QUALIPORT
Qualiport Takes Up Johnston Press Rights

By Maynard Paton (TMFMayn)
April 15, 2002

Last month, Qualiport member Johnston Press (LSE: JPR) announced its annual results and a rights issue to help fund the acquisition of Regional Independent Media (RIM). After reviewing Johnston's latest performance and the terms of the deal, the Qualiport "remained a content Johnston shareholder". Last week saw the purchase being rubber-stamped and Johnston shares going ex-rights. All that matters now is how the portfolio will proceed with the rights issue.

Know your rights

The purchase of RIM is to be funded partly by a 2 for 5 rights issue. In other words, for every five Johnston shares previously held, the Qualiport has the right (but not the obligation) to buy two extra shares. By owning 1,421 shares, the portfolio now has the opportunity to buy another 568. Although the Qualiport is happy with the underlying deal, the issue price for the new shares is 280p. Are the shares of a Johnston/RIM combine worth buying at that level?

The 2001 results for Johnston contained:

* An operating profit of £90.7m;
* A depreciation charge of £11.6m;
* Net capital expenditure of £24.3m, and;
* Net interest payments of £16.3m.

Taxed at 30%, the resulting free cash flow comes to £43.2m.

As previously highlighted, RIM traditionally has had little requirement for working capital and fixed asset expenditure. Thus its reported profits are a genuine reflection of free cash. As before, the following assumptions on the group's near-term profitability are:

* A 2001 operating profit of £40.2m is boosted by £9m of expected synergy savings, and by a further £1.3m after the group's Internet operation reaches breakeven this year (as forecast by RIM);
* Interest on the £340m of extra debt taken on is charged at 7%, and;
* Depreciation equals net capital expenditure.

Taxed at 30%, RIM's prospective free cash flow comes to £18.7m.

Taken together, the Johnston/RIM combine should generate around £61.9m of annual free cash. With the enlarged group having 282.3m shares in issue, that figure equates to 21.9p per share. The 280p issue price therefore allows Johnston shareholders to buy into Johnston/RIM at a very attractive 7.8% free cash flow yield. It's worth remembering that the only growth assumptions involved in that valuation relate to prospective merger synergies and the breakeven of RIM's online business. For the Qualiport at least, the rights are certainly worth taking up.

Sell to buy

Here's where things get complicated. If the Qualiport wanted to buy its full allocation of shares, then a payment of £1,590.40 (568 shares * 280p) would be required. At the moment, the portfolio's coffers contain just £98.32.

The cut-off date for payments relating to the rights issue is May 3rd. While a £119.85 dividend from Lloyds TSB (LSE: LLOY) due on May 1st will help, the portfolio won't be able to buy its full 568-share allotment. However, with Johnston shares currently standing at around 370p, having the right to buy the same shares at 280p is obviously worth something. In fact, it's worth the difference between the two prices (in this case, around 90p).

Importantly, this 'right to buy' (technically called a nil-paid right) at 280p can be sold on to other investors in the open market. Thus the Qualiport can sell a portion of its nil-paid rights, the proceeds of which can be used to take up the remainder. In City jargon this process is known as 'swallowing your tail'.

With a current bid price of 87p, the sale of 378 Johnston Press nil-paid rights would raise £313.86 (including a £15 dealing charge). Adding that figure and the Lloyds TSB dividend to the present cash balance will leave £532.03 as at May 1st. That amount would therefore allow the Qualiport to take up its remaining 190 rights, the payment required being £532.00 (190 * 280p). Thankfully, buying additional shares through rights issues doesn't involve stamp duty or dealing charges.

To summarise:

* Within the next five trading days, the Qualiport will sell approximately 378 Johnston Press nil-paid rights, and;

* On May 1st, the Qualiport will take up its option on approximately 190 Johnston Press nil-paid rights (effectively purchasing 190 new Johnston Press shares at 280p).

The actual number of nil-paid rights sold and subsequently taken up will be dependent on the bid price at the time of the initial disposal.

Notional headache

Being a notional and educational portfolio, the Qualiport has had to indulge in a little more trading than perhaps necessary. In reality, most investors would probably find some extra cash to help fund a rights issue. But to keep performance measurement simple and transparent, cash is no longer added to the Qualiport. 

It's also worth noting another option for those wishing to sell nil-paid rights. Simply leave the nil-paid rights to lapse and let the underwriters of the rights issue sell them for you. No dealing charges are involved here, but "related expenses" on behalf of the underwriters will be incurred. However, because the proceeds from any underwriters' sale will be paid after the cut-off date for acceptances, this option was unfortunately unavailable to the cash-strapped Qualiport.

More: Great News From Johnston Press | Johnston Press discussion board

The author owns shares in Johnston Press