City Comment: Running out of growth ideas?
6 July 2012
Adecco cheered equity markets when it announced its intention to issue CHF375m (£249m) of debt and use the proceeds to buy back €400m (£319m) worth of its shares for cancellation.
Fri, 6 Jul 2012 | By Kevin Lapwood, head of support services equity research, and Caroline de La Soujeole, support services analyst, Seymour Pierce
Adecco cheered equity markets when it announced its intention to issue CHF375m (£249m) of debt and use the proceeds to buy back €400m (£319m) worth of its shares for cancellation.
It is a straightforward arbitrage in which the company is swapping equity that yields 4.1% for debt with a coupon of between 1.875% and 2.625% and, in the process, generating around 4-5% of earnings accretion. The Adecco share price responded positively, rising by almost 15%.The transaction increased the company’s net debt from €870m to €1,180m resulting in an increase in the net debt/EBITDA [earnings before interest, tax, depreciation and amortisation] ratio from 0.94 to 1.28, which is comfortably below the level at which analysts become worried. Adecco is not alone in this. Michael Page, which at last count had net cash of £58m, has recently bought back 2.5m of its shares to add to the 9.3m that were already held in trust and SThree is also using some of its considerable cash balances for the same purpose.
Clearly, given the positive reaction of share prices, investors generally approve of share buybacks. Money is recycled to shareholders for reinvestment elsewhere. By swapping high-cost equity for low-cost debt or cash on which there is a minimal return, companies can benefit by reducing their total cost of capital, and the process increases earnings per share.
However, there is another side to this virtuous story. In returning equity capital to investors over and above the usual dividend payments, companies are implicitly recognising that they are running out of options for growth. Adecco, for example, which has expanded rapidly over the past 15 years to become the largest staffing company in Europe, has always relied heavily on acquisitions to grow by expanding into new territories and disciplines. So far this year, it has completed just one acquisition for a total consideration of €90m. A direct consequence of its share buyback announcement was a fall in the share prices of Hays and Michael Page, because markets assumed that Adecco could no longer be regarded as a potential bidder for either company.
In the past, Adecco has made no secret of its desire to buy professional recruitment specialists and Hays has often been mentioned as a potential target. Indeed, Adecco made a tentative approach to Michael Page at a higher share price in 2008. Looking at the strength of the balance sheets of most large staffing companies, there is clearly plenty of scope for acquisition activity. However, despite the fact that share prices are at cyclical lows, and many privately owned companies are struggling with the economic headwinds, there is little appetite for takeover activity. (For more on M&A activity in the recruitment sector, see News Analysis in July’s Recruiter, out next Friday, 13 July.)
Perhaps the industry has become more cautious because acquisitions have gone wrong in the past. In an industry where most of the assets have legs, it is possible for them to simply walk away from their new owners. Or perhaps, the industry has genuinely run out of new ideas for growth. Either way, it does little to boost the job prospects of investment bankers.
Kevin Lapwood, head of support services equity research, and Caroline de La Soujeole, support services analyst, Seymour Pierce
Adecco cheered equity markets when it announced its intention to issue CHF375m (£249m) of debt and use the proceeds to buy back €400m (£319m) worth of its shares for cancellation.
It is a straightforward arbitrage in which the company is swapping equity that yields 4.1% for debt with a coupon of between 1.875% and 2.625% and, in the process, generating around 4-5% of earnings accretion. The Adecco share price responded positively, rising by almost 15%.The transaction increased the company’s net debt from €870m to €1,180m resulting in an increase in the net debt/EBITDA [earnings before interest, tax, depreciation and amortisation] ratio from 0.94 to 1.28, which is comfortably below the level at which analysts become worried. Adecco is not alone in this. Michael Page, which at last count had net cash of £58m, has recently bought back 2.5m of its shares to add to the 9.3m that were already held in trust and SThree is also using some of its considerable cash balances for the same purpose.
Clearly, given the positive reaction of share prices, investors generally approve of share buybacks. Money is recycled to shareholders for reinvestment elsewhere. By swapping high-cost equity for low-cost debt or cash on which there is a minimal return, companies can benefit by reducing their total cost of capital, and the process increases earnings per share.
However, there is another side to this virtuous story. In returning equity capital to investors over and above the usual dividend payments, companies are implicitly recognising that they are running out of options for growth. Adecco, for example, which has expanded rapidly over the past 15 years to become the largest staffing company in Europe, has always relied heavily on acquisitions to grow by expanding into new territories and disciplines. So far this year, it has completed just one acquisition for a total consideration of €90m. A direct consequence of its share buyback announcement was a fall in the share prices of Hays and Michael Page, because markets assumed that Adecco could no longer be regarded as a potential bidder for either company.
In the past, Adecco has made no secret of its desire to buy professional recruitment specialists and Hays has often been mentioned as a potential target. Indeed, Adecco made a tentative approach to Michael Page at a higher share price in 2008. Looking at the strength of the balance sheets of most large staffing companies, there is clearly plenty of scope for acquisition activity. However, despite the fact that share prices are at cyclical lows, and many privately owned companies are struggling with the economic headwinds, there is little appetite for takeover activity. (For more on M&A activity in the recruitment sector, see News Analysis in July’s Recruiter, out next Friday, 13 July.)
Perhaps the industry has become more cautious because acquisitions have gone wrong in the past. In an industry where most of the assets have legs, it is possible for them to simply walk away from their new owners. Or perhaps, the industry has genuinely run out of new ideas for growth. Either way, it does little to boost the job prospects of investment bankers.
Kevin Lapwood, head of support services equity research, and Caroline de La Soujeole, support services analyst, Seymour Pierce
