Final Week in CIMIC vs Macmahon

Construction giant CIMIC (CIM) has fired its final bazooka in its attempt to gain control over mining contractor Macmahon (MAH). Yesterday it declared that it won’t be extending the bid beyond 9 March and it won’t be raising the price above $0.145.

I’ve received a number of queries from fellow Macmahon shareholders about events over the past few weeks so. With the deadline now locked down, I’ll lay some thoughts out for investors to consider.

Forager Funds is CIMIC's largest shareholder with a little over 8% of the company's outstanding shares. We weren’t particularly impressed with CIMIC’s $0.145 bid to start with. They will get no argument from us about Macmahon’s woeful historical performance. The losses being generated at its newish Telfer contract are completely unacceptable and the company hasn’t, until now, been winning enough new work to justify its overheads.

But we don’t value businesses based on the past. We value them based on the future. Macmahon has a platform and a number of core contracts that offer the potential for much higher future profits. And the current management team looks more likely to capitalise on that potential.

Start with the existing business. The independent expert’s report has them pencilled in for $30m-$35m earnings before interest and tax (EBIT) in the 2018 financial year. Most of you probably know my view of the worth of these “experts” but the calculation here doesn’t suggest any pie-in-the-sky assumptions. Stop losing money at Telfer and they will be most of the way there (if they can’t fix the problems on this contract soon, my view is they should find a way to walk). My personal expectation is for management to exceed this number in 2018. That alone would make the $0.145 bid from CIMIC look inadequate.

The recently announced  deal with Indonesian mine owner AMNT, however, is a game changer for my valuation.

Friends with benefits

AMNT and Macmahon have agreed terms on a deal that involves getting the contract to mine the giant Batu Hijau copper and gold mine in Indonesia. In exchange for roughly US$150m worth of mining equipment, AMNT would be issued shares in Macmahon that could result in AMNT owning something like 44% of Macmahon (the exact number will depend on the final value of the equipment).

The deal would bring two main benefits to Macmahon’s non-CIMIC shareholders. Firstly, it would more than double the company’s revenue.

I’ve said on a number of prior occasions that Macmahon is too small. The company generated more than $1.3bn of revenue in 2009 (compared with less than $400m this financial year). Despite cost cutting, it still has the corporate overheads of a large company. The contract to mine Batu Hijau Indonesia would lift total revenue back to near $1bn in 2018 and give Macmahon the scale it needs. There are a few other significant contracts in the pipeline and Batu Hijau could grow. I wouldn’t put it in a base case, but Macmahon could be eclipsing 2009’s revenue number in a few years’ time.

Using $1bn of revenue and 6% margins (the low end of industry standards), the company should be generating $60m of EBIT. Accounting for the new shares issued to AMNT, today’s implied EV/EBIT ratio of less than 5 times looks attractive with plenty of potential upside.

A new controlling shareholder

Secondly, it would dilute CIMIC’s stake to less than 15% (based on their current 23% stake in Macmahon).

CIMIC will rightly point out the risks of bringing in a new shareholder with an effective controlling stake in Macmahon. However AMNT only wants to appoint two board members, they bring a very large contract with them and their participation potentially opens up more contracts in South-East Asia.

CIMIC, currently the largest shareholder, has stated an intention to replace the entire board, delist the company from the ASX and, if they achieve their aims, it will trigger a change of control clause in Macmahon’s largest existing contract at Tropicana. We obviously need to see the details, but I’m feeling quite good about our new potential friends.

The next five days of trading are crucial. If CIMIC can increase its stake to something like 30%, it will be hard to stop them scuppering the AMNT deal. They are not making any progress at the moment and the current market price is above the bid price. I hope and will be trying to ensure that it stays that way.