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Tuesday, June 03, 2008

Reed Backs Sale of RBI with Debt Deal

Nobody said it was easy, but this report by Rafat Ali implies that the sale of RBI is very hard indeed. It appears that Reed Elsevier has been lining up debt which it will make available to buyers providing the buyer takes the whole caboodle. This is called stapled finance and is not that rare, but it clearly shows how nervous Reed is becoming about the ability of private equity to get their debt ducks in a row to make a bid.

The availability of debt finance may well flush out more interested bidders who will be able to make an independent decision on the equity piece and not need to seek their own debt funding. Reeds hope will be that this makes for a more competitive auction and thereby a higher price.

It also underlines Reeds determination to to sell the business in one deal rather than risk flogging off the good bits and then being left with a load of old toot to get rid of.

Nevertheless, the mere fact the finance is available does not necessarily mean that the price expectation will be met. The price tag is supposed to be £1.3b. The stapled finance is said to amount to £750m on RBI earnings of £160m which amounts to a little over 2.5 times interest cover. In the normal world this looks unagressive. But this is not a normal world. Lets play with the maths over three years. If we assume the capital is repaid over seven years and profits are flat, cash flow generated amounts to £480m. Capital repayments will be £321m and interest repayments will be £180m. Equity has grown over the three years(as the debt has been paid down+the cahs outflow on debt servicing) from £550m to £849m which is an annual return rate of around 15%.

If that all seems like meaningless nonsense let me explain....

Private equity return rate expecations are much higher than 15%. So to get to a better return rate either the price has to fall or the profits have to grow. To achieve a 25% return rate, the equity value would have to be over a billion pounds in three years. That implies a profit growth of perhaps £20m. At face value this is achievable, but remember that RBI has a lot of magazines. Are they going to grow or decline? They will decline by my estimates by at least £20m over three years. That means the rest of the business has to grow by £40m to hit the 25% target. Or put another way not far short of 10% profit growth every year. Looking a little harder now huh?

Oh and there's another problem - all those liabilities on severance and pensions. Cutting costs won;t be cheap. Lets say the new owner culls 250 jobs of folk with average 5 years service. Thats a severance cost of about £5m.

Now all this may be doable, but if the market got tough(er) and magazine decline got aggressive, and web spend didn't increase (what will happen to Total Jobs revenue in a recruitment downturn?) it could all get a bit scary.

The stapled finance arrangement makes perfect sense for Reed but, in my view, it is not certain that this will be enough to shore up a price expectation much north of a billion.

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At 1:04 pm, Anonymous Peter Kirwan said...

Question: Are we seeing Reed Elsevier doing a zig-zag -- first insisting on an all-in-one sale, then agreeing to a transatlantic break-up, and now insisting on One Big Deal again?

Or is Mr Ali doing a bit of zagging?




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