EUR 850.00 For Business Accounts Only

Morningstar | McMillan Wisely Abandons Eclipx Merger; FVE Unchanged

Our fair value estimate for no-moat McMillan Shakespeare is unchanged at AUD 14.20 per share following the company's decision to abandon its proposed merger with Eclipx Group following Eclipx’s most recent earnings downgrade made March 20. The company does not believe extending the scheme completion date will resolve the target’s issues or be in the best interest of McMillan shareholders. We agree with McMillan’s position; we had already assumed the merger would not proceed and removed it from our modelling following Eclipx’s initial earnings downgrade made Jan. 29. Accordingly, the confirmation of the abandonment of the merger does not affect our fair value estimate. At our fair value estimate, McMillan has a fiscal 2019 price/earnings of 13 times and a fully franked dividend yield of 5.1%. At current prices, the company screens as moderately undervalued.

We agree with McMillan’s decision not to acquiesce to Eclipx’s request to extend the deadline for the proposed merger and instead abandon it. Eclipx had sought to extend the end date for the completion of the merger by two weeks to May 14. However, we do not believe it would be in the best interest of McMillan shareholders to proceed with the merger, given the extent of the decline in Eclipx’s underlying net profit after tax. Eclipx indicates its underlying NPAT was 42.4% lower in the first five months of fiscal 2019 relative to the same period in fiscal 2018. Given its operating uncertainties, Eclipx is also not prepared to provide specific full-year guidance for fiscal 2019 other than indicating it would not achieve underlying NPAT consistent with fiscal 2018.

We believe the serious operating difficulties Eclipx is now facing make the integration risks of this merger untenably high from the perspective of McMillan shareholders. Integration risks were always inherently high with this transaction due to the acquisitive history of each company and the size of the transaction relative to each company’s market capitalisation. The key rationale for the merger despite these risks was the material potential economies of scale and cross-selling opportunities by combining the companies. These synergies were originally estimated at AUD 50 million EBITDA per year, but we expect they are now unlikely, given Eclipx’s material earnings downgrade. McMillan shareholders would be also faced with increased operational risks by the merger making McMillan a more capital-intensive business, with a lower proportionate share from its high-margin, high-cash-flow-generating salary packaging and novated leasing business.