We have been sitting around waiting for Melrose Industries to make another purchase since the sale of the last one, the Elster metering business, at the end of last year. The next deal has duly arrived and, gosh, is it a complicated one. Melrose is buying Nortek, a maker of household items such as heating equipment, air conditioning, alarms and surveillance, based in Rhode Island, for £2.15 billion in dollars. This splits into £1.1 billion for the shares, which are quoted on Nasdaq, and the rest accounted for by the company’s huge debt, much of which is being paid off.
The main shareholders are seeking an exit but have left the door open until August 6 for another bidder. Melrose is offering $86 a share; any other bidder must find the equivalent of $89 to take account of a $3 “break fee” by then. Melrose is giving no details, but bits of Nortek are not terribly well run. They can be improved, applying the company’s usual model, by efficiencies, cutting costs, selling unwanted offices and so on. It seems feasible that Melrose can increase the current return on sales, about 10 per cent, to maybe 15 per cent that way.
Nortek is also emerging from a period of underperformance, to do with a distribution network that went wrong last year and disruption from a takeover approach from another bidder. Melrose’s model means that as large businesses such as Elster are sold and the money handed back to shareholders, it shrinks. The only asset at present is Brush, which makes turbo-generators and is not yet ready for sale.
This means that the market capitalisation before yesterday, when the shares were a bit more than £4, was about £600 million. The deal has to be funded by means of a 12-for-1 rights issue at 95p. That ratio of new equity would normally suggest a company in dire danger of going bust, but it is down to the complicated mathematics of what is effectively a reverse takeover.
What you need to know is that the market’s reaction was to mark Melrose shares up 187¾p to 597½p. The market likes this deal, which will almost certainly go ahead. You should too. I have been tipping the shares for years now and Melrose has not put a foot wrong.
My advice Buy
Why? The company’s record speaks for itself. The share price movement gives a good idea of how well recevied the deal is in the market
Carillion
Carillion is another of those stocks that have fallen so far that the dividend yield is compelling unless you believe the business is going to fall apart in the next couple of years. The company is expanding into support services, providing property maintenance for the government and on the roads and railways.
The market has had its doubts about the outsourcer because of concerns that the level of debt may constrain it from taking on extra work. To that must now be added fears of a slowdown in new UK public infrastructure work and in commercial property. The latter looks pretty certain, but this is only a small side of a construction division that has already been shrunk to half its size. The former is a definite uncertainty but the facilities management work, for example, should go on regardless.
Carillion’s half-way trading update suggests that the future workload, the main measure of such a business, is building up. Two more contracts worth up to £600 million were announced yesterday; almost all this year’s revenues are locked in and about 65 per cent of those for 2017. There is a pipeline of potential work worth more than £40 billion.
All this suggests that profit forecasts for this year, which have the dividend almost twice covered by earnings, are reliable enough, as is that dividend. Carillion shares, up 1½p at 223p, have fallen from about 280p before the referendum and now yield above 8 per cent. That market mistrust may limit any upside but the yield is worth having.
My advice Hold
Why? Yield is attractive even if some doubters remain
Tullow Oil
It is encouraging, to say the least, that an explorer and producer such as Tullow Oil can get a bond issue away in these markets and see it more than twice subscribed by institutional investors. Tullow is raising $300 million by means of a five-year bond paying a coupon, or interest rate, of 6.625 per cent. The aim is to shuffle its debt to put a bit more on to bondholders, taking some pressure off the refinancing of part of its borrowings when this comes due later this year or early next.
Tullow is unlike other smaller oil companies in that it has two assets in west Africa either producing or just about to. The Jubilee field has seen some interruption for technical reasons, while the huge TEN field will see first oil shortly. When both are up and running, the cost of production will be $8 a barrel, to be sold into the world market at a time when the price remains a bit shy of $50.
Much good has this done Tullow shares, off 30p at 210½p for technical reasons to do with temporary shorting by hedge funds taking the convertible bonds. The company is as well placed as any in the sector. It’s up to you if you think it is time to go back into oil stocks, though.
My advice Avoid
Why? Probably too early to dive back into oil stocks
And finally . . .
It may not be that 3i gets its money back tenfold, as with Action, the European discount retailer I wrote about the other day, but the quoted venture capital group has alighted on its latest investment, an upmarket “new Nordic design” furniture maker. Many of us may not have heard of BoConcept, but its model is to do the design and let franchisees handle the retail. The company sells into 64 countries; 3i is part of a consortium paying £166 million, with the intention of growing it into a big international brand.
Follow me on Twitter for updates @MartinWaller10
