Paladin Ma

Introduction

Patrick Corporation Limited (�Patrick’) is an Australian logistics company with interests in ports, rail and air. The main operations include stevedoring, container terminals, shipping and rail. It also owns a majority stake in Virgin Blue Airlines. The strategy, under Chief Operating Officer Chris Corrigan, is to develop a national multi-transport logistics group. Toll Holdings Limited (�Toll’) is another major logistics company, but its operations are in road, warehousing and distribution. Toll has subsidiaries in New Zealand and some Asian countries on a joint-venture basis or through domestic clients. The firm’s strategy is to maintain services in Australia and seek international opportunities or strengthening existing positions.

On the 22nd August 2005, Toll launched a bid for Patrick with a view to providing a fully integrated transport and logistics company in Australia. The management at Patrick immediately rebuffed the offer but as of 14th April 2006, accepted a significantly revised offer. This report seeks to find the logic of accepting the bid, with regard to a number of issues such as synergies, regulatory concerns and value creation; and why Patrick rejected the first offer.

1. Terms of the Acquisition

The terms of the final offer by Toll for Patrick is 0.4 Toll share and $3 cash per a Patrick share. In addition to monetary consideration, a particular condition is of interest. A provisioned contained words to the effect that the directors of Patrick were to resign upon Toll reaching 50.1% of Patrick shares outstanding. It is a stipulation typical of hostile takeovers. It signals the control of Patrick’s assets that Toll has wanted and was willing to pay a premium for it. Another signalling effect is that by removing senior management, there is a lack of information asymmetry to conduct a management buyout or a higher offer is not forthcoming.

2. Bid Premium

The calculating of the bid premium is an indication of the amount of information and rumour in the market. The premium is relevant because of its usefulness in determining the deal to design to satisfy the requirements of investors and arbitrageurs. In the Patrick-Toll bid, there were a number of successive bids by Toll to obtain Board approval. It would be more useful to consider the initial and final bids because the underlying themes are common in the initial and consecutive bids, until the final offer.

On the day of the first bid, the share price of Patrick shares opened at $7.15 and closed at $7.38. However the price had closed at $6.45, the previous day. At that price, the bid premium is implied to be $0.93. It should be noted that there had been media coverage and market speculation since the 26th July 2005 about a possible Toll bid. Therefore $6.45 is unlikely to be useful as an ex ante price. The least “coloured” indicator would be the volume weighted average price of 45.57 for the month preceding 26th July 2005. This would give a bid premium of $1.812 or 32.5% over the average price. The narrowing of the bid premium over August suggests either information leakage or rumour. In the absence of any insider buying, as per Market Announcements, it is most probably hearsay that had reduced the premium and not enough to satisfy many shareholders.

The subsequent proposal had been rejected by Patrick management and only increased the opportunity for arbitrage as indicated by the large volume of shares traded relative to the previous periods. The price of Patrick has fluctuated between $7.80 and $8.10 in the preceding time. However, the final offer indicated there was little bid premium. The previous market close was $8.03 and after the final bid, the price had closed at $8.61. The premium of $0.58 or 7.22% is low, relative to the magnitude in August 2005. In the absence of any higher bid, the Board recommendation signalled to the market that a higher premium was not available. Furthermore management holdings were signed over to Toll.

The level of information in the market is being continuously analysed by participants as evidenced by the initial increase in the share price. Arbitrage played a role in increasing the price to the extent the bid premium had sufficiently closed. Management’s actions were a sign that the final price was fair and value was created in the process.

3. Motives and Synergies

M & A activity aims to create economic value. This may come as a result of a reduction in transaction costs, improving management or through the creation of synergies. Synergies are often quantitatively described without sufficient analysis, causing deals to be incorrectly valued. The fundamental logic behind Toll’s takeover bid of Patrick is that shareholders of both companies stand to gain from the integration of activities. The vertical integration enables Toll to provide its customers with an integrated supply chain service catering for a wider customer base and improving efficiency. The primary benefits Toll stands to receive are in the form of pricing power benefits through improved market power. Other motives for the deal include non-pricing revenue synergies that allow the increased service range and result in incremental business growth. Cost reduction synergies are relatively small due to the relatively small overlap in vertical integration. Due to ACCC opposition to the deal Toll has promised to divest 50% of Pacific National, yielding asset reduction synergies.

In order to value synergies a discount rate that reflects the associated risk must be used. It is assumed that the respective cost saving and revenue enhancement synergies are as variable as EBITDA, and so cost of debt (kd) is the appropriate discount rate.

Cost of Debt:

kd = (Net Interest)/(Net Debt)

Assuming the rate of increase in cost of debt remains stable, the projected cost of debt for FY07 is 17.35% (see appendix 3.1).

Inflation Rate:

When forecasting future values the inflation rate must be accounted for. In this analysis 5 year forecasts are used in valuing the synergies. Accordingly the average inflation rate over the last 5 years has been assumed as the inflation rate. Taking figures from the RBA yields a 5 year average of 2.53%.

Revenue Enhancement Synergies

Pricing Power:

The improved market position that Toll stands to