Description

Company: Guinness Peat Group (GPG)

Ticker: 3 Listings ~ GPG LN, GPG NZ, GPG AU

Price: 23.50 Pounds (UK Listing)

S/O: 14.07

Market Cap: £330mm

Enterprise Value: £578mm

Recommendation: Long GPG

 Price Target: £37.50 pounds (60% upside ~ 30% IRR over 2yrs)

Link: https://www.scribd.com/doc/254409907/Guinness-Peat-Group-GPG-VIC-Memo

Thesis:

GPG is an international holding company wind-up investment with two primary assets: 1) £369mm pounds of cash at GPG and 2) 100% interest in wholly owned subsidiary Coats Plc (largest thread manufacturer in the world with 250 year history). The cash pile at the holdco is the result of a multi-year liquidation process started in 2010 by activist shareholder Soros Management of Sir Ron Brierley’s investment vehicle (GPG). In regard to the second asset, Coats is the last remaining operating company within GPG and will be the central business going forward.

 The only item holding up GPG from collapsing its holding company shell into Coats and distributing the cash at GPG is a pension settlement negotiation with the UK regulator in regard to GPG’s two legacy plans (Brunel & Staveley ~ B&S). B&S is part of legacy GPG, so the UK pension regulator wants to ensure that these plans are “sufficiently” capitalized prior to approving a relisting of Coats and letting the GPG board distribute cash back to shareholders.  

 Guinness Peat offers 30% IRR over next 2 yrs with a reasonable estimate of downside and multiple levers to drive returns higher than the base case estimate. The GPG mispricing exists for 3 reasons:

1)  Warning Notice to GPG from UK Pension Authority (Staveley & Brunel Plans): On December 2012, the UK pension regulator issued a Warning Notice (WN) in regard to B&S creating short-term uncertainty around the amount of net distributable cash available to shareholders of GPG and timing of a Coats listing.

2)  Wind-up Process: At its peak in 2009 GPG held 55 minority investments until a group of large shareholders speared by Soros voted down Brierley’s plan to split up the company in favor of liquidating the minority investments, returning ultimately the cash and relisting as Coats. Rob Campbell was promoted to Board Chairman and has led the liquidation process. Given the wind up of GPG into Coats, the corporate mandate has changed from an international conglomerate to a perceived sleepy textile company.

3)  Transitional Shareholder Base and Analyst Coverage: Most of the legacy shareholders in GPG are New Zealand and Australian institutional investors with a penchant for Sir Ron Brierley (richest billionaire in NZ). Following his ouster and announcement of the GPG liquidation, the shareholder base has been in flux. Historically, only 15% of the shares were held outside of NZ/AU, but today that % has grown to 45%. This number will grow following the listing of Coats in the UK and the washout of the 25-30% retail shareholders in NZ/AU as well. For sell-side coverage, GPG has 3 legacy analysts that are pretty much in “maintenance model” mode given the liquidation. Coats just hired a dedicated investor relationship contact to pitch the story more to US and UK investors. 

Valuation:

Base Case (£37.50) - At £23.50, the market is “pricing-in” GPG funding more than its available cash into the pension deficit for all plans (£400mm) plus Coats trading at 5x ’15 EBITDA. Even though the UK regulator is playing harder ball than the fast money hedge funds expected, I believe the market is off on both value drivers: 1) the size of the needing cash pension settlement and 2) the valuation of stand-alone Coats.

 Pension Settlement - In the above SOP valuation, there are two objectives: 1) estimating the size of pension settlement and 2) valuation for Coats. I begin with the pension settlement topic and assume £321mm pounds for all three schemes, which is all of B&S and UK Coats in 100% cash leaving £2.35/share in GPG net cash.  

·       Brunel & Staveley - The UK regulator issued a Warning Notice for B&S. In speaking with GPG Chairman, Rob Campbell, it appears that regulators want to see “additional cushion” for B&S up and above the £124mm reserve that the board and B&S plan trustees agreed upon as sufficient. Because the regulators are on the hook if Coats goes defunct in the future, regulators will be more conservative than plan trustees (agreed to £124mm in the past). Given GPG’s desire to wrap up this negotiation process as soon as possible, I assume B&S is required to be fully funded (£213mm pounds) in in 100% cash upfront. From the regulators standpoint, B&S should be the more worrisome plans b/c they are legacy GPG while the Coats plan – albeit larger – is part of an on-going concern with $50mm in FCF post pension contributions.    

·       Coats - Coats has a current plan deficit of £148mm pounds and as expected received a Warning Notice on 12/22/14. This is unchartered territory as the UK regulator has never issued a Warning Notice to an on-going concern business (thepensionregulator.gov.uk). In fact, the regulator has only issued six determinations [4 Financial Support Determinations (FSD) and 2 Contribution Notices (CN)] to 6 companies (Nortel, Lehman, Sea Container, Boxclever, Bonas and Desmond & Sons). To be conservative, I assume that GPG contributes 100% of Coats UK deficit (US plan is not included in WN) via cash in the amount of £108mm.

Coats Fundamental Valuation:

·       Coats is the dominant thread supplier to the clothing trade and second biggest zip manufacturer in the world. The business has operated for 250 years and works with clients including, Adidas, P&G, Michelin, Ikea and Coach. GPG purchased Coats in 2003 for 414mm pounds and after a multi-year restructuring program (relocated factories from high to low cost locations) has been able to get back to mid-single digit revenue growth, low double digit free cash flow growth and low teens EBITDA margins. On a FCF basis, using the peer multiple of 12.5x to free cash flow implies a £500mm valuation (£35/share). 2014 was a tale of two stories. The industrial business has performed better than expected and has made up for the slack in the Crafts business (more fashion trend oriented).

Adding it up…GPG + Coats

Assuming GPG fully funds Brunel & Stavely and the UK Coats Plan, we are left with Coats valuation plus the net cash (£37.50/share).

Downside Case – To be even more draconian, we can take the £213mm pension settlement for B&S (brings to fully funded) and then assume the regulator requires Coats to be more than 100% funded (200%), resulting in £216mm infusion. This brings the total settlement to £444mm (including £15mm of GPG overhead cost). In regard to Coats, lets assume it trades down to 5x EBITDA (multiple associated with businesses in secular decline). This brings the valuation to £20.63 or downside of 12%.

This translates to roughly a 5:1 risk/reward assuming equal probabilities of upside/downside scenarios.

Upside Case – Coats has been rumored to be a private equity takeout target following the settlement of the pension schemes and its UK listing. Coats’ closest competitor, American & Efird (A&E), was purchased for around 7.5x EBITDA in 2011 despite being 1/5^th the size of Coats, similar pension issues and lower EBITDA margins. Using our SoTP pension settlement GPG net cash distribution constant and applying the A&E multiple to Coats (Coats should trade at a premium to A&E in my view), we get a £52 valuation or 120% upside. 

Summary Valuation – Excluding the M&A scenario, GPG is approximately a 5:1 risk/reward on a non-probability adjusted upside/downside scenario.

Two Key Considerations:

Timeline: Timing uncertainty is the biggest risk here in my view. GPG is in active negotiations with the UK regulatory and the plan trustees, but there is a risk that no settlement is reached and either or both B&S/Coats go to a determination panel [DP] (i.e. courts). If either plan goes to the DP, then the earliest we could hear about a Financial Support Direction (FSD) would be 1H16. However, if an FSD is issued, GPG can contest it and the matter could be pushed to the Upper Tribunal, which would approach the situation with a clean slate, but obviously push out the timeline and increase costs to GPG (reducing value).

As of GPG’s last public communication, here is where we stand:

Brunel & Staveley – Regulator rejected the “informal” £124mm reserve that the B&S trustees had previously agreed to. In response to this news, GPG has now proposed £170mm for B&S and awaits a response (we assume £213mm clearing level). The earliest we can hear back on B&S is 1H15 assuming settlement is reached, but could be pushed out 1-2 years if the battle goes to the Upper Tribunal.   

Coats – Coats could be the wildcard in terms of timing, but I expect the actual settlement clearing price to be lower than B&S given that Coats is an on-going concern and making well-sized annual contributions (£20mm+). I believe that the Warning Notice Coats received is part strategy/part learning more. I don’t expect the full UK plan to have to be funded (we model full UK funding) b/c in speaking with GPG management, it sounds like the regulator only has beef with 1 of the 4 plans. GPG doesn’t break out the size of the different UK plans that make of the £108mm deficit, but it provides optionality that it is less than 100%. 

Contribution Structure: In our model, we assume 100% cash funding into the account, but the structure proposed by GPG is effectively 50% cash and 50% reserve account (that can be lifted if rates increase and/or pension plan returns exceed forecasts). Anything less than 100% in non-refundable cash, would be incremental value to GPG.

Additional Fundamental Information:

Coats Business Overview: Coats PLC is a world-leading industrial thread and consumer textile crafts business that has been in existence since the 1750s. One-fifth of garments worldwide are held together using a Coats thread. For example, every year, a Coats thread is used in the making of 75mm airbags and 300mm shoes. Also, Coats PLC produces annually enough yarn to knit 65mm scarves. 1mm teabags using coats thread are brewed every 10 minutes. Coats PLC is the second largest and fastest growing zip manufacturer worldwide. Finally, Coats operates in two segments – Industrial and Craft – both of which are currently operating at or near trough margins. Even on trough margins, Coats generates a more than acceptable level of returns on invested capital of 15% with a business scale, operating history and a clientele that is difficult for new entrants to match.

Catalysts – GPG is misunderstood by the market for a number of factors and I expect these factors to play out over the next 1-2 years.

·       UK Pension Scheme Resolution

·       GPG Cash Distribution

·       Coats Plc Listing

·       Coats Index Inclusion (FTSE 250)

·       Coats dividend announcement

·       Rising Rates (currently at low historical levels)

·       Rebound in Industrial and Craft margins to mid-cycle levels.

Key Players

·       GPG Board – In 2010, GPG board member Robert Campbell was promoted to Chair the liquidation of GPG following Soros’ ouster of Richard Brierley and his plan to split the company up. Robert has liquidated over 50+ investments over the course of 3 years achieving sufficient value for shareholder. In speaking with him, he welcomes the end of this process and that he will be moving onto the next restructuring.

·       Coats Management – Paul Forman (CEO) took the helm of Coats following the Soros shakeup and has done a great job restructuring the business in terms of reducing operating costs and pushing into specialty threads (30% market share). Coats management is incentivized on the success of the Coats IPO based on the below target levels achieved.

 Major Shareholders

o   Soros Management – 9.5%

o   JPMorgan – 9.5%

o   Blackrock – 8.3%

o   AMP Capital – 6.0%

o   MSD Capital  – 5.7%

o   Southeastern Asset Mgt –5.6%

Risks

·       Industrial Thread business tied to GDP Growth

·       Craft business tied more to the retail fashion trends

·       Inability to lower tax rate (50% in 2013)/use NOLs

·       GPG decides to fight UK pension regulator in courts and dragging out the process

Pension Deficit Sensitivity: GPP estimates that an 80bps, 230bps and 160bps increase in real discount rates would eliminate Coats, Brunel and Staveley pensions.

Peers P/E Multiple (Coats): Even though there is no clear comp to Coats, UK peers trade close to 12-13x on a P/E basis.

Catalyst

UK Pension Scheme Resolution

·       GPG Cash Distribution

·       Coats Plc Listing

·       Coats Index Inclusion (FTSE 250)

·       Coats dividend announcement

·       Rising Rates (currently at low historical levels)

·       Rebound in Industrial and Craft margins to mid-cycle levels.