Greencross Limited (ASX: GXL) pursues a strategy of buying up vet clinics and pet stores and aims to dominate this currently fragmented industry. So far it has just an 8% market share but is growing fast.
I am not a fan of this type of type of business because I think that growth by acquisition is difficult to do successfully and usually leads to destruction of shareholder value. There are exceptions and I think Slater and Gordon Limited (ASX: SGH) is an example of a company that has done a decent job so far, although its latest acquisition is questionable.
I am not convinced that Greencross is a good investment because of its lacklustre earnings history and recent deals have been too big for my liking.
Financial results
In the latest half yearly, Greencross recorded a profit after tax of $3.7 million compared to $4.3 million in 2013. This is despite making two major acquisitions in January 2014 and July 2014, which more than doubled its store footprint. Normalised figures were included in the report showing that underlying profit for the half was $19 million, indicating how the current business will perform once the acquisitions have bedded down.
The difference between the statutory and underlying figures is made up of $8 million in acquisition costs, $4million of store harmonisation costs and $4 million of redundancy costs. Hopefully the business will reflect the underlying results in the future, but I will reserve judgment until then. Based on management's underlying earnings per share target for 2015, I calculate that the business is trading on a price-to-earnings ratio of around 23.7, after adjusting for debt. Even under this best case scenario, the shares look expensive.
Mammoth Pet Holdings acquisition
In January 2014, Greencross merged with Mammoth, owner of Petbarn and Animates pet stores in Australia and New Zealand. 52.6 million Greencross shares were issued to shareholders of Mammoth in payment for the business. The transaction was unconventional for the following reasons.
- The shares issued were not subject to an escrow period
- Mammoth's key shareholders prior to the merger included:
- Jeff David, a Greencross director prior to the merger and current CEO of Greencross:
- Glen Richards, then CEO of Greencross:
- TPG Growth, a private investment firm, of which Greencross non-executive directors Matt Hobart and Scott Gilbertson are partners.
- TPG Growth sold its 17% stake in Greencross for $9.75 per share on 29 August 2014, less than a year following the completion of the acquisition.
- Dr Glenn Richards, former CEO and current board member of Greencross and former shareholder of Mammoth, sold 300,000 of his 5.9 million Greencross shares for $7.80 on 11 February 2014.
- In the Greencross 2014 accounts, there was a $130 million write down related to the Mammoth acquisition. The reason for this was that at the time when negotiations began, the Greencross share price was $5.40 valuing Mammoth at $284 million. By the time the deal was done, Greencross shares were trading at $8.24 and so Mammoth shareholders received $433 million worth of Greencross shares at completion.
Mammoth's 2014 forecast earnings before interest, tax, depreciation and amortisation (EBITDA) at the time were $34 million.
When the shares were issued to Mammoth shareholders, the Greencross share price was $8.24 and so effectively Greencross paid 12.7x EBITDA for Mammoth.
It could be argued that the high share price at the time was driven by the Mammoth takeover news, but the impairment charge subsequently recognised in the Greencross' accounts suggests it did not get a bargain.
