Investor update

Dec 16, 2016

Slides

Summary

The transaction transfers Benelux and German workwear and Hygiene businesses to a Haniel JV for EUR 520m cash and an 18% stake, strengthening the balance sheet. Proceeds support growth investment, while retained operations focus on Pest Control and Hygiene.

Good day, ladies and gentlemen, and welcome to the Rentokil Initial company announcement conference call. For your information, today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Andy Ransom, CEO. Please go ahead, sir. Thanks, Clover. Good morning, ladies and gentlemen. Thank you all for joining the call. You will have seen that we've today announced a significant deal involving our Benelux and German workwear and Hygiene businesses. Hopefully, you've realized that the slides for this call are on the website. I'll talk to the page numbers as we go through the slides. In a few minutes, Jeremy's going to provide you with details of the key terms and a financial overview of the agreement and a summary of the retained Rentokil Initial group after completion. I'll give you a very brief update on group strategy, and then we'll be pleased to take any questions. Firstly, though, just to set the scene for the call, let me give you a few opening remarks on today's agreement and the rationale behind it. So I'm now on slide two on the executive summary. The joint venture that we've entered into with Haniel, they're the owners of CWS-boco, is going to create a business which will have the scale, the volume, and the density needed to become a strong leader in the European workwear and Hygiene market. I believe this is an excellent agreement for Rentokil Initial shareholders. Firstly, we've got the valuation of our businesses transferring into the JV, and that reflects a very good value at a multiple of 15.2x its profits, and that's based on the 12 months to June 30, 2016. Secondly, the agreement strengthens our balance sheet, delivers EUR 520 million in cash, and that's going to be used initially to reduce net debt, which will in turn reduce our interest costs by around GBP 7 million per annum. Thirdly, it represents an excellent fit with our capital allocation model. It's going to increase our capacity to invest in our pest control and our Hygiene businesses in both growth and emerging markets. Finally, we've also agreed a fixed annual dividend for our holding in the JV of EUR 19 million, and we've secured various exit options to unlock further potential value for shareholders in the future after the delivery of synergies in the JV. Overall, we believe there is a compelling logic in bringing together our respective workwear and Hygiene businesses in these European countries, freeing up capital to invest in our higher growth markets and delivering value for our shareholders. Before handing over to Jeremy, let me briefly take you through the rationale for the deal. I'm now on slide three. As you know, over the last three years, we've been executing our RIGHT WAY strategy to migrate the group's revenues and profits into higher growth emerging and growth markets and delivering greater focus on our higher margin businesses of pest control and Hygiene. Today's announcement is a continuation of this strategy. Once the transaction's been completed, we will have taken a major step in the transformation of our Rentokil Initial business. I'll come back to our capital allocation model and the shape of the group going forward in a few moments. As well as receiving the EUR 520 million, Rentokil Initial will also receive an 18% stake in the joint venture, and therefore, we'll enjoy a share of the significant value creation potential from both growing the top line and from the delivery of synergies in the venture. The cash received also provides additional capacity for M&A in our core pest and Hygiene businesses. Today we've announced that we will increase our target M&A spend in 2017 to GBP 100 million. Finally, I want to be very clear about the Hygiene element of this agreement. In the Benelux and our Central and Eastern European countries, our workwear operations are highly integrated with the Hygiene businesses. Therefore, we took a pragmatic decision to include them in the joint venture rather than to try and separate them out and to risk the success of integration and delivery of the synergies. Elsewhere, our Hygiene businesses typically operate alongside our pest control businesses, and we remain fully committed to our global Hygiene business, which will continue to operate in over 30 countries and have revenues of around GBP 320 million post-completion of the deal. As you will have seen, we're retaining our workwear and Hygiene businesses in France, and these remain a substantial and an important part of the group. With that, let me now hand over to Jeremy to take you through the financials. Thank you, Andy. If we move to slide four, I'll talk you through some other key aspects of the transaction and then look at some of the key financial information relating to the deal. As you'll have read, all Rentokil and Haniel workwear and Hygiene businesses in the relevant countries come together in the JV. In continental Europe, we'll retain our pest control, plants, specialist hygiene, premium scenting, medical, dental, and other operations, as well as our workwear and Hygiene businesses in France. The Rentokil businesses transferring into the JV delivered revenues of EUR 328 million and profits of EUR 53 million based on the 12 months ended 30th of June 2016. As part of the agreement, we also have options to acquire Haniel's Hygiene businesses in Italy and Ireland, which have combined annual revenues of around EUR 50 million. The transaction also provides the potential for a strategic alliance between our pest control business and the JV, as well as the development of Hygiene technology to support the JV and our retained Hygiene operations. Completion of the transaction is subject to EU competition clearance, and the target is for completion in mid-2017. Moving now to slide five, I will just talk you through some key financials in relation to the joint venture. The JV will have combined pro forma revenues of around EUR 1.1 billion and profit of EUR 130 million based on results for the year ended June 30, 2016. The two businesses have complementary operations, products, and capabilities, providing the potential for future growth as well as efficiencies and synergies over the next three years. The EUR 520 million of cash that we will receive for the transfer of our businesses will be paid to us by the JV, and the JV will fund this through raising debt, which will be provided by Haniel at market-based interest rates. Moving now to slide six and looking at the pro forma impact on EPS. As you will note from the RNS, the deal is marginally dilutive to EPS in the year following completion. The pro forma impact from the transfer of the business to JV is offset by reduced overheads, GBP 5 million on a run rate basis by the end of 2017, a GBP 7 million reduction in interest costs, and our pro forma share of the JV's profits. The pro forma share of JV profits on the slide of GBP 13 million is based on a year one JV profit of EUR 130 million, with no underlying profit growth or synergies included in this pro forma calculation. Although there is a marginal dilution in EPS, on a pro forma basis, the transaction will improve Rentokil's underlying organic revenue growth and profit growth, as well as the group's net margins on an adjusted profit before tax and amortization basis. Before I hand back to Andy, just moving to slide seven, looking at the impact of the transaction on our balance sheet. Firstly, the profit on the transfer of the businesses will be calculated after completion, but our estimate is around EUR 540 million based on estimated net assets of around EUR 265 million. This profit does not include one-off costs to be incurred by Rentokil in relation to the transaction, which are estimated to be in the region of GBP 20 million. The cash to be received from the joint venture will reduce our net debt on a pro forma basis from 2.5 times EBITDA to around two times as at June 30, 2016. Thanks, Jeremy. Finally, let me just say a few words about the implications of the transaction for our RIGHT WAY strategy, and then I will wrap up ahead of any questions. Over the last three years, the group has made considerable progress in the execution of its RIGHT WAY plan, and today's transaction is completely in line with that strategy. After completion, over 70% of our group revenues will be in the growth and emerging quadrants, and that was about 36% back in 2013. Pest Control and Hygiene together will account for around 80% of both the group's revenues and profits. In short, we are going to continue to execute our strategy with renewed focus on our growth in emerging markets. Our M&A pipeline remains very strong, and as I mentioned earlier, we have now increased our spend guidance on M&A for 2017 up to GBP 100 million. On slide nine, in summary then, this is an excellent deal for our shareholders. We have got the initial cash consideration of EUR 520 million. That strengthens our balance sheet. It is releasing capital to be deployed into growth in emerging markets, particularly in pest control. It is giving us a fixed annual dividend of EUR 19 million, and it is providing us access to a share of the operational synergies in the joint venture before we exit the venture in a few years' time. Of course, this is also a transformational agreement for the workwear business, and in Haniel, we have selected a very high-quality strategic partner with a shared vision for quality of products, quality of service, and commitment to people. I am absolutely confident that this is the best deal for the long-term future of the business. As Jeremy has said, we are expecting that the deal will close around mid-2017. With that, I am going to hand back to the operator, and Jeremy and I will be happy to take any questions. Back to you, Clodagh. Thank you, sir. Ladies and gentlemen, if you wish to ask a question at this time, please press the star or the asterisk key followed by the digit one on your telephone. Please ensure that the mute function on your telephone is switched off to allow your signal to reach our equipment. If you find that your question has already been answered, you may remove yourself from the queue by pressing star two. Once again, it is star one to ask a question. We will pause for just a moment to allow everyone to signal. We will now take the first question from Jane Sparrow from Barclays. Please go ahead, madam. Morning. Just a couple, if I may. Could I just ask whether you discussed a full sale of the business, or was your preference always for this JV structure to allow you to benefit from the potential synergies that you see out of that structure? Secondly, are there any specific countries within that portfolio that is being exited, where there is likely to be a market share competition issue from getting the EU competition clearance? Then finally, are you able to shed any more light, and I suspect the answer is no, onto what these various exit options are after a period of five years? Morning, Jane. Thanks for that. In terms of the structure of the deal, I think the honest answer is, I have been asked many times by lots of people over the last three years around whether or not we would entertain offers for our business. I have been exceptionally clear over that period that we would only look at transactions that create, manifestly, that create value for our shareholders. It was clear to me that this, for me, is a transaction that absolutely does that. So, I have been very keen, Jane, from day one, that we retain an interest in the venture. I think it is the best way to preserve and create value for the shareholders. I think it is a good thing to support our other businesses in France. We are going to get some real additional benefits from the joint venture through collaboration on technology and other interests like that. For me, no, this is the RIGHT WAY deal because it creates the most value for shareholders. So, it has been designed that way deliberately, and it is our choice, if I can put it that way. Yeah. In terms of competition, well, what can I say? There are only two certainties in life, death and taxes, possibly this year Chelsea winning the Premiership. Oh, low blow. Yes, sorry. Jane is a Spurs fan, for those who didn't know. Look, you can never say never. We've done a lot of work with our advisors, with our expert advisors, a lot of internal work, and all I can say is we're highly confident that this is a transaction that should be approved by the authorities. But look, we've got to go through the process, and we'll absolutely respect that process and provide all the information and data that we have to. So, you don't know until you get there, I suppose, is the answer. But we're clearly confident that the transaction will be approved. But these processes also take a bit of time, and that's the main reason we're saying that we anticipate the deal will close in the middle of the year. In terms of exit options, you're broadly right that it's not a subject I can give you a lot of detail on. We've essentially agreed a three-year period, you can call it a lockup if you like, but a three-year period where we're not remotely looking to exit. That three-year period coincides with the period when synergies should pretty much all be delivered. After three years, into year five, we have a range of potential options to exit, and those options have been carefully built and designed to ensure that we get really good value for our share. Obviously, throughout the joint venture, I think we've got a great partner with Haniel, but we've got positions on the boards, we've got reserved powers around decision-making in the venture as well, and we're expecting to play a full role in the joint venture over the next few years. All of those things are designed to help us ensure that we create maximum value through the venture. The exit routes are quite complex, but they have been designed to protect and to promote shareholder value for the day when we do exit, but that's going to be a few years down the track. Yeah. Thank you very much. We will now take our next question from Nicholas de la Grense from Bank of America Merrill Lynch. Please go ahead. Morning, guys. Two questions, please. With regard to the use of proceeds from the sale, obviously, immediately you're going to pay down debt, and you mentioned that spend on acquisitions could be higher in 2017 or should be higher in 2017. Just wondering how we should expect the M&A spend going forward to be split between pest control and Hygiene, and whether we might be able to expect that the higher level of spend in 2017 could be sustained given the balance sheet position. The second question just is on France, and you mentioned that you'll be able to kind of get some benefits from collaboration with the new JV in terms of turning that business around. If you could just kind of elaborate a bit more on why it wasn't included in the deal, how it's trading at the moment, and what your plan is with regard to the French business going forward. Thanks. Thanks, Nicholas. In terms of, first off, your first part of the question was M&A split between pest and Hygiene. Over the last two or three years, I would say probably about 80% of all of our transactions have been in pest control, maybe a little bit higher than that. I did mention at the last results that we are now increasingly looking to acquisitions in Hygiene as well. Indeed, as Jeremy's mentioned, we've got an option with regard to CWS-boco's Italy and Ireland Hygiene business as well. That sort of reinforces that intent that we have to increase our spend on Hygiene businesses. It's still going to be predominantly pest control acquisitions. That's where the pipeline sits at the moment. If we get the right opportunities in the right cities, we're absolutely going to increase the number of Hygiene deals that we do. I don't want to put a figure on it, but at the moment, the pipeline remains pretty weighted towards pest control, but we are actively now looking for more Hygiene opportunities in the key cities that we want to grow in. Your second question was about M&A spend. Jeremy, do you want to cover that one? Yeah. Predicting the pipeline beyond 2017 is difficult, but I think, as we've said previously, we wouldn't expect that pipeline to be constrained by balance sheet or free cash flow. Clearly, the deal strengthens our balance sheet, gives us a lot of balance sheet capacity, and we'll look to drive value-creating M&A. While we can't give guidance to what the number is from 2018 and beyond, we're certainly looking to continue to pursue the strategy we've got of value-added M&A in the pest and Hygiene areas, as Andy said. Can't guide beyond it, but certainly an aspiration to continue operating as we are. Thank you. France, I think, was your other question, Nicholas. France was never intended to be in the venture. CWS-boco has no business in France. In terms of how we run the French business, with the exception of some small sort of overlay in the supply chain and procurement areas, the business is essentially standalone. The French business is essentially standalone from the other workwear countries, other workwear businesses. It wasn't logical to include it in the joint venture. There'd be no synergies from doing it. As I say, CWS had no business in France. Our plan for France remains exactly as it was before this morning's announcement. We've announced a plan based on quality, improving the quality, becoming the number one player in the French market with quality. We've been enjoying good operational improvements, and our KPIs, by and large, are all moving in the RIGHT WAY. I'm happy with the way the business is performing on an operational level. France remains a tough competitive environment and a tough economic environment, nothing really has changed in that regard. But I do think this deal is going to enable us to focus very clearly on the actions we need to take in the French business. As I said, I think there's going to be some side benefits potentially from the JV supply chain and procurement opportunities that should have some rub-off benefits for our French business as well. That's essentially where we are. In terms of current trading, obviously, our guidance that we gave about the business is unchanged, and our guidance for the group, I think we've confirmed in this morning's RNS, the outlook remains the same as we previously updated the market. Thank you. It's very clear. Our next question comes from Emily Roberts from Deutsche Bank. Please go ahead, madam. Hi, morning. Thanks for taking my question. A couple from me, please. Firstly, on Benelux, your market share will clearly increase materially with the JV. Do you see room to increase prices there? Secondly, just a bit more color on your M&A pipeline. Could you give us detail on how much of your pipeline is represented in the U.S. versus outside of the U.S., and how much of it is new cities or geographies versus building up scale in cities where you are already? Thanks. Sure. Simple answer on the first one is no. There's nothing in this joint venture proposition which is based on an assumption that the combination would be able to increase prices or would attempt to. This is a highly competitive marketplace. I think it would be a rash assumption of anyone to be going into it thinking they can put prices up, and certainly, there's not been any discussion of that nature. I'd be very surprised if there was any pricing power that would come simply through a combination like that. Very competitive markets. The big opportunities are really through driving operational synergies, procurement synergies through density, combination of routes, et cetera. It's not a price-driven model at all. In terms of the pipeline, difficult to say in terms of percentages, to be honest. I will say that the M&A pipeline is the fullest it's been since I've been in the company, and we've sort of turned the tap on in all of our markets. North America is the number one priority, and probably has got more candidates in the pipeline than any other single market. Europe's probably got the fewest number of candidates, because there don't seem to be too many prospects available at the moment. But around the world, Asia continues to look good, but deals are slow. Pacific looks good. Latin America looks good. Other parts of the ROW world look good as well. The U.K., we've got some as well. It really is a good mix. The vast majority of those deals are relatively small, which is what we like, because they're highly synergistic when you do them, bolt them in at branch level, and they're low risk in terms of execution. But there are one or two more medium-sized deals in the pipeline as well, and hopefully, we'll be successful in landing one or two of those over the next few months. Great. If I could follow up with one more question. Could you give us Sure some numbers around the level of synergies that you're expecting with the JV, please? Hi, Emily. Yes. It's too early really to do that. As Andrew said, we'd expect there to be significant synergies arising from operational efficiencies. But the focus has been on putting the deal in place. Once we're moving towards completion, we'll be working with Haniel on what those synergies look like. Really, these are going to be led by CWS-boco. We've got a big stake in the business, but really, the synergy delivery is going to be driven by CWS-boco. So, it's early to do that at this stage. Thank you very much. Again, ladies and gentlemen, if you wish to ask a question on today's call, please signal by pressing star one on your telephone keypad. We will now take the next question from Robert Plant from JPMorgan. Please go ahead, sir. Morning. Italy and Ireland are being kept out of the joint venture. Why is that? It looks like you might end up buying some of their businesses in those countries. Morning, Robert. I hope we do end up buying them. That's the plan, really. Those businesses don't essentially have workwear assets in them. They're Hygiene assets. As I said in my earlier remarks, we're absolutely committed to the Hygiene business. So, it's potentially an opportunity for us to buy Hygiene assets in two markets which are important to us, Italy and Ireland. The honest answer for why it takes the form of an option as opposed to anything more concrete was we simply didn't have the time to do all of the work that we wanted to do in the time frames that we had. So, we deferred Italy and Ireland to do due diligence post this morning's announcement. If those businesses look good, we would plan to exercise the option and add another, give or take, EUR 50 million of Hygiene revenues to our global Hygiene business. It's very much a positive and upside for me if we're able to land those deals and bring them into the fold. Nothing more complex or clever than that, really. Just to clarify, Robert, I think you said they weren't in the JV. They remain in the JV unless we exercise our option to buy them. Oh, okay. That's clear. Thanks. We will now take our next question from Andrew Farne from Morgan Stanley. Please go ahead. Hi, good morning, everyone. Just a quick question on France. You were saying before about the fact that you could run it more closely alongside the JV, or at least there are some benefits from running the supply chains more closely. Does that mean that you, at some point, if they were to become more integrated or work alongside the JV, that it could be spun into it? Or is your partner just totally opposed to exposure to that market? It's very much a theoretical question, to be honest, Andrew. We haven't really talked about whether or not they have an ambition regarding France. It's actually, oddly enough, not a conversation we've even had. All I can tell you is, as we sit here today, our plan is to run that business and to improve it and to execute our strategy. The future will be what the future will be. At the moment, there's no thought or plan that France would ever find its way into the joint venture for the reasons I gave earlier. I wouldn't characterize it in the terms that you did, whatever it was, that the JV partner would never have any interest in France or something like that. That's not a discussion we've had in that sense. Plan is we're going to run it separately, we're going to execute the plan, we're going to improve it and continue to improve it. The future will be whatever it will be, but there's no plan for it to go into the JV. Right. Just on, I think some of your competitors in France have talked about a gradual improvement in the pricing environment. Is that something you're seeing? I'm not sure that I would know how to answer that. I don't know where that comment's come from. What I'll tell you is that the steps that were taken from aggressive price positioning maybe three years ago, two and a half, two years ago, take quite a long time to work through in a portfolio business. If you think about it, most of our contracts in workwear are sold on typically five-year contracts. The very significant aggressive price behavior probably a couple of years ago takes quite a long time to work through the business, work through the portfolio, work through the system, if you like. I'm not sure I would be able to tell you instantly if we could see an improvement in pricing. I do think it's absolutely fair to say we've not seen any further deterioration in the pricing environment in France for some time. But probably a little bit early to be able to say that we can see that prices have started to move up again. Jeremy, I don't know whether you'd have a more accurate- No, that's absolutely right, Andy. I totally agree with that we don't see any deterioration in the position. But given the nature of the business and this portfolio effect, it continues to remain a very competitive market, and we are still seeing those prices correcting from the actions that were taken two years ago. Absolutely right. Okay, thank you. Just one final one. Nothing has changed in terms of what your view on sort of balance sheet structure and leverage targets? Yeah, that's right. We've said previously that our kind of sweet spot is in the 2x to 2.2x net debt to EBITDA. We're committed to a triple B credit rating. Clearly following the Steritech deal, and with the strength of our M&A pipeline, we'd be running slightly ahead of that. This deal brings us back on a pro forma basis as at June 2016, back to 2x. So we're very happy with the balance sheet capacity that the deal gives us, and we remain our funding policy remains to be at triple B and being that 2x to 2.2x net debt to EBITDA over the long term. So, very pleased with where this gets us to. Okay, that's great. Thank you. As a final reminder, ladies and gentlemen, to ask a question, please signal by pressing star one on your telephone keypad. We will pause for a moment to allow for any further questions. We will now take the next question from Christopher Bamberry from Peel Hunt. Please go ahead. Good morning. Just a quick one with regard to the pro forma share of the JV, the 13 million. You gave us the assumptions on the EBIT line. I am just wondering what the assumptions are with regard to interest and tax arriving at that number? We have assumed an interest rate of about, sorry, tax rate of 30%, and we have assumed interest on the funding of the JV, which we said is in the region of EUR 520 million, which is the cash we are taking out at around 1.5%. Thank you very much. There are no further questions in the telephone queue at this time, gentlemen. Lovely. Thank you very much, Claudia. Thanks, everyone, for joining us. Obviously, as usual, if you have any follow-up questions, feel free to reach out to Katharine Rycroft. But that's it for the moment. Thanks for joining us, and have a good day. Ladies and gentlemen, this concludes the Rentokil Initial Company Announcements Conference Call. Thank you all for your participation today. You may now disconnect.