Bankers win when major mergers are reversed

Macquarie Group, which sold Dyno to Incitec in 2008 and now advises on the split with UBS, could be the biggest winner on this occasion.

The history of Australian business is rich in high-level mergers that naturally end in splits, with Wesfarmers and Coles, and Fosters and Southcorp (which became Treasury Wine Estates) being prominent examples.

Ironically, Incitec Pivot announced its split on the same day as Tabcorp’s split of its lotteries and bets became official – less than five years after the closing of the deal that brought together Tabcorp and Tatts Group. UBS was the principal advisor on both transactions.

There are a few other fascinating points of similarity between Incitec Pivot and Tabcorp, not least the behind-the-scenes role Perpetual’s equity team has played in prompting both boards to consider a split.

And while we like to fool investment bankers and dealmakers a bit, it should be emphasized that the strategic rationale for both the original Incitec Pivot and Tabcorp deals and subsequent splits was and is sound.

When Incitec bought Dyno Nobel, and when Tabcorp took over the lottery business from Tatts Group, the companies bought companies that would become their crown jewels.

For Incitec, Dyno brought resilience to what had been a notoriously cyclical fertilizer stock. For Tabcorp, the lotteries brought with them a monopoly power that helped offset the deteriorating performance of a gambling company under intense competitive pressure.

The splits also make sense. In a particularly forward-looking paper released last month advocating the demerger of Incitec, Perpetual said there were two main reasons why demergers benefit shareholders.

First, splitting a company into two bite-sized pieces increases the chances of one of the two companies being acquired. (Of the 28 Perpetual splits analysed, one of the two incorporated companies was acquired 18 times within a few years.)

Second, dissolved entities receive more love once they are dissolved.

These two factors apply to the demerger of Incitec. As pure plays, both companies will be more attractive to potential buyers, and both companies will be able to cater to the increasingly specific needs of their customers.

While the fertilizer trade is enjoying a moment in the sun amid a global fertilizer shortage, CEO Jeanne Johns emphasizes that high commodity prices are not the driving force behind this deal.

Rather, she argues that investments over the past three years — when a split was last considered — have helped make the fertilizer industry more resilient. At the same time, the strength of Incitec’s balance sheet has improved to such an extent that the fertilizer business can be divested without debt.

Perhaps most importantly, separating Dyno Nobel’s cyclical fertilizer business will make the latter shine.

Perpetual portfolio manager Anthony Aboud points out that Incitec Pivot is trading at a P/E ratio of just six times 2022 earnings, while Dyno Nobel’s closest competitor Orica is trading at 23 times.

To be clear, he says there are reasonable reasons for this disparity, most notably the cyclical nature of the fertilizer industry, whose boisterous results may overwhelm Dyno Nobel’s numbers. Making Van Dyno a pure-play explosives company should lead to a revaluation over time.

This is a similar driver behind the Tabcorp split, where the infrastructure-like qualities of the lottery business are arguably hidden by the struggles of the gambling industry.

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