There are valid reasons for companies seeking to diversify, such as employing a competitive advantage to increase efficiency in a related industry.
A prime example is Woolworths Limited's (ASX: WOW) retailing prowess, distribution network and relationships with suppliers that make its move into home hardware through its Masters chain of stores an understandable and logical diversification.
What is not valid diversification is when the business being acquired is far outside the realms of the company's current operating businesses, such as is the case with Seven Group Holdings' (ASX: SVW) acquisition of oil and gas play Nexus Energy (ASX: NXS).
Seven has no current operations in oil and gas, instead reliant mainly on its investment in Seven West Media Group (ASX: SWM) and Westrac Group – the sole authorised dealer of Caterpillar mining equipment in Western Australia, NSW and the ACT, as well as North Eastern China. Seven also owns AllightSykes, which supplies lighting towers, generators and pumps, and a 45% interest in equipment hire business Coates Hire.
Now Seven may have spotted what it thinks is a bargain, offering just 2 cents for each Nexus share, which last traded at just under 6 cents a share. Nexus is in all sorts of strife, including coming up with the funds to pay a legacy legal settlement of US$30 million, refinancing $44.4 million of debt associated with its Longtom Gas project — which has had operations at one of its wells suspended since February 21 due to a fault, and an April 3 deadline to satisfy asset sale requirements for its bankers.
Talk about being over the barrel!
As part of its commitment to Nexus, Seven says it will outlay around $400 million, including more than half of that on capital expenditure on existing Nexus operations, with the remainder used to repay debt and $33 million to fund the legal settlement.
Foolish takeaway
Stuck between a rock and a hard place, Nexus board members have had no real choice other than to recommend the takeover to shareholders. The only other route is something far worse.
For shareholders in Seven Group, if you ever doubted that the company's direction is at the whim of majority shareholder and billionaire Kerry Stokes, the move on Nexus should be all the proof you need.
