More Carrot Required

Preliminary feedback from unitholders received during the past few weeks has shown a great deal of scepticism and reluctance to accept PaperlinX’s forthcoming offer in its current form of 250 ordinary PPX shares per PXUPA hybrid.

The  case made by PaperlinX in its announcement to the ASX continues to rely on the ‘stick’ of fear-mongering and continuing to withhold distributions rather than the bona fide ‘carrot’ of a fair and reasonable offer.

Despite the Chairman’s AGM proverb “we’re all in the same boat,” sounding agreeable, it is a false representation. Our boat (PXUPA) has a life raft called priority.

“In formulating the offer, the board has considered the relative market value of the Hybrids and PaperlinX ordinary shares…”

Note the selection of relative market prices rather than a $100 priority entitlement and claim on the company as an anchor point for the value split and remember which class of shareholders the board is accountable to. A buyer’s objective is to pay the lowest price possible.

With regard to the forthcoming offer, it is also important to note that normally, a bidder requests access to the target’s books because as outsiders, they have less information than the company they wish to acquire. In this case, we have unusual circumstances where it is the bidder (PaperlinX) who has more information than the owners (PXUPA unitholders) about the company they intend to bid for (PaperlinX SPS Trust).

We would hope for the sake of all unitholders and in the interests of board integrity that the process is conducted with full disclosure on the nature and terms of unitholders’ investment.

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PaperlinX’s prospective 250:1 offer is unlikely to attain meaningful acceptances in its current form and requires more ‘carrot’ to improve the value proposition and encourage acceptances.

The proposal considered below is designed to appeal to hybrid holders, both those electing to convert, and those not converting. Importantly, it also raises capital for PaperlinX.

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250:1 Conversion with Option ‘Kicker’:

This adjustment to the offer is based upon the grant of options to Executive Director (Andrew Price);  item 4 in the Notice of 2013 AGM which was passed with a comfortable majority:

1. All existing PPX holders are offered the same options’ package as Andrew Price, 1 option for each PPX they hold, but with the option exercise prices discounted by 20%
2. All converting PXUPA holders get the same deal based on 250:1.

See here for workings:  Option Kicker Example

This would also put pressure on the board to be generous to its long suffering shareholders; and the cash injection would help Andrew Price achieve his personal options’ exercise prices.

• Andrew Price’s options package would be protected against dilution.
• Robert Kaye can make the  “all in the one boat”  claim defensible in reality.
• An important, mutually desirable outcome is achieved: more paid-up capital (cash) on PaperlinX’s balance sheet.

If:

1. 50% of hybrid holders accept; and
2. PPX gets to a sustainable exercise price, say 8.0¢, within 2-3 years; and
3. Every option holder exercises; then

This would inject $77m into PaperlinX. That’s approximately the same as a 3:2 fully subscribed rights issue at 8.0¢ which would be a near-impossible sell at present.

If the business plan is sound, but for lack of capital, this sum of $77m could conceivably propel the price of PPX to 12.0¢ within 2-3 years, thereby bringing in an additional $116m proceeds from options being exercised.

At 12.0¢, PaperlinX has potentially received $193m of fresh capital and the implied value of each non-converted PXUPA is $30.00. It is a logical assumption that the value of PaperlinX would be significantly higher with an extra $193m of cash on the balance sheet.

Each of these cash injections also helps Andrew Price reach his options’ exercise prices. It’s a win-win.

Positives

• It looks and feels equitable;
• 8.0¢ doesn’t appear to be a big stretch;
• It may convince more PXUPA holders to convert, or have a “bet each way” and partially convert; and
• It’s a simple decision by the board.

Negatives

• The only negative immediately obvious is that options add another dimension to the capital structure which could be a barrier to any potential takeover.

In summary:

We discount the 20¢ “Exercise Price for AJP” by 20% to get an  “Exercise Price for Others” of 16¢. This gives an an implied price of $40 per hybrid ($0.16 x 250). This equates to a ROI of 42% pa; ie $14 to $40 in three years assuming no distributions. Given the foregone 5 recent distributions totalling $18.77 per hybrid, which have kept PaperlinX solvent, this seems fair and equitable.