27/07/2009 

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 On 28 July 2009 Transfield Services (TSE) announced its FY09 result would be impacted by an impairment charge of A$168m (US$135m) on a pre-tax basis relating to its USM business. It also confirmed guidance for FY09 NPAT pre-amortisation growth at the lower end of the 10–20% range.
Implication

 Hitting guidance is encouraging. Prior to the announcement CBA was forecasting growth of 8.7% and consensus expected growth of 7.9%. We noted in June that the sale of the wind farm developments (at an estimated pre-tax profit of $3–5m) significantly increased the chances of it hitting its FY09 guidance. This will be an ongoing revenue item for TSE and so we do not see it as low quality.

 Impairment charge flagged. With the new CEO coming on board in March we thought that there was a good chance of impairment charges in USM. TSE has written down the carrying value of USM (which includes the Horizon and Whelan’s bolt-ons) by 32% to US$283m. In 2006, we commented that TSE overpaid when it acquired USM for $372m on an EV/EBITA multiple of 9.7x. At the time USM’s EBITDA margins were double digit. We argued this was unsustainable given the low single digit margins in the Australian facilities management business and since the acquisition USM’s margins have fallen to high single digit. Revenue has also been $100m below the assumptions in TSE’s acquisition model.

 Dividends not impacted by writedown. TSE has stated that the impairment does not impact its ability to pay dividends. The writedown will not be recorded in the parent entity’s retained earnings account which was last quoted at $62m in the FY08 accounts. Dividends are paid from this account and the balance will be sufficient to pay future dividends.
Earnings and valuation revisions

 We have increased our EPS forecast in FY09 by 1% to reflect 10% NPAT growth (as per guidance). Our forecasts in FY10 and FY11 are unchanged, as are the DCF valuation of $3.63 and 12-month price target of $3.15.

 NPAT: FY09 $116.3m; FY10 $121.5m; FY11 $127.4m.

 EPS: FY09 31.8 cps; FY10 29.0 cps; FY11 29.9 cps.

Investment view We look forward to the FY09 result where we expect an update on TSE’s strategy, particularly with respect to its international expansion of recent years. Domestically, the business has struggled to retain some large contracts. Notwithstanding current challenges, we see significant valuation upside in TSE on both an absolute and relative basis (particularly when compared to UGL which trades at 12.4x FY10 EPS vs TSE at 8.4x). Our recommendation remains ACCUMULATE / MARKET PERFORM. TSE will report its FY09 results on 26 August 2009.

Mergers and Acquisitions 2009 2010

Eastern Star Gas (ESG) During a most difficult year in the stockmarket, the performance of the coal seam gas (CSG) sector was, thanks to M&A activity, nothing short of breathtaking. At the large end, BG bid unsuccessfully for Origin and successfully for Queensland Gas, while Petronas and Santos committed to a large joint venture, something former target Origin also did with US giant ConocoPhillips.

At the smaller end. both Sunshine Gas and Pure Energy were taken over, and we think another target in this range is Eastern Star. It has vast CSG reserves in Queensland and recently “welcomed” Santos on to its register after the latter bought a 20% stake from Hillgrove Resources.

Origin (ORG)/Santos (STO) At the larger end of the CSG sector, there is still a strong chance Origin and Santos will either merge their Queensland-based assets (much like is currently occurring with BHP and Rio’s iron ore holdings in Western Australia) or their entire corporate structures.

Along with the aforementioned BG, both companies are attempting to build huge CSG plants around Gladstone in Queensland to supply energy-hungry Asian customers. At present each of the three players plans to develop separately owned pieces of infrastructure, but given the many billions of dollhttp://www.australianstockwatch.com/ars this would require, at some stage the three main players will become two – or even one.

 So we look forward to a fruitful start to a booming year of Mergers and Acquisitions