Merger proposal for Skilled Group is only the first volley

There are only two things that can be said with any confidence about the proposed takeover bid for staffing solutions company Skilled Group (ASX: SKE)Programmed Maintenance Services (ASX: PRG) will have to lift its bid if it wants to win over shareholders in the target and there is no such thing as “merger of equals”.

The only time one would try to sell an acquisition as a “merger of equals” is when the buyer is trying to escape paying the obligatory takeover premium.

On average, this premium is estimated at around 30% above “fair value” of the target. The problem with the concept is that you’ll seldom get consensus on what fair value is.

On that note, Programmed claims its cash and scrip offer provides a “significant” 21.3% premium to Skilled Group’s last traded price before the offer was announced. The bidder is willing to pay Skilled shareholders 25 cents cash and exchange each share for 0.5032 of a Programmed share. This implies a takeover price of around $1.49.

That’s unlikely to win over Skilled’s major shareholders as the deal will still leave many underwater following Skilled’s 56% fall from grace this calendar year.

BT Investment Management and Celeste Funds Management have recently increased their stake in Skilled as the share price fell heavily and they would be instrumental in deciding how the bid plays out.

Both companies are fairly evenly matched in operational performance but Skilled generates a slightly better return on equity and is cheaper on an estimated enterprise value to earnings before interest, tax depreciation and amortisation (EV/EBITDA).

I am not surprised by the offer but believe the merger proposal is a low-ball offer that is aimed at capitalizing on the “bottom of cycle” pricing that’s afflicting companies servicing the resources industry.

However, Programmed’s ability to improve the offer is somewhat constrained by its balance sheet. Not only is the bidder’s market cap of $297 million below Skilled’s $345 million, but the former only has about $40 million in the bank.

While the bidder has capacity to borrow more given its gross debt to equity is 16% compared with Skilled’s 37%, over 70% of Programmed’s debt is under current liability – which implies it needs to be refinanced in the next 12 months.

Skilled shareholders should sit tight. Despite these issues, I suspect this is only the first volley in the game.

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Motley Fool contributor, Brendon Lau, owns shares in Skilled Group.

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