Transport giants fire opening salvo

By Stephen Bartholomeusz
September 8, 2005

THE battle lines are being drawn in the $4.6 billion internecine battle between Toll Holdings and its rail freight partner, Patrick Corporation.

Patrick has made clear its intention of fighting the bid, which would combine its port operations and half-share of the Pacific National rail joint venture with Toll's logistics and freight businesses.

Its opening salvo has been diversionary in nature — an application to the Takeovers Panel over the inclusion of shares in its subsidiary, Virgin Blue, in the offer consideration and the igniting of a dispute within the PNL joint venture over allegations of favourable treatment of Toll.

Neither of those issues is likely to determine the bid's outcome. The Virgin Blue issue is, at this stage, largely one of semantics that can be remedied by Toll making it clear the Virgin Blue shares (0.3 Virgin shares for each Patrick share) will only be distributed to Patrick shareholders if it gains control. The PNL dispute is likely to take longer to resolve than the bid timetable.

The larger issue, made critical because the bid involves mainly Toll shares (0.4 of a share plus 75¢ a share of cash), is the business logic that underpins the concept of merging the two businesses. Toll needs to convince Patrick shareholders that there is a fundamental logic, and benefit, from gaining the capacity to offer large customers with international supply-chain end-to-end transport and logistics services under one umbrella.

Patrick has questioned the relative quality of Toll's operations versus its duopoly positions in key ports. It is likely to launch a more fundamental attack on the business logic of the merger as the bid proceeds.

The Patrick position was supported by a Merrill Lynch research report this week that said precedent for the strategic sense of the combination were not obvious but that the financial benefits were clear.

The broker said it was unaware of any major ports or logistics companies making a success of the type of vertical integration being pursued by Toll and that, indeed, if anything the reverse had been the trend with recent divestments of non-rail assets, including ports, by CSX of the US and by P&O's sale of its shipping and logistics businesses. It pointed out that the customer bases are quite different, with Patrick dealing largely with shipping lines and Toll end-customers.

Toll's estimate of the synergies a successful bid would generate start at $30 million a year and rise to $60 million by year three. Those would be offset by the leakage of value created by selling down the Virgin Blue stake to Richard Branson and other third parties and by the probable need to make some divestments, and offer some concessions to competitors, in the areas where the potential cost savings are greatest, if the bid is to have a chance of gaining a clearance from the ACCC.

Thus the appeal of the deal appears to lie in whether the combination makes sense, not in the opportunity to make major cost savings.

The financial benefits, presumably, would arise by either the enlarged Toll's ability to increase its revenues and profits from offering a complete supply chain service or because it has bought Patrick cheaply by issuing overvalued paper, or because the bid undervalues Patrick (which is vulnerable because of its exposure to Virgin Blue and because it is in the midst of a massive capital expenditure program) or both.

Paul Little has a customer on his side. Woolworths' Roger Corbett has publicly endorsed the bid and the potential it would give Woolworths to deal with only one party in moving and tracking its goods from offshore markets, through the ports, to its stores.

He might highlight that there are "virtual" logistics groups that are major competitors to Toll because they are able to offer a synthesised version of an end-to-end service.

He can also point to the announcement last week that Deutsche Post and the British logistics group Exel are in merger talks as evidence that consolidation is starting in the global logistics sector and could argue that a response to the threat of global logistics companies tying up multinational end-users is to provide end-to-end services in this region. Little has spoken of the capacity and need of a bulked-up Toll to expand further into Asia.

If he wanted to be cute Little could also highlight Patrick's expansion into aviation, and rail freight and the attempted acquisition of the big freight-forwarding company, FCL Interstate Transport that was rejected by the ACCC yesterday. Patrick's ability to attack Toll's strategy of integrating ports into its operations is weakened by its own expansion strategies.

The ACCC decision, while highlighting the sensitivity of merger activity in the relatively concentrated and economically important transport sector, in some respects helps Toll because it knew it would have to divest FCL if the Patrick purchase was cleared. The ACCC has helpfully taken the concentration issue off the table but the larger issue of its attitude to complete vertical integration has yet to be resolved.

Maintaining FCL as an independent competitor to its own freight forwarding operations also means that the ACCC has preserved a larger competitor group to which it can force Toll to make concessions as the price of approval for its bid — if the bid is to be approved.

Because the Toll bid comprises mainly scrip the arguments about the value of the customer proposition Toll argues is the compelling strategic underpinning for its bid aren't academic. Both Toll and Patrick shareholders are vitally interested in whether there is robust business logic to the deal and, if there is, that the benefits of combining are fairly shared.
