 2014.

Sales by division:

*Note – 2017 numbers are based on continued operations.

Owned brand sales growth was mostly driven by the success of Dr. Lewinn’s brand, especially in China. In 2019 the company signed a JV with ABM to sell Dr. LeWinn’s brand products through ABM distribution channels in China. The JV turned out highly successful growing Dr. Lewinn’s sales in China 5x during FY19 and further +130% during FY20. Dr. Lewinn’s is currently MCP’s Nr. 1 brand and has generated 26% of revenues in FY20 (ending June).

 

Valuation

In its response to Kin Group offer MCP management argues that the offer significantly undervalues the company based on peer comparison and analyst targets, which do not include control premium.

However, management’s peer analysis is somewhat flawed. Apparently, MCP has no close publicly listed peers and most companies used in the peer comparison table above are not really “compatible” with MCP (most of the peers are in the food and beverage industry). Despite that, a comparison with much closer peers, beauty and personal care companies, indicates that the discount levels are actually even higher leaving plenty of headroom for an improved offer:

These competitors are much larger companies, however, they compete in the same industry with similar business models, so the comparison should be at least directionally correct.

 

 

Timeline

• 20th Oct’20 – MCP issued Q1 FY21 trading update showing strong financial results YoY – 4% growth in revenues, 84% in underlying profit before tax (PBT) and guided 20%-30% growth for H1 FY21 (ending Dec’20) and 5%-10% growth in FY21. However, the company has also highlighted $5.7m inventory write-down for hand sanitizers. The market reacted negatively to this announcement with shares dropping 7% on the same day and another 16% in the next two weeks. In the recent target’s statement, management explained that the write-down was due to their supplier being late in delivering as a result of which certain customers have canceled the offer.
• 27th of Oct – MCP completed $27m acquisition of Global Therapeutics and closed $36.5m institutional placement of shares at $2.27 (market price was $2.47/share at the time). The agreement included an additional $10m share purchase plan.
• 25th Nov – share purchase plan of $9.4m shares was put into effect at $2.15/share price (shares traded at $2.11/share the day before).
• 1st Dec – The trading update was released highlighting lower than expected sales in China during 11/11 event. H1 FY21 PBT guidance was amended to a revenue decline of 12%-23% YoY and the guidance for FY21 was withdrawn. Nonetheless, it was noted that ABM (Chinese JV partner) forecasts 40% to 50% growth in sales through ABM channels in CY21. MCP share price dropped from A$1.82 to A$1.19/share.
• 10th Dec – MCP CEO resigned without much explanation.
• 17th Feb’21 – H1 FY21 results were released (see financials in the “Business” section above). Underlying PBT reported slightly above the upper range of the amended guidance (A$7.7m vs A$7.5m). MCP stated uncertainty in short-term outlook due to difficulties in future sales in China and expectation of H2 and FY21 EPS materially below previous years’ results. The share price dropped from A$1.32 to A$1.21/share.
• 25th Mar – Kin Group announced a A$1.34 on-the-market offer noting the need of urgent strategic and operational change for MCP due to recent earnings downgrade and lack of visibility/transparency in Chinese operations.
• 25th Mar – MCP board recommended shareholders to take no action considering the offer to be “utterly opportunistic and profoundly undervaluing”.
• 30th Mar – The buyer confirmed that while it has no intention to raise the price at the moment, it reserved the right to do so.
• 31st Mar – Media reports highlighted two major MCP shareholders, Microequities Asset Management and Investors Mutual, opposing the offer.
• 31st Mar – MCP released larger PR against the offer, noting that shareholders should wait for an operational review results in May. Domestic brand sales grew 5% in three months since Dec’20.
• 7th Apr – Lennox Capital that owned 5.81% sold about 2.3% of total MCP shares ceasing to be a major shareholder.
• 8th Apr – MCP issued a full responce statement rejecting Kin Group’s offer highlighting the opportunistic timing and low price (relative to peers and analyst targets). The company claimed that the recent quarter has been hard for the whole industry and many of its peers have also withdrawn their guidance. MCP also stated that it expects China sales to recover and the unused inventory (from the 11/11 event) to be cleared during CY21. Multiple other arguments, including lack of control premium, long term value creation potential of the recent acquisition ($27m), large franking credit balance ($0.195/share), Kin Group’s operational synergies with MCP, were presented as arguments to reject the offer.

 

Kin Group

Kin is an investment vehicle of the Melbourne billionaire family (Raphael and Fiona Geminder). Amongst other investments, Kin holds:

• 44.26% in Pact Group – the largest manufacturer of rigid plastic packaging and other products in Australasia. Serving customers in personal care, household consumer, industrial chemical, and other industries.
• 19.34% in The Reject Shop – operates 355 discount stores in Australia.
• 51.6% Pro-Pac Packaging – manufacturer and distributor of flexible packaging, industrial packaging, etc.
• Other consumer-focused brands like Cobs, Green’s General Food, etc.