By Jonathan Underhill
Feb. 15 (BusinessDesk) - Fletcher Building paid US$700 million to buy Formica Corp from private equity owners Cerberus
Capital Management and Oaktree Capital Management in 2007. It may be a good time to sell a business that sits outside
its core operations, Morningstar says.
In a note released after Fletcher announced wider losses in its construction business and breaches of lending covenants
yesterday, the research firm said it anticipates "the divestiture of assets, especially those earning low returns with
no synergies across the rest of the business".
"These should be the focus as long as they can be realised at attractive prices," Morningstar analysts said. "In our
opinion, Formica fits the bill on both criteria."
In detailing further provisions at the Building + Interiors unit of the construction division, chief executive Ross
Taylor said yesterday that he expected to unveil a revamped business strategy for Fletcher by June, including "what
bits, if any, we want to trim".
The company expects to have negotiated new covenant terms on all of its funding lines by the end of March, having gained
a waiver from its banking syndicate for breaches of conditions related to earnings ratios. It is also in talks with
holders of its debt issued in the private placement market.
Yesterday's update brings two-year losses at B+I to $952 million. Taylor said he is "quite convinced we've got these
provisions right. Once we've confirmed that and got that monkey off our back ... we'll look at where we want to take
Former Fletcher CEO Jonathan Ling bought Formica in 2007, adding to the existing Laminex business in Australasia, with
the aim of creating "a truly global laminates platform" and further diversifying the group's earnings exposure.
Acquisition funding included a US$325 million issue of notes in the US private placement market and about $328 million
raised from a share placement.
Cerberus and Oaktree had bought Formica out of Chapter 11 bankruptcy in the US and had chalked up three years of
earnings growth before selling to Fletcher at 7.2 times forecast 2008 normalised earnings including expected synergy
benefits, including rationalisation of Australasian manufacturing and streamlining of raw material procurement.
Formica sits in Fletcher's international division alongside Laminex and Roof Tile Group. Formica operating earnings
before one-time items jumped 42 percent to $88 million in 2017, contributing to a 27 percent gain in earnings for
international as a whole.
In 2009, Fletcher cut the carrying value of Formica's goodwill by $56 million and reported an impairment against the
assets of Formica Europe of $65 million.
Morningstar values the international division at $1.36 billion or 7.5 times estimated 2018 earnings before interest and
tax. "Applying these same multiples to just Formica, we think a sale of Formica alone would have to fetch $730 million
to be neutral to our valuation and would also lead to lower gearing and provide greater certainty about the business."
It says Fletcher's focus should be on businesses where it has the strongest competitive advantage - building materials
and distribution (which includes the Placemakers chain). "A sale of the Formica business would achieve those goals as it
earns a low return on capital and does not have any integration or synergy benefits from belonging to Fletcher's New
Zealand and Australia focussed businesses," Morningstar said.
Return on capital employed in the international division at 8.7 percent, is "a fraction below our cost of capital of 9.1
percent. With current economic conditions in the US and Europe, now could be a fortuitous time to approach a sale."
Fletcher cancelled its interim dividend yesterday and said no decision had been made on whether to make a full-year
payment. It would save $270 million by omitting the full-year dividend, Morningstar says. A further $50 million could be
saved by cutting growth in capital expenditure to 1 percent of sales, it said.
As at Jan. 31, the company had borrowing headroom of $1 billion and said net debt is forecast to increase by about $250
million this calendar year. Net debt stood at $2.1 billion with $173 million of cash on hand.
The shares fell 0.4 percent $7.02, adding to yesterday's 9.3 percent slump when trading in the stock resumed from a