TLDR; 1+1 = 2 not 3

The proposed merger with Brickworks could result in a new ASX50 name.

Esther Holloway

Soul Patts and Brickworks have agreed to merge. The new combined entity will also raise about AUD 1.3 billion of new equity to cover transaction costs and reduce debt. Since the announcement, shares in Brickworks and Soul Patts were up 28% and 16%, respectively. 

Fundamentals don’t justify rally

The market likes the deal, and we agree that it has merits. It fixes a long-standing governance issue by eliminating the cross-shareholding, boosts free float, and may result in ASX 50 inclusion. Given the positive market reaction, we expect the merger to go through. 

We don’t see material synergies and neither does management. Cost-cutting in Brickworks isn’t on the table, and savings from lower listing fees are negligible. The merger doesn’t create value, so fundamentals don’t justify the share price rally. 

Instead, the merger reallocates value between the existing shareholders of Soul Patts, Brickworks, and the new investors in the institutional equity raise. One plus one still equals two, and for every winner, another party must pay up. 

Merger undervalues Brickworks

The merger undervalues no-moat Brickworks, and we cut our Fair Value estimate 9% to AUD 29 per share. It would lift Soul Patts’ fair value estimate by about 3%, but this is offset by transaction costs. Our AUD 35 fair value estimate stands. 

Both companies are overvalued after the rally. Perhaps Soul Patts shareholders expect more demand from passive money, and indeed, many large caps we cover trade at a premium. 

The combination of the two companies is likely to see extra near-term demand for the shares. But to unwind the cross shareholding, Brickworks shareholders will need to pay. We will make a call on the relative merits of this when we see a scheme booklet