25/02/2010 - 00:00

Muted response as Stokes plugs Seven into the China mix

25/02/2010 - 00:00

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Kerry Stokes’ planned merger of the Seven Network with his giant WesTrac mining services arm is designed to make it the first choice of investors wanting low-risk direct exposure to the China story.

Muted response as Stokes plugs Seven into the China mix

WHEN Seven Network chairman Kerry Stokes launched his tilt for board control of West Australian Newspapers Holdings in 2008, he blasted its directors for squandering the chance to cash in on WA’s “unparalleled” growth.

The clear inference was that Mr Stokes saw WAN as a window on the China-fuelled resources boom, one that could give potentially give Seven an advantage over its more conventional media rivals.

Yet 18 months later, and despite WAN giving it a broader media delivery platform, Seven’s WA strategy has appeared less than a masterstroke.

Firstly, Mr Stokes’ protracted battle with the WAN board negated any perceived benefit Seven would derive from its 23 per cent stake in the publisher during the height of WA’s mining boom.

And by the time Mr Stokes did finally gain control in late 2008, the mining downturn had hit full speed and Seven’s added WA exposure merely heightened investor concern.

But with the downturn now retreating, this week’s surprise acquisition of Mr Stokes’ prized mining equipment supplier, WesTrac Holdings, is in many ways an extension of his WAN strategy.

Recognising that those in other states viewed WAN as little more than a minor provincial publisher, Mr Stokes figured a better way for Seven to benefit from the growth powerhouses of the WA and China markets was to plug into them directly.

It was a point Mr Stokes made clear at the very outset of his presentation to analysts and media on Monday.

“WesTrac is my pride and joy and has been for the last 20 years,” he said.

“So I suggest you take the time to look at WesTrac’s business and appreciate its strengths, and the opportunity it presents to transform Seven.”

His reasoning was simple – WesTrac is closely tied to the rapidly expanding Chinese economy, both directly as the exclusive Caterpillar dealer in north-eastern China, and as the exclusive Caterpillar dealer in WA and NSW where it dominates the supply of mining equipment to the iron ore, coal and construction industries.

Peter Gammell, Mr Stokes’ long-serving lieutenant and the proposed chief executive of the enlarged Seven Group, told WA Business News the opportunity to create a more robust diversified business offering direct low-risk exposure to the world’s fastest growing economies was at the very heart of the proposal.

“I really think that is key; if you want to get exposure to West Australian and Chinese growth without being exposed to exploration risk, then this is a pretty good way to do it,” he said.

“People have not yet worked out that the West Australian economy is completely different to the rest of Australia. When you start talking to people in the east about the Pilbara, there is just no comprehension of the scale of development going on up there.”

Certainly few outside Mr Stokes’ inner circle would have had any real idea of WesTrac’s scale until he lifted its skirts this week.

WesTrac’s Australian business alone turned over $1.87 billion for earnings before interest and tax of $151 million in FY2009. Though it was hit by the global downturn, FY2010 revenue is still forecast to top $1.61 billion for EBIT of $135 million.

Yet with Australia’s recovery now in full swing, Westrac’s local sales are projected to top $1.9 billion in FY2011 for EBIT of $168 million.

Those numbers come down to its dominant position in WA’s iron ore, alumina and construction markets, and were the main reason that its 10 WA branches sold 597 machines in 2009. At the same time, its 15 NSW dealers sold 529 machines in 2009, primarily to the coal sector.

Crucially, almost 40 per cent of WesTrac’s earnings come from servicing the more than 31,000 Caterpillar machines now operating across the country.

Meanwhile, its Chinese business has gone from a standing start nine years ago to a business with 38 dealers, which sold a staggering 1,709 machines in 2009, again primarily to the coal sector.

That, in turn, has resulted in WesTrac’s China revenues doubling since 2007 to $555 million in 2009, a figure projected to hit $661 million this year and top $832 million in 2011.

Still, WesTrac China has been hit by the global downturn and Australia’s stronger dollar – EBIT topped $26 million last year, but is forecast to drop to just $18 million in 2010 before recovering to $25 million in 2011.

In total, including earnings from its 66 per cent owned National Hire Group equipment rental unit, WesTrac is projected to turn over $2.73 billion in 2011 for EBIT of $192 million.

In comparison, Seven’s conventional but struggling media business is forecast to turnover just $96 million for EBIT of $51 million in 2011. The business includes its 47 per cent stake in the Seven Media joint venture with private equity group KKR, and its separate investments in WAN, Consolidated Media Holdings, Prime Media and Vivid Wireless.

But add WesTrac to the mix, and the new Seven Group looks entirely different. Revenue is projected to hit $2.35 billion this year before topping $2.83 billion in 2011. Over the same period, EBIT is forecast at $160 million and $238 million respectively.

Despite taking on WesTrac’s $1 billion in debt, it will also retain a strong balance sheet, with over $500 million in cash and a similar amount of debt.

Yet market reaction has been inconclusive.

While Seven stock plunged 5 per cent on the news, it has since begun recovering slowly as investors get over their initial shock at marrying media with a seemingly incompatible mining equipment group.

Analysts have also held back on judgement pending more analysis, though some have questioned the limited free float of the new company, given Mr Stokes’ stake will grow from 48 per cent to 68 per cent.

But Mr Gammell was confident that, with time, analysts and shareholders would recognise the value that Seven believes it can create by acquiring WesTrac.

“This is a good business being put in at a good price. You can’t just go and buy Caterpillar dealers,” he said.

With shareholders due to vote on the plan in April, the race to convert the doubters is on.

 

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