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Patrick Corp's action in entering into an alliance with FCL after the Australian Competition and Consumer Commission opposed the acquisition of the road and rail freight forwarder arguably breaches one of the conditions of Toll Holdings's $5 billion takeover bid.
Toll will no doubt give consideration as to whether it views the alliance as an action designed to frustrate its bid and, if so, whether it should take it to the Takeovers Panel.
The alliance only increases the need for Patrick to spell out in the target's statement, scheduled to be released early next week, whether its strategy in pursuing a dispute with Toll over their jointly owned rail operation Pacific National, is intended to break up the joint venture. If so, it needs to explain how that would create greater value than it would destroy, and over what period it would take to realise that value.
Patrick and Toll have invested about $1.7 billion in Pacific National which compares with the average broker valuation of $2.8 billion. A break up would therefore involve hefty capital gains tax, if the assets were split the remaining operations would have less scale, and there would be considerable efficiency losses. The Toll camp believes the value destruction would be in the order of $1 billion.
Moreover, Patrick's desire to expand in freight forwarding only endorses the Toll bid rationale. Toll is already the largest and most efficient freight forwarder, by a significant margin so combination of Toll and Patrick would give Patrick shareholders a continuing interest in just the sort of vehicle Patrick wants to create, without any of the execution risk, and giving Patrick holders a premium on the shares to boot.
Patrick's attempt to buy FCL was opposed by the ACCC because of Patrick's involvement in Pacific National - it considered it would reduce competition between Patrick and Toll, leading to a substantial lessening of competition. A break-up of the joint venture could free Patrick to resurrect the deal, and that possibility was alluded to by Patrick yesterday. Patrick said it was in on-going discussions with FCL's owners to preserve Patrick's ability to acquire FCL's assets and businesses at a later date "subject to ACCC approval". That won't be forthcoming while ever Patrick remains a joint owner of Pacific National.
Toll maintains that the dispute with Patrick is not material and therefore doesn't provide grounds to break up the joint venture. The ACCC is therefore likely to take an interest in the alliance to determine whether it considers it to be an attempt to bypass the regulator.
One of the Toll bid conditions is that Patrick doesn't enter into any material transactions during the offer, which includes doing or permitting "any material act, matter, event or circumstance which is not in the ordinary course of business".
In addition to entering into the alliance Patrick, through its subsidiary Patrick Finance, has agreed to lend FCL up to $32.5 million for 18 months to enable that company to refinance its existing borrowings and provide funding for FCL's requirements and working capital. The loan is secured over first ranking mortgages over real property and a charge over FCL.
It's questionable whether such a loan is in Patrick's ordinary course of business. Certainly the company has never described itself as being in the business of lending money. Its accounts do not show any loan receivables - that is external loans - which suggest that Patrick Finance exists for internal financing purposes, with inter-group loans eliminated on consolidation.
Patrick's announcement does not state that the loan to FCL is on commercial terms which poses the question as to whether it is at a low interest rate or perhaps even interest-free. If so, it would be even more questionable as to whether it is in the ordinary course of Patrick's business.
That FCL obtained a short-term loan from Patrick to refinance its existing borrowings and provide working capital also poses questions as to the financial condition of the freight forwarder. It's suggested that, before the ACCC knocked it on the head, Patrick had agreed to pay $150 million for FCL but that the freight forwarder earned only $200,000 profit in the latest year.
Patrick says that under the alliance Patrick and FCL will jointly market combined services to their customers, develop integrated logistics offerings, combine sourcing of consumables and capital equipment and share expertise on operational matters. The alliance is expect to provide customers of both companies with a better, more integrated service.
Patrick says the alliance will provide strategic benefits and flexibility but, of itself, is unlikely to have a material impact on profit. The alliance is for an initial term of six months, but can be renewed for two further six month terms.
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