Join our community of smart investors
OPINION

Conjuring up value

Conjuring up value
November 29, 2012
Conjuring up value

By the time you read this - and barring the improbable - Cookson's shareholders will have voted to split their company into two. Where once a shareholder had 'x' shares in Cookson, from mid-December he will have 'x' shares in Alent (shiny, exciting and sexy) and 'x' in Vesuvius (plain, dull and boring, despite its dodgy name). In a sense, therefore, nothing changes. A shareholder will have the same claims on the net profits and assets that he had in November, but they'll be packaged differently - and therein lies the hope that appearance can somehow transcend reality.

The sceptical response is to say that Cookson's shareholders have fallen for what's labelled: 'the syllogistic illusion'. This is based on the form of a syllogism, which says that where a=b and b=c, 'a' must also equal 'c'. In the case of Cookson, the syllogistic illusion might well have run along the following lines: "Gosh," says besieged chief executive, "we've had to make a profits warning, trading is still lousy, the share price has plummeted, and shareholders are giving us stick for our pay packages. We've simply got to do something."

"Okay," replies City adviser, "here's a formulaic plan that'll cost a bit, but it'll certainly amount to something."

"All right. Let’s do that."

Besides, by chopping the business into two, Cookson's bosses can dangle the prospects of creating value by suggesting that the sexy bit of the group, Alent, is hidden under Cookson's drab mantle. Get it out, flaunt it and value will be conjured up. At least that becomes plausible given Alent's connection to Apple's iPhone and similar fast-growing consumer electronic products. That Alent supplies the consumables that help make printed-circuit boards for these products - the solder and electroplating chemicals - is perhaps less glamorous.

Nevertheless, Alent qualifies as a speciality chemicals company and that implies a share rating in line with the likes of Victrex or Croda International (say, 17 times net profits). If so, then Alent might be worth £1.3bn, assuming that the £75m-worth of net profits it made in 2011 is the base for further lively growth. The significance of that stab at value is that it accounts for over three-quarters of the market value of Cookson's equity (with the share price at 590p).

In other words - and this is the enticing bit - Cookson's other half - Vesuvius - is implicitly valued at less than £400m. Granted, Vesuvius is the dull and boring side, it makes the pipes and valves that control molten metals in foundries. But, as the table indicates, it's hardly a basket case - in 2011 its net profits were £78m. Sure, they will be much lower this year, but Vesuvius is in a cyclical industry, so they should recover. In that case, is it really fair to value Vesuvius at less than five times 2011's net profits?

The hidden-value argument can be played other ways. For example, in 2011 both sides of Cookson generated about the same amount of free cash (see table). Assume that Vesuvius's will grow slowly while Alent's may grow fast, then you would capitalise them using different interest rates - say 5 per cent for Vesuvius and 3 per cent for Alent. If so, then the two combined would be worth £2.4bn, almost 50 per cent more than Cookson's present market value.

 

Plain or sexy?
year end Dec (£m)200920102011
Alent
Revenue530721814
Operating profit8.866.999.7
Free cash flow  64.719.346.6
Profit margin (%)1.79.312.2
Return on Capital (%)1.711.416.5
Free cash flow return on cap (%)19.65.111.6
Vesuvius
Revenue1,4311,8252,012
Operating profit16.6156.1179.0
Free cash flow  92.644.443.5
Profit margin (%)1.28.68.9
Return on Capital (%)1.08.49.4
Free cash flow return on cap (%)8.43.63.4

 

Sure, this is simple - perhaps even simplistic - stuff. Still, you can be confident that when the break-up plan was being discussed among Cookson's bosses and their City advisers it was implicit - and maybe explicit - in the discussion. And there is nothing wrong with that. Value is so elusive there is little point in trying to capture it with complex formulae. But it's sufficiently tangible to be offered in a stock-market price every minute of the trading day. Which is why it's worthwhile using every legitimate trick in the book to tease it out. If that means splitting Cookson into two, that's fine. If it does not work out, nice try.

But Cookson's shareholders should not be fooled by what might happen. The more that Alent's sexy share price rises in trading, the more they should sell. The more that Vesuvius's dull price drops, the more they should buy. In equity investing, that generally works out over the long haul - sell sexy and buy boring.