Regular readers may have seen my article on the Affinity-G8 tie-up last week, when I wrote that the rejected takeover offer was a blessing in disguise for G8 Education Ltd (ASX: GEM) shareholders.
This morning, Affinity Education Group Ltd (ASX: AFJ) released a market-sensitive announcement indicating that they had hired independent advisors to 'assist the board in its assessment of G8 Education's proposed offer.'
Wait, what?
Just a few days ago, Affinity knocked back G8's offer out of hand, arguing that it was opportunistic and undervalued the company.
Is Affinity now thinking about the proposal?
It certainly looks like it; or at least they may be trying to value the company to determine if the takeover offer is in fact a fair one. In recent days G8 Education has upped its shareholding in Affinity to 19.89%, making it the largest single shareholder in the company.
The plot thickens…
As it happens, this is actually the third offer that G8 Education has made for Affinity, with both previous occasions involving a 'nil-premium merger' where G8 would acquire Affinity in return for shares. The previous offers (based on G8's share price at the time) valued Affinity at approximately $1.105 (in April) and $0.825 (in June).
Both companies had agreed to meet on 4 July to discuss the most recent proposal, but G8 snapped up a slice of Affinity and made its most recent offer, at $0.69 per share, before talks could be held. This prompted Affinity management to reject the takeover as opportunistic.
So, where to next?
Well, with G8 increasing its stake in Affinity it looks as though the company is determined to get the deal across the line. However, as Affinity management pointed out, G8 was recently prepared to pay a substantially higher premium for the company and in this light investors are probably less likely to accept the offer.
Surprisingly, shares in both companies have declined in trade so far today and it looks as though G8 shareholders are nervous about the potential deal while Affinity owners aren't confident a better offer will materialise.
A higher price?
A decision by G8 to pay a higher price for Affinity would be a terrible outcome for G8 shareholders, and would be a strong catalyst to prompt a rethink of my shareholding in the company.
The whole point of a roll-up company is to acquire privately held businesses, buy them at a cheap multiple around 3-4x annual earnings, and then effectively 'sell' them to shareholders in the form of share issues (which fund the purchases) for a higher Price to Earnings (P/E) multiple of say 12 or higher.
When share prices start to fall or the acquisitions aren't great, the strategy can unravel because the company stops performing as expected. G8 paying a higher price for Affinity's average centres (below 80% occupancy) could become an example of this.
Furthermore because G8 operates in a labour-intensive service industry (childcare) there are limited synergies that can be achieved by getting bigger. Acquiring Affinity would allow a reduction in management headcount and a few other areas, but neither company's centres will miraculously serve more children or generate an increase in revenue proportional to the size of the acquisition.
G8 is already offering a high price in terms of a greater number of shares required to buy Affinity (because G8's share price is down), so a decision to pay more for Affinity would dilute earnings even further without the potential for organic earnings growth to justify it.
Investors looking enviously at G8's depressed price and sky-high dividend yield may be better off focusing on other companies for the time being.
