A pre-Christmas tip proved on the money, and analyst Edmond Jackson made a big profit, but shareholders must now decide whether to stick or twist.
It reinforced a conviction bet, given a stock price of 370p implied a £185 million equity valuation supporting around £500 million of financial debt. But despite financial risks, there was scope to get lucky.
Saviours of shareholders, or sensing a major long-term opportunity?
On 4 January, the stock leapt 25% to neat 530p after Dignity declared it had been in receipt of a proposed 525p a share cash offer - remarkably, since 13 November. That’s a gain of 44% from the 16 December tip price, and it’s still 36% at today’s price of 505p.
The potential bidders are effectively Gary Channon, an ex-Dignity CEO who runs Phoenix Asset Management, which owns a 29.7% stake; and Sir Peter Wood, the founder of Direct Line Insurance and a consummate marketeer.
As the UK death rate rises amid ageing demographics and an NHS struggling to cope, it is hardly surprising these businessmen say Dignity has a long-term future.
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But they contend that listed status does not accord with achieving it: Dignity should be outside public markets to obtain long-term committed capital and “a safeguarded environment for management”.
The board and its financial advisers, Rothschild & Co, are minded to recommend this mooted 525p offer to shareholders, many of whom kept patient through the Covid disruptions and see a long-term stock chart rising from an all-time low around 250p in April 2020.
Dignity reached over 800p variously during 2011 to 2016, although regulation has toughened since accusations of industry profiteering. Yet a possible 525p a share offer aligns with prices seen only last springtime.
An apparently cheeky offer – in chart terms – would be sweetened by the option for shareholders to maintain an equity interest in “Valderrama”, an unlisted company set up to enact a bid, or a listed share alternative in Castelnau Group (LSE:CGL), which is exposed to six other companies besides 29.5% of its net assets already constituting Dignity.
Only now does the market learn that discussions about a potential takeover started on 13 October with an indicative price of 475p against Dignity’s then price near 350p. This was revised upwards to 500p and 510p before 525p appears to work.
The stock market is being criticised for failing to provide an appropriate environment, yet participants in this takeover set no moral example in covertly proceeding with takeover discussions. Granular Capital, for example, has during this period sold down a 10% stake in what is arguably a false market.
Supposedly, the Takeover Panel exists to ensure all shareholders are treated equally.
Given the Monaco stake-builder further raised his holding to 19.4% on 16 December, if he is willing to accept a 525p cash offer, then a takeover would seem increasingly likely.
A circa 20% premium to market price is usually the basic level for control of a listed company. A 5 January announcement by the potential offerers citing premiums to Dignity’s recent market prices is cute, given the stock dropped a long way and last October represented a low point in markets generally.
Why could Rothschild have got onside for such a deal?
The long-term context is Dignity forming in 1994 by merging two ex-listed funeral providers: Plantsbrook and Great Southern, which had been acquired by a US services group.
It re-floated in 2004 and the stock rose 50% over 12 months despite a 3% slip in the UK death rate. More recently, a 2018 to 2020 industry investigation by the Competition and Markets Authority have weighed – together with Covid and concerns about debt.
The offerers claim a 525p offer is “full and fair, when the general investment outlook is very uncertain and Dignity faces substantial operational challenges...”.
Moreover, growth prospects “can only be realised over a long-time horizon and require significant additional near-term capital...”.
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That appears true to an extent. Dignity’s 1 July interim balance sheet had a £274 million net assets deficit resulting from financial liabilities of £513 million longer-term and £12 million near-term, versus £49 million cash. This generated a £14 million net interest charge, swelling a £48 million loss already posted at the operating level.
As I made clear when concluding with a speculative “buy” stance last month: the key financial risk is a primary debt covenant requiring EBITDA (close to operating profit) over 1.5x which had declined to 2.1x last December and 1.6x last March. Dignity might thus cope with a relatively short shallow UK recession but a long tough one could mean trouble.
A rights issue for example might require discounting to an extent it would be prohibitively dilutive. Possibly, Channon considers Phoenix Asset Management and its Castelnau vehicle have dug in deeply enough – buying from early 2018, to hold 29.7% of Dignity by April 2019 – and radical action is needed to recover value.
Phoenix has also provided a £50 million loan for any business purpose, which a going concern report cited as implying “no plausible scenario of exhausting liquidity in the period to 30 September 2023”. So, it is a bit hard for the offerers to hint at a near-term liquidity crisis.
Scope for sale and leaseback of crematoria assets
In an April 2021 interview, Channon said more than £1 billion could be raised by a sale and leaseback of crematoria assets. Moreover, Dignity statements have hinted at exploring sale and leaseback as a means to cut debt.
Looking back to 2016 when Dignity acquired five crematoriums from the Co-op for £43 million - if the average value of a crematorium has risen from £8.6 million to say £12 million, Dignity’s 46-strong estate implies £550 million value. Mind, I do not know how the Co-op assets compared with Dignity’s.
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Yet the balance sheet showed only £241 million, property, plant and equipment.
Properly, all such should be discussed at a shareholders meeting, but with a few key people controlling Dignity it appears the outcome will be decided well beforehand.
Do capable professionals really need a ‘safe space’?
The offerers continue their justification: “...as a private company, would be working in a safeguarded, supportive environment...”.
The implication being that scrutiny of analysts and the press undermines managers’ ability to get results.
Yet when it suited an agenda to float and promote the company, coverage was actively sought. As I imagine would be the case in years hence, if the consortium eventually re-listed Dignity as a means to realise gains and move on.
While this takeover situation has enabled some traders to gain, overall it is a frustrating one. Dignity is UK market leader, although I am sceptical another operator would want to take it on, including the liabilities. It is logical how a small market premium to the mooted offer price has eroded, with the market price now 505/510p.
Waiting for an offer could extract a few more pence per share, which is what I would tend to do if I held the shares myself. But pragmatically, it seems best to move on, unless you prefer Castelnau equity say for tax management reasons. Broadly: Sell.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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