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Morningstar | McMillan Under Review Following Its Proposed Company Transforming Takeover of Eclipx

We expect no-moat McMillan Shakespeare’s proposed takeover of Eclipx Group will be company transforming--not only due to its size but also because it will fundamentally change the company’s underlying business and funding structure. The new combined group will be a more capital-intensive asset management business, with new funding sources from securitisation vehicles. While we believe there are significant opportunities for both economies of scale and revenue synergy benefits, we also think the size of the deal means there are significant integration risks. McMillan’s current market capitalisation is about AUD 1.37 billion and Eclipx’s market capitalisation is about AUD 776 million. Given the transformative impact of the deal, we have placed McMillan under review and intend to update our model and recommendation by early next week.

We expect synergy benefits from economies of scale are likely to be generated from supply chain management in areas such as vehicle procurement and end-of-lease asset management as well as operating efficiencies from areas such as reduced occupancy requirements per employee leading to lower rents per employee. The company expects synergy benefits to boost earnings before interest tax and depreciation by about AUD 50 million per year within a three-year period. About 80% of these are from cost savings arising out of economies of scale and 20% should come from revenue benefits from cross-selling opportunities from a larger client base, which will include Eclipx’s clients. We expect the synergy benefits will be staggered over the next three years, but the one-off integration and transaction costs totaling about AUD 40 million will be more front-loaded.

While McMillan described the deal as a “friendly merger,” we believe the deal is more akin to a takeover, with McMillan being the acquirer. However, the deal is unanimously recommended by Eclipx’s board in the absence of a superior offer.

Pursuant to the deal, Eclipx’s shareholders will receive 0.1414 McMillan shares and AUD 0.46 cash per Eclipx share. Applying McMillan’s share price of AUD 16.90 per share on the day prior to the announcement, this represents a consideration of AUD 2.85 per Eclipx share. However, given the sharp sell-off in McMillan’s share price to AUD 15.82 per share following the announcement, this currently represents consideration of AUD 2.70 per share. This places some uncertainty over the deal as Eclipx’s board had in August 2018 rejected a takeover proposal from SG Fleet with a higher cash component valued at AUD 2.52 per share. At that time Eclipx’s board primarily rejected the deal due to what it regarded as an inadequate price. We expect the sharp sell-off in McMillan’s share price following the announcement may be as a result of the transformational nature of the deal, high integrations risks, and because McMillan shareholders are not being given an opportunity to vote on it.

The deal is structured as a scheme of arrangement that is expected to be implemented in the first quarter of fiscal 2019. Only Eclipx’s shareholders are being given the opportunity to vote on the transaction. We believe best practice would be for McMillan’s board to give its shareholders an opportunity to vote on this transformational deal that changes the risk and reward characteristics of an investment in McMillan. The transformation results from the new entity combining Eclipx’s core operating lease business with McMillan’s core salary packaging and novated lease business. We believe the risk and reward characteristics change via the new combined entity becoming a more capital-intensive asset management business. Upon completion, the more capital-intensive asset management business is expected to account for about 42% of pro forma combined group’s underlying net profit after tax, or NPAT. Whereas the previously dominant capital-light and high margin salary packaging and novated leasing business is expected to account for 37% of pro forma NPAT, with consumer finance about 21%. This compares with McMillan as a stand-alone business where salary packaging and novated leasing accounted for 68% of underlying NPAT in fiscal 2018 and retail financial service 9%, with asset management accounting for 23%.