Initial step - Rentokil has shown how a disposal can affect value as much as an acquisition
Here on The Value Perspective, we often talk about how an acquisition, and specifically the price paid for it, can enhance or destroy value in a business but we rarely look at the other side of the equation – how the disposal of an asset can affect the value of the company making the sale. Rentokil initial’s sale of city link to restructuring specialist better capital at the end of April affords such an opportunity.
We believe this could prove a significantly value-enhancing deal for Rentokil, which, given it received the sum of just £1 for the parcel delivery firm, might at first seem an odd thing to say. It certainly does not sound like a deal-making masterstroke until you add in the fact that city link posted losses of £25m last year and has lost more than £100m over the last five years.
So Rentokil has managed to obtain some money – albeit a tiny amount – for a business that has proved a serial loss-maker for it. Far more importantly, however, the company has given itself an excellent chance of seeing a notable uplift in the way it is valued.
When people invest in a company, they will look at the profits it makes and put a multiple on that number. To keep things simple, let’s say investors might pay a multiple of 10x earnings for a business like Rentokil and that, before offloading city link, Rentokil had been making £100m of profits a year. That would have valued it at £100m x 10 = £1bn.
the thing is, investors are as inclined to put a multiple on losses every bit as much as profits and so of course, sticking with the above figures, the disposal of city link and its £25m of annual losses has the effect of lifting Rentokil’s profits to £125m a year. That now values the company at £125m x 10 = £1.25bn – a very significant rise and one that cost it marginally less than nothing to achieve.
By selling off a company that has proved such a drag on it for so long, Rentokil should benefit in two ways. One is the dispelling of the negative sentiment that attaches to owning a business that had not made a profit for five years. City Link had become a bit of a millstone for Rentokil and indeed the first reason to which many investors would point for not buying the stock.
The other is the value enhancement that comes from disposing of something for an attractive price, which of course to our minds is a much bigger issue. Both aspects are clearly significant positives for the stock and, while the market reacted tentatively in the immediate aftermath of the deal, it should ultimately prove a big step forward for Rentokil and the start of better things.
Fund Manager, Equity Value
I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.
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