Why the Foster’s takeover is hard to swallow

SABMiller has the option of not using a dime of its own money to buy Foster’s for $10 billion. Foster’s in 2010/11 generated disposable cash of a massive $650 million, which provides a yield of around 6.7% on the bid price. Accordingly, SABMiller is able to borrow the $10 billion required for the bid in the US debt market at a much lower cost than Foster’s cash generation rate.

So if SABMiller uses borrowings, the acquisition will add to its bottom line from day one. That puts a very low value on Foster’s goodwill and brands. Of course, maintaining that level of disposable cash generation is obviously subject to risk, but Foster’s beer business has been badly managed in past years and the beer and cider markets are showing life, so there is an excellent chance that Foster’s $650 million annual disposable cash generation will be increased substantially in the next few years.

The Australian tax authorities may be unhappy at SABMiller buying Foster’s on 100% leverage or the SABMiller directors may prefer to use some equity, but the point is that unless our tax authorities or prudence dictates the use of equity, there is no financial need.

So how do we get to a situation where Foster’s directors say $5.10 (plus cash it was going to distribute anyway) represents good value? The answer to that question tells us a lot about the current Australian market and the de-skilling of Australian investment analysts, which in turn has affected the attitudes of our boards.

It also reflects some bad decisions by the Foster’s board, who decided not to explain to shareholders that Foster’s earned $650 million in sustainable yearly disposable cash in 2010/11.

The only way you can discover the figure is by reading the Eureka Report or Business Spectator. I would not have known how to calculate it and share those calculations with readers but for a briefing a few journalists received earlier this year.

In fairness to the Foster’s directors, as we saw last night, Wall Street is slumping as the Americans discover to their horror that neither the Federal Reserve nor the president know how to fix the problem with the US economy. Meanwhile, in Europe, we are getting closer and closer to forcing the banks to own up to their enormous losses on sovereign debt.

Accordingly, the $5.10 (plus surplus cash) SABMiller bid price is way above what the market would price Foster’s shares, so it’s really hard to knock it back. I have little doubt that in the absence of a higher bid the SABMiller proposal will go through.

Yet, if we had skilled superannuation investment managers thinking about the long-term interests of their customers, then companies like Foster’s with sustainable cash generation would be highly prized to those looking to provide long-term returns for people approaching retirement. But we have de-skilled our investment analysts to the point where they think only about the short-term. The failure of the big institutions to provide a service tailored to the needs of long-term superannuation investors is one of the reasons why Assistant Treasurer Bill Shorten is forcing them to slash their fees.

The analysts’ arrogance has risen with their de-skilling which, combined with regulation, means that Foster’s never told shareholders that they generated $650 million in disposable cash.

I believe that, despite the pressures, the Foster’s board should have disclosed its disposable cash so shareholders could see it, but I also admit that in today’s world it would not have changed the share price because the analysts are not interested.

In the short-term, those Foster’s shareholders wanting quick returns have had a huge win. But those wanting lower risk, long-term superannuation returns and who are less concerned about the immediate share price are the big losers.

This article first appeared on Business Spectator.