On 5th October, UPP announced the following corporate activity:
- Acquisition of 58.3% of Canadian-listed Taiga Building Products (“Taiga”) for C$18.9mn
- Purchase of C$46.0mn principal amount of 14% unsecured subordinated notes issued by Taiga for C$52.9mn
- Issue of 1 warrant for every 1 existing ordinary share with an exercise price of SGD0.37
Acquisition of Taiga shares
Taiga is the largest independent wholesale distributor of building products in Canada. As a wholesale distributor, Taiga maintains substantial inventories of building products at fifteen strategically located distribution centres throughout Canada and two distribution centres in California. Taiga also owns and operates three wood preservation plants that produce pressure-treated wood products.
The acquisition price implies a valuation of C$32.4mn for the entire company.
On an earnings basis, this translates to a P/E of c.3x which is very cheap. But there is a reason for that cheapness – Taiga is highly leveraged. It is clear than earnings are anything but stable. If I am reading the balance sheet right, the company has no cash and is actually in an overdraft position of C$81.3mn vs its C$32.4mn valuation. Group equity is negative C$26.5mn.
Clearly, this Is not the usual type of company that we go for. Whether the acquisition is a right move for UPP depends ultimately on one’s view of Taiga’s earnings potential going forward. If they can maintain the same earnings and pay off its debts eventually, Taiga will be regarded as a steal at 3x P/E. Unfortunately, we do not have conviction on that front.
As the acquisition is a related party transaction (Dr. Kooi Ong Tong is the Charmian of Taiga), I am inclined to believe that the acquisition was made to lend greater financial support for Taiga considering UPP’s net cash position.
Purchase of Taiga unsecured subordinated notes
Despite purchasing the notes at a 13% premium to par, UPP will have a current yield of 12.2%. Yield to maturity will be slightly lower at 9.3%. Think of it as making a 13% capital loss (when the notes get redeemed at par in 2020) while earning 12.2% interest rates along the way.
A 9.3% yield is high, but one has to ensure that it is commensurate with the risk. I would argue that UPP shareholders were getting about 10% FCF yield on the power plant which is a much less risky instrument than the Taiga notes.
If earnings do come through over the next 4 years, then 9.3% will be a good yield. Once again, it all boils down to one’s conviction in the sustainability of earnings in Taiga.
Given my negative view of the acquisition of Taiga shares and unsecured notes, the value of the warrants becomes is close to zero. Even before this series of acquisition, my intrinsic value for UPP was less than SGD0.37. Not to mention, the exercise period is only 6 months. I think it is very unlikely for the warrants to be exercised.
Without being able to develop conviction into Taiga’s prospects, I think the recent acquisitions serve as a good exit opportunity for UPP. Share price rallied 30% on the announcement to SGD0.255. Going forward, UPP will be in a much poorer shape – at least for the next 4, 5 years as the net cash have been used to acquire the risk that is Taiga. Leverage will also increase as it consolidates Taiga debt.
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