The Shoeshine Column: Don't carve up Fisher & Paykel

Friday 2nd June 2000

Splitting out the healthcare division won't bring the benefits fund managers expect

A while ago one of Shoeshine's mates was conversing with a US funds management old timer.

"Used to be," says this character, "a CEO and the executive team and the board figured out a strategy and had the intestinal fortitude to believe they were right, never mind what the market said or did."

"Now, they're all aware if they don't deliver what the market thinks is the right thing they might not survive or the company might get taken over."

The tale sprang to mind with a report this week that fund managers and analysts are pressuring Fisher & Paykel to split off its healthcare division from whiteware.

The institutional investors apparently argue F&P - which these days derives two-thirds of its earnings from selling healthcare products despite its public image as a whiteware company - suffers from a low share price compared with "health stocks" listed overseas.

One answer, they suggest, is for F&P to "carve out" healthcare from the rest of the group, keeping a major stake and floating the rest of the division as a separately listed company.

That's a common enough call for companies with a fast-growing division whose performance isn't reflected in the parent's share price. Telecom is under the same pressure to carve out its mobile and internet businesses.

The idea is the market will value the shares of the faster-growing business at a higher multiple than those of the parent. This in turn will be reflected in the parent's share price as it puts a market value on the stake the parent retains.

But F&P chief executive Gary Paykel is definitely one of the old school and he is likely to ignore the pressure. That's just as well because splitting up the company makes no sense whatever.

For one thing the healthcare division has total assets of about $98 million, putting it in the same league as Williams & Kettle or Dorchester Pacific.

Sure, its operating earnings are far higher - $23 million for the September half-year - and are rising much faster. So it could expect to command a multiple of either of those companies' market capitalisations.

But it would still be far too small to make an appreciable blip on overseas institutions' radar screens. And with F&P holding half or more of the scrip there wouldn't be enough shares available to attract investors who buy in $US100 million bites.

In short, splitting the division off wouldn't bring the international pricing local institutions want.

Companies considering a carve-out look to advantages other than a simple re-rating of the share price. In Telecom's case a separately listed high-tech subsidiary could - before the Nasdaq "tech wreck, anyway - have issued highly priced scrip to raise cash for expansion or to finance acquisitions or cement alliances.

But F&P's healthcare division doesn't need to raise large amounts of capital. Nor for that matter does whiteware which has all the capacity it needs for the foreseeable future.

And what funding healthcare does need it can raise through the group structure much more cheaply than it could as a stand-alone entity.

The bombed-out New Zealand dollar has exaggerated healthcare's performance relative to the whiteware division. Healthcare is a substantial net exporter and has been a big beneficiary of the low exchange rate. Whiteware imports large amounts of components. Last year the weak dollar wiped out, in many cases, all the cost savings F&P had achieved from finding cheaper component suppliers.

These characteristics make F&P an export growth play with something of a natural hedge against exchange rate fluctuations.

And while healthcare is growing fast it's also a far higher-risk beast than whiteware, with 65% of its sales coming from the respiratory humidification group of three products. It will remain that way until it has achieved enough scale to hack it against big international competitors.

While F&P's share price hasn't been that flash this year the same can be said of the sharemarket as a whole. Overseas investors don't like our market at the moment but there's not much, including spinning out divisions, F&P can do about that.

Meanwhile, with both the share price and the local currency in the doldrums F&P may find itself the target of overseas takeover attention. But the same can be said of just about any New Zealand listed company.

Shoeshine would be the last person to discourage a bit of institutional activism. Our sharemarket's poor performance is partly down to many of our top companies' propensity for wholesale wealth destruction, and that's partly down to local fund managers' reluctance to pressure companies to create value.

In Australia these guys regularly require whole boards to fall on their swords, as AMP recently found out.

F&P's annual profit has fallen for four straight years so a bit of grouchiness is only to be expected.

But the company's looking in better shape than it has done for years. After a false start it now has a viable toehold in the US where consumers are highly quality-conscious.

F&P's strategy of product innovation, which contrasts with the general trend towards commoditisation of whiteware goods, should stand it in good stead there.

Broker Merrill Lynch rates F&P a "focus stock," saying both whiteware and healthcare could double earnings over the next five years.

If so it's hard to see how flogging off up to half of healthcare would be in shareholders' best interests.

Customers may always be right but big investors aren't.

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