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The surprise merger of America Online (NYSE: AOL) and Time Warner (NYSE: TMX) lit a match beneath most media stocks. Emap (LSE: EMA) was no exception. It was nice to see such a large deal being announced without being broken by the press many weeks in advance. The Wall Street Journal seemed to have the scoop, but only a matter of hours before the official announcement. If only UK investment bankers could be similarly tight-lipped about such matters.
At one point this morning Rentokil touched the dizzy heights of 278p, valuing the company at just over 20 times forecast earnings for the year just ended. Of course the price started to slip back as soon as I started to write this article. Even more unfortunately, Bruce was not around to take advantage of this lofty position and exit the Rentokil stable. At that price Rentokil was on more or less the same profits multiple that PizzaExpress (LSE: PIZ) enjoys, the company which he favoured for a top up.
It looks like Bruce has all but given up hope on Rentokil. Just prior to the Christmas break he wrote "these days I just can't get excited about Rentokil. But, I'm reluctant to sell at around 225p, given the initial earnings yield and their past growth record. Yet, when you compare an investment in Rentokil to one in PizzaExpress, the latter has the better growth prospects". Now that the two are trading at more or less the same multiple it seems that this may a good time to make that switch.
In my opinion, once a company does not suit your investment strategy it ought to disposed of sooner rather than later. Hanging on for months waiting for the best price possible is too distracting. And why should the market price respond to your belief of value in the short term? Isn't better to look for another company which will offer a better rate of return from this point in time? Investors should focus their attention on their best performers. It is too easy to get dragged down worrying about the laggards. You may be reluctant to sell at a small loss or because you believe that the company is being unfairly treated at the current time. But if alternatives offer better long term prospects why should that be a concern?
I think a multiple of 20 represents a fair price for a company that only managed to grow sales by 2.5% in its last set of results. You could argue that that just represents prices increasing in line with inflation. Volume growth is therefore non-existent. That's not what we are looking for in a Qualiport company. Rentokil is about to take the knife to some of their divisions that have disappointed. This may help the headline growth rate, but the changes look as if they will be cosmetic rather than significant. Another initiative that Rentokil is undertaking is a share buyback. This still needs to be approved by its shareholders, but again it is tinkering around the edges and does not solve the underlying problem.
The Rentokil story provides a good lesson. I think the message is: beware of companies that are predominantly growing earnings by raising profit margins rather than by increasing sales. Raising margins is a relatively simple process. It is all about expanding the difference between what you can sell your products for and what they cost you. Rentokil's margin growth seemed to come mostly from cutting costs. Such gains are usually a one-off. I think sales growth is a much better indicator of the long-term growth prospects.
In fact I mentioned a few months ago on the Qualiport message board that there are many parallels between the experience of BTR and Rentokil. BTR was a star performer in its day, buying a wide variety of companies and ruthlessly cutting costs. In fact it was famous for emphasising margin growth ahead of sales. This worked well when BTR could use its highly rated equity to sweep up underperforming industrials. But eventually they dried up, the share price stumbled and BTR was swallowed up by Siebe, and renamed Invensys (LSE: ISYS). Such an approach is based upon short-term profits at the expense of long-term growth. Companies should use binoculars rather than reading glasses.
As previous articles have pointed out, Unilever (LSE: ULVR) is in much the same position. It is culling its brands in the same manner that Rentokil is getting rid of its less successful subsidiaries. Of the two I think this offers the better long-term prospects. But other companies already in the Qualiport offer even better still. Independent Insurance (LSE: IIG) looks attractive to me at its current level. But then I would say that because I have got some of their shares already. And Lloyds TSB (LSE: LLOY) is not looking that expensive considering they were described in the original buy report as "the acknowledged best bank in the sector, and one of the best managed banks in the world". But will Bruce take the plunge? After all, it's his money. It is all very well for us to offer numerous opinions but in the end he has to make a decision that he feels comfortable with.
Other Qualiport news
The stock market attention has naturally turned to who will follow these behemoths into the merger arena. Freeserve (LSE: FRE) to merge with BSkyB (LSE: BSY) perhaps? But maybe AOL will continue to keep one step ahead. Maybe they should merge with Wal-Mart (NYSE: WMT) as well, and complete the encirclement of the consumer. Now that would be a scary company. And is encirclement even a real word? Anyway, new buzzwords seem to the order of the day. "Value media chain" was one of my favourite terms to emerge from the initial press conference relating to the megadeal.
It was interesting to note that despite AOL's market capitalisation being double that of Time Warner's, the former's shareholders are only to end up with 55% of the enlarged company. Perhaps traditional companies are fighting back. If so, companies with a broad variety of media content such as Emap look well placed.
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Company Change Bid DELL(US)-1.80 46.10 EMA +1.27 14.45 IIG -0.00 2.84 MSY +0.72 8.16 PIZ +0.00 8.20 RTO -0.08 2.56 ULVR -0.18 4.77 LLOY +0.19 6.94 Qualiport Stocks Last Rec'd Total # Company Buy Current Change 22/04/99 542 Misys 5.57 8.16 46.4% 17/04/98 301 Emap 10.20 14.45 41.6% 27/10/98 1133 Indep Ins 2.60 2.84 9.2% 27/01/99 74 Dell (US) 44.63 46.10 7.3% 04/11/98 245 Pizza Exp 7.93 8.20 3.5% 19/12/97 783 Rentokil 2.55 2.56 0.4% 29/09/99 356 Lloyds TSB 7.56 6.94 (8.1%) 17/07/98 266 Unilever 7.53 4.77 (36.6%) Last Rec'd Total # Company In At Value Change 22/04/99 542 Misys 3065.85 4422.72 1356.88 17/04/98 301 Emap 3139.85 4349.45 1209.61 27/10/98 1133 Indep Ins 2990.63 3217.72 227.17 27/01/99 74 Dell (US) 2007.42 2067.52 60.10 04/11/98 245 Pizza Exp 1966.34 2009.00 42.66 19/12/97 783 Rentokil 2046.53 2004.48 (42.05) 29/09/99 356 Lloyds TSB 2723.20 2470.64 (252.56) 17/07/98 266 Unilever 2052.00 1268.82 (783.18) Cash: £ 57.27 Current Total : £21,867.62 Total Invested: £20,184.62 Profit/(Loss) : £1,683.00 Value Per Share Day Month Year History Qualiport +3.09% +0.15% +0.15% + 3.54% FTSE 100 +1.58% -4.65% -4.65% +12.33% FTSE All Share +1.48% -3.47% -3.47% +17.04%