Hello and Happy New Year!
Here’s part 2 of my “merger of equals” analysis of the proposed merger between Xenith IP and QANTM IP. I stuck with the same picture as the first post in this series, not because there is a paucity of bird of prey pictures, but because this one is so cool!
As you may recall, in my first post we worked through the first 5 and a bit slides of the investor presentation at http://qantmip.com/wp-content/uploads/2018/11/181127-QANTM-ASX-Investor-Presentation-Proposed-Merger-of-QANTM-and-Xenith.pdf.
My take home from that analysis was that the most significant part of this section of the slides is the step-change from two small companies to a company that is capable of being part of the ASX300 index. From what I had heard, an increase in scale of this nature can result in a significant higher share price relative to the company’s financial performance, particularly if the merged entity has a decent strategy.
As we go through the remainder of the presentation, you will see that it is my view the most clearly identified benefit of the merger is that by virtue of the increased size of the merged entity, it has better economies of scale.
What makes this a more compelling proposition than mergers of other types of where disparate companies (with potential synergies) are brought under the one umbrella is that every patent attorney business in the merged entity has a very similar culture and client mix. This makes any merger of patent attorney businesses intrinsically more scalable. Why? Because essentially they all do the same thing with the same sorts of clients. I have touched on this in the initial posts of my blog. In essence, the same argument applies to an Asian expansion – the types of work being done in Malaysia or Singapore or China are essentially the same as the work done in Australia. In addition, the back office and IT support, particularly the docketing system (the heart and soul of a patent attorney business) can be the same in every country.
This ability to scale (relatively) easily is why the merger is less risky than with other types of acquisition in professional services firms, such as the acquisitions in the UK that went so terribly wrong for Slater & Gordon.
Of course, there will always be teething troubles, such as the acquisition of Griffith Hack by Xenith IP which is taking a year or two to bed down, but fundamentally it is different to taking on a business you don’t understand in a market you don’t understand.
Now let’s have a look at the QANTM/Xenith’s take on the strategy which is set out in the remaining slides.
Slide 6 – Significantly enhances shareholder value
This slide sets out the benefits of the merger, and provides some elements of strategy. It shows an arrow gradually accelerating upwards from left to right implying that after an initial cost cutting phase, the benefits of the merger will start to flow through to shareholders in the merged entity. A picture tells a thousand words! At various stages in the arrow’s progression, there are statements that illustrate the benefits because pictures don’t always cut it! Let’s take a look at these.
“Roll-out of initiatives including IT transformation and corporate / back office simplification to deliver synergies”
The merged entity will cut costs by merging back office functions and applying a standard IT platform.
“Increased balance sheet strength to continue expansion in Asia”
The merged entity will have more money compared to each individual company pre-merger. That money can be spent on expanding the Asian operations.
“Increased liquidity and enhanced potential for ASX300 inclusion”
Because the merged entity will have a higher market cap, investors are more likely to trade shares in it (see my previous post).
“Stronger ability to capture revenue opportunities in Asia and across a broader service offering”
I am not sure what this means beyond the fact that the merged entity is bigger than each individual company. The broader service offering may be a reference to the fact that Xenith IP has Glasshouse Advisory (which seems to be a grab bag of IP searching and R & D tax concession services together with an IP strategy arm which, from my experience watching IP strategy businesses over the years, is a difficult area to monetise) and QANTM IP does not. Otherwise the service offerings from each firm seem pretty similar.
“Delivers earnings accretion for both sets of shareholders”
The company will earn more money than the two individual companies combined. Due to statement 1 and statement 4 presumably.
“Enhanced cash flow conversion from greater operational efficiency to support sustainable dividends”
This implies that the merged entity will have a higher margin than the two individual companies due to efficiencies (possibly associated with the greater scale of operations).
So a few motherhood statements, the benefits of which mainly come down to scale and cost cutting with vague references to Asia to justify revenue growth. Is there more detail in the following slides? Let’s see.
Slide 7 – Merger rationale
Well this is a bit more promising – some itemised justifications for the merger…
Hmm, well most of these statements come down to the fact that the merged entity will be big (bigger than IPH in Australia!) and there will therefore be better economies of scale. There are a few interesting titbits though.
“Strategic and cultural alignment”. I take this as code for “it won’t be a sweatshop like IPH” which is a perception amongst some patent attorneys so the professional staff are more likely to stay than if QANTM or Xenith merge with IPH.
“Leverage QANTM’s existing presence in Asia with Xenith’s growing operations, clients and opportunities in the region”. I have previously mentioned that Xenith has a client, Colgate-Palmolive, who use Xenith to coordinate patent and design applications across the region,. Capturing that revenue within the organisation rather than using foreign associates in each individual jurisdiction would be a significant result for the merged entity. I don’t know what other opportunities Xenith might have. This is a genuinely good reason for the merger. It saves duplication of infrastructure and development efforts in Asia, a genuine economy of scale.
My favourite is “Enhances career opportunities”. I guess a bigger organisation has more scope for multiple interesting roles but I do wonder whether this is basically a pitch to the professional staff so they don’t feel threatened and try to leave.
Slide 8 – Creates a market leading IP services group
Yes, the merged entity will be bigger than IPH! In Australia at least. Not even close in the rest of world.
Slide 9 – Creates a market leading IP services group
This lists out the brands again – note the duplication across the various cities. Hard to believe that this won’t be rationalised.
Slide 10 – Accelerates Growth in Asia
Again, interesting to see the reference to Xenith’s Asian strategy and pipeline of identified opportunities. I wonder what they are.
“Continued engagement with global clients as well as growth in inbound Asian filings (Xenith having a leading position in inbound patent filings from China / Hong Kong)”
Yes, the good old in-bound filings from China. It is hard to believe that this is genuinely a large proportion of revenue as traditionally Chinese agents and companies file comparatively little into Australia. For comparison, IPH has an office in China which shows where they judge the better business to be – filing into China from overseas countries rather than capturing outbound filings.
Slide 11 – Greater scale and efficiencies
The main (and persuasive) justification for the merger
Slide 12 – Drives automation and innovation
IT will help us cut costs and we have better bargaining power to use IT services because we are bigger.
Slide 13 – Expands client base
Because the merged entity is bigger!
Slide 14 – Enhances career opportunities
Because the merged entity is bigger!
Slide 15 – Highly experienced Board and management
Well, yes and no. The only person on that list who really knows patent attorney firms is Leon Allen. The others have more general board and commercial experience. Is that a bad thing? Not sure: there is a strong argument for having listed company expertise in managing these companies and (with the exception of IPH’s management) pretty much no Australia (or international) patent attorney has it.
Slide 16 – Benefits to stakeholders
Bit of repetition here.
Well there’s my initial take on the proposed “merger of equals”. I might have more to say on this in the coming weeks as the merger progresses and the Australian business community yawns and stretches its way out of the summer holidays.