GUARDIAN HOLDINGS Ltd (GHL) and RBTT Financial Holdings Ltd (RBTT), according to paid advertisements in the press, have decided to alter the level of ownership the two companies have in each other. First, GHL will lower its interest in RBTT from 20.9 per cent to 14 per cent by selling the equivalent amount of issued capital (24 million shares) for a cash consideration of $515 million or $21.45 a share. RBTT, on the other hand, will convert its 20 per cent holding in GHL's Life and General insurance companies to a 15.7 per cent stake in the holding company, GHL. This will be done through the issuance of 29.9 million new shares in GHL thus expanding the capital base of GHL.
Before stating the impact these new developments will have on the respective shares in the companies involved, it should be noted that the transaction will have to be approved by regulatory bodies and shareholders.
The percentage of ownership with regard to the accounting treatment merely provides guidelines to such treatment. There are other factors that will determine what type of method can be used. Primarily, the matter of 'significant ownership' will be the main issue that will determine the eventual outcome. Given there are inter-locking directorships, it implies that the composition of each board will change in the near future.
GHL: The injection of $515 million, according to the chairman, will be used to reduce the debt burden of GHL, which by the end of June 2003, stood at $1.3 billion. Finance charges should commensurately be reduced by an estimated $40 million or roughly 22 cents per share (using the expanded capital base and assuming no further debt). The issued share capital would increase from 161.7 million shares to approximately 190.5 million shares.
The debt-to-equity for GHL should, by the end of the process, improve to 0.7 from approximately 1.15 where it stood by mid-year. The effect on the P&L statement would depend on the movement in the share price of RBTT, since GHL hopes to mark-to-market their investment in RBTT.
In addition to this, if GHL is allowed to mark-to-market its investment in RBTT, it will result in an immediate one-off increase of an estimated 108 per cent of original cost using the latest prices or approximately $2 a share. On a cash flow basis, there would be a reduction in GHL's cash flow, on one hand, since the dividends received would come from a smaller quantity of shares while on the other hand, interest payments should fall substantially and there should be a significant overall net improvement in free cash flow to both shareholders and bondholders. Return on equity and total assets should decline as assets and shareholders' equity increase by approximately $450 million each.
RBTT: RBTT now accounts for its investments in GHL's Life insurance subsidiaries via the equity method thus picking up its proportional share of the profits of these companies. As stated, RBTT's plan to 'upstream' its investment to the holding company level where the level of ownership would be 15.7 per cent. Assuming RBTT can account for this investment by marking to market GHL's shares, RBTT's P&L should reflect changes in GHL's price, including unrealised gains or losses.
RBTT will have a $515 million cash outflow while its issued share capital may decline by 7 per cent (assuming shares are not sold on the open market).
Earnings per share will thus be affected by GHL's share price and lower capital base. Higher levels of profitability may be reported by RBTT through metrics such as Return on Equity (ROE), from higher leverage from raising $515 million, a smaller net capital base as the decrease in issued capital is offset somewhat by adjustments to the revaluation reserve.
Summary: The proposed transaction, from a preliminary standpoint, looks better for GHL since there should be an improvement in its financial ratios, which may be reflected in its stock price although the economic reality may be a bit different since GHL may be booking unrealised gains through to the P&L. Dilution of earnings through the issuance of new shares may reduce earnings per share but there should still be a net improvement.
RBTT, on the other hand, apart from dividends received, will also depend on the performance of GHL's stock for improvement in their earnings and stock price (if the 15.7 per cent level of ownership is maintained), which may significantly more or less than the profits declared from their interest in the insurance segment of GHL. ``Over the past 52-weeks, RBTT and GHL shares have appreciated by 56.1 and 32.5 per cent respectively.
