(Published in The Tribune March 23, 2011 and reprinted here with the permission of the author)
The recently-launched offering of 7.5 million shares of Commonwealth Brewery, 25 per cent of its equity capital, presents one of our largest companies as a well-run, profitable, debt-free enterprise with long-established product lines effectively marketed to the Bahamian consumer. But a full understanding of Commonwealth Brewery was somewhat marred by a poorly organised Offering Memorandum, together with simultaneous press stories carrying improper "sales talk" that can only confuse potential investors.
Instead of giving a key-points summary of the company’s business and finances, the Memorandum scatters them indiscriminately through the document: The informative ‘Management Discussion and Analysis’ is buried after pages of boiler-plate. On its cover, the Memorandum bears the usual edict that "no person has been authorised to give any information…other than through this Offering Memorandum", which did not deter Cchief executive LeRoy Archer from articulating a jumble of facts to The Tribune. The restrictive edict should be strictly obeyed in a public offering that is reviewed by unsophisticated investors.
These shortcomings were mitigated by two excellent and well-attended public meetings, where speeches and a ‘Term Sheet’ hit the essential high-lights.
But not all investors could attend these events, so let’s repeat some of the fundamentals.
At the offering price of $8.33 per share, the gross proceeds will be about $62.5 million.
This offering is not a "new issue", since the proceeds (after issue expenses) will immediately be turned over to Heineken, Commonwealth Brewery’s parent company, which had previously owned the shares being offered.
The offering will not result in any addition to Commonwealth’s shareholder capital, or any increase or dilution of per-share equity.
There will be no change whatever in the company’s financial resources, except that it will pay the $1.880 million issue expenses.
The vompany has been successful in running three vertically integrated operations: brewery production of Heineken, Kalik, Guinness and Vitamalt, Kalik being a true Bahamian beer that is beginning to catch on in the US; wholesale distribution; and retail sales through a wide network of stores that offer most of the accepted brands of beer, wines and spirits. In 2010, these three business segments generated $109 million in sales, down about 4 per cent from the two years ago, and operating income of $20 million, up about 35 per cent.
The drop in sales clearly resulted from the recession and decline in tourist activity, while the impressive increase in earnings seems attributable to an aggressive cost-cutting campaign, for which management should be congratulated.
The technical and marketing expertise from the worldwide Heineken group continued to make positive contributions.
If, as seems likely, we have reached the bottom of the economic cycle, the drop in demand for the company’s products may have levelled off and could be set to rise in 2011 and future years, with an obvious positive effect on Commonwealth Brewery’s finances. The Memorandum underlines as a major risk to profitability the increasing trend of illegal imports that circumvent import duties – a factor beyond the company’s control that depends on more vigorous Government enforcement.
Mr. Archer told the press that the brewery is operating at only 60-65 per cent of capacity.
Does this startling disclosure, not found in the Memorandum, suggest problems in the production process, or rather the growth available if demand picks up? The Memorandum mentions the risk of higher duties and excise taxes, stating that $22.6 million was charged in 2010, while Mr. Archer laments that the figure was $29 million.. Whom do we believe? With regard to major competition, he tells us that he "could sit down and cry" at contemplating the duty-free imports enjoyed by Sands Brewery in Freeport, yet the Memorandum does not even mention that company. He also targets high electricity costs in Trinidad and Panama, where beer sells for $0.50 per bottle; the Memorandum says nothing about these markets. Mr. Archer does a fine job as manager but should keep his tongue in control on investor relations.
Two things are crucial to investors: dividend yield and capital appreciation. The Memorandum tells us that the company’s present "policy" is to distribute 100 per cent of net income as dividends, and that based on 2010 earnings this would give an attractive 7.7 per cent yield on the $8.33 offering price.
Correct, but 100 per cent pay-out is pretty rare for any company and leaves no free cash flow available to cover unexpected contingencies or any desirable acquisitions.
The directors are not committed to follow this ‘policy’, and can reduce the pay-out whenever they deem prudent.
And, of course, earnings may decline, so the 7.7 per cent is not in any sense guaranteed.
Possible capital appreciation depends first on investing at the right price, usually based on a price-to-earnings ratio (‘P/E’). The Memorandum gives 2010 earnings per share of $0.74, but says nothing about the crucial P/E figure, which can be calculated as a reasonable 11.3X ($8.33/$0.74).
This is attractive, since it is a 15 per cent discount from the average 13.3X for BISX Tier I companies. It’s unfortunate that this key comparison, so significant to investors, did not appear in the Memorandum itself but was only given by Michael Anderson, president of RoyalFidelity, in his loquacious Tribune interview.
Perhaps the largest risk for investors arises not from the company itself but from poor liquidity in our capital markets.. . The Memorandum warns: "An active secondary market may not develop for the shares". Quite true, but this statement represents an indictment of our whole inter-linked "securities industry", not simply BISX, which even after 10 years struggles with low revenues, largely resulting from the Ministry of Finance endlessly delaying its trading in public bonds. Thus it cannot undertake sorely-needed publicity and investor education.
For contrast, look at the highly informative website of the Jamaica Stock Exchanger, operating in a country with lower per capita wealth than the Bahamas.
The indictment must also include our Securities Commission, with its lax enforcement and Government inertia in giving it more statutory powers; our institutional investors, who rarely seem to provide market support by buying undervalued securities; and our four broker/dealers members of BISX who take little interest in active market-making in listed shares, merely posting buy or sell orders.
With the limited number of issuers and publicly held shares, we will never enjoy the instant trading, in both up and down markets, found in New York or London and other mature financial centres, but we must move in that direction.
Something is seriously askew when the figures on the BISX website show Commonwealth Bank, possibly our strongest company, with 176,226 shares up for sale at $7, and zero shares listed for buy at any price!
In any normal market, professional market makers would step in to clear this imbalance at least partially.
We noted Mr Anderson’s quoted remarks, hopefully speculating that the size and quality of the Brewery issue will "reignite" interest in our stock markets.
Why does not RoyalFidelity contribute to this optimism by offering to make a market in the new issue, to stand ready to buy or sell a reasonable number of shares at prices that it determines?
The firm is slated to earn a fee of $1.25 million for handling this offering – without taking any underwriting risk, since Government commits to buy any unsold shares.
Surely a portion of this guaranteed compensation could be devoted to secondary market support, but nothing of the kind is indicated.
In short, an investor will have no trouble buying a share of this successful company, but he cannot count on selling it, through Royal Fidelity or any of the other three securities firms, Colina, FamGuard or Colonial.
We wonder if the Government will take steps to encourage greater market liquidity for its own share offerings later this year – BTC and the Arawak Cay Port Company – which it clearly wants to distribute to our legendary "little man", who often needs to sell in a pinch.
Mr. Coulson has had a long career in law, investment banking and private banking in New York, London, and Nassau, and now serves as director of several financial concerns and as a corporate financial consultant. E-Mail Mr. Coulson.
The views expressed are those of the author, and not necessarily those of the Nassau Institute (which has no corporate view), or its Advisers or Directors.