The Emperor’s New Clothesalso known as The naked kingis a story written by Hans Christian Andersern and published in 1837 as part of a series of fairy tales told for children. Two rogues convince the king that they can make him a suit of the finest fabric ever made. The garment had the special ability to be invisible to any person incapable of their position. The king was unable to see the cloth, as were his subjects, but no one dared to say it until two children did. The story metaphor is frequently used, indicating a situation in which a vast majority of observers decide to collectively ignore a true fact..
The appearance in the month of July of Broookfield, in the Grifols saga, could be interpreted as that of a white knight who came to save the honor of the lady, the company, outraged by the markets. In deciding not to go ahead with the offer in November, he came to say that, at certain prices, the company was naked. Brookfield is not an opportunistic investor, as some media outlets have wanted to expose. At the same time that it was analyzing Grifols, it was selling its shopping centers in Brazil, purchased three decades ago. Long term in its purest form.
At first the fit seemed perfect. A company with a great industrial positioning but suffocated by its financial situation, like its control partners. On the other hand, a highly prestigious investor, whose funds under management are estimated to be close to 800 billion dollars and investments in thirty countries.
However, there was a clear asymmetry of interests and risks with respect to the price to pay. The main reason why many company purchases do not generate value, but rather destroy it, is overpaying for them. A mistake that is made on the first day of the investment and that is very difficult to turn around. In this hypothetical offer, the only one putting up cash and taking a real risk was Brookfield.
The potential offer was high risk. On the one hand, its size was very large in the capital part, buying shares for more than 6,000 million euros. On the other hand, there were about 9 billion gross debt. Changes in control of a company always require renegotiation with bondholders. In essence, the main objective of the negotiation is to agree on the increase in the interest rate that these lenders demand from the new owner in order not to demand immediate repayment of the debt due to a change in control of the company. The purchase of the shares and the renegotiation of the debt were two certainties. The generation of future cash flows that would allow a risk-adjusted return was an uncertainty. The offer price should trend downward.
For Grifols, a high price meant the revaluation of the assets of its controlling shareholder, which had been severely punished in the last year, both in economic and reputational terms. A high share value is a key element when shares are put as collateral for your particular loans, as is the case. Going public had the additional advantage of no longer suffering from the continuous scrutiny of analysts and investors, a no small suffering. In addition, private funds manage companies with higher levels of debt, away from the scrutiny of public markets.
The withdrawal of the Canadian fund once again exposes Grifols to its difficult reality, which the market is adjusting through its price. While the company insists on its 115 years of value creation, the market only looks to the future. In the stock market, past returns are never a guarantee of future returns.
The price shows great volatility, with a drop of close to 20% in the days following the abandonment of the possible takeover bid at the end of November. The refinancing of part of its debt two weeks later produced an increase of close to 10%, which was diluted in the following sessions. This volatility shows that It is an action with which you can earn money in the short term, if you have the soul of a card player. This makes it not a stock in which long-term investors invest today. Volatility is too important a risk for the profitability of more traditional funds
The aforementioned refinancing of the 2025 maturities gives the company an important respite before considering undertaking the loans that mature in 2027. The fact that it is a private placement shows that the banks, which were so flexible a few years ago in the definition of EBITDA adjusted, today they prefer not to increase their exposure to the company, whose rating credit is high risk according to Moody’s. Going from a financial cost of less than 2% to levels of 7% represents a significant increase in financial expense that erodes operating cost savings and continues to distance the possibility of recovering the dividend. A company without dividends is off the radar of many investors. Renewing the line of credit is an important source of oxygen, but every time this line is used, it becomes debt.
An important aspect that the market will determine in the future through the price is what level of debt/EBITDA debt it is willing to admit that allows the stock to rise continuously. Before Covid, Grifols managed levels close to 4 times what is the company’s objective, according to its famous credit facility. When said credit facility was granted, these were times of cash generation and dividend payments. Banks had a huge appetite and need to grow their results, increasing business volume via loans, given that rates were close to zero percent. Today these debt ratios seem very high and the banks’ willingness is probably to reduce risk with the company.
Reducing debt in absolute terms means amortizing it, versus reducing it in cosmetic terms, based on reducing the EBITDA debt multiple, making said EBITDA grow. Between 2022 and 2024, the company will have generated some 4.5 billion EBITDA tight, but unfortunately none of that figure has translated into cash flow that has allowed it to reduce debt. One of its main competitors, the Australian CSL, has communicated to the market a target of 2 times its EBITDA, a figure that seems very far from Grifols’ possibilities in the next three years. Debt in absolute terms will be an important barrier to sustained growth in the price.
Reducing gross debt means either selling assets, or dedicating a large part of the free cash flow to this task instead of growth. In short, shrink a company to strengthen it. Difficult balance, although when debt takes control, the decision becomes easier. In the worst scenario, there is always a capital increase, which is usually denied until the day it is finally announced.
Another subject where the company needs to improve in the future is its relationship with analysts and investors, neglected in the days of success and with important gaps. “Markets are conversations,” says the famous Cluetrain Manifesto. It has been announced a capital market day in 2025, during which the company will likely improve its latest public forecasts that spoke of 2.5 to 2.7 billion free cash flow between 2025 and 2027. It will be important to know what strategy the company offers in the balance between future growth and financial strength. Find out to what extent you are concerned about the recovery of your credit rating, probably necessary for the banks to allow you to return to paying dividends. It is curious that the investor who has not invested money in the company, Brookfield, is the one who has received the most future information in recent months, at least in theory. The company has improved its transparency in recent months. Being transparent is a necessary condition but it is not a differentiating element, in the face of markets that demand fast, realistic, concise and clear communication.
In terms of corporate governance, the company has partially renewed its Board of Directors. As in the case of transparency, when the market becomes strict, it is not a factor that alone causes the price to rise. What the company is doing is complying with the minimums required of companies of its size and industrial quality. The incorporation of activist funds to its Board of Directors opens a chapter of corporate governance rarely seen in Spain. These funds do not seek control of the company as Brookfield intended, but rather to influence management.. These activists raised the tone by publishing letters addressed to the company and directly criticizing some director. A textbook strategy, with a response also from a defense book, to incorporate the dissenter into the Council. Next year we will see what their real capacity is to influence the future of the company.
2024 has closed with a fall of close to 40% compared to falls of its direct comparables, the Australian CSL and the Japanese TAKEDA, which fluctuate around 2%. If we look at the last 5 years, Grifols shows a drop of 71% compared to 2% for CSL and 3% for Takeda. A lost five-year period. Compared its current price with the price compared to the day before the publication of the report, of other companies that have suffered the Gotham attack (AAC Technologies, 2017, -75%, Aurelius, 2017, -80%, MDC Partners, 2016 – 68%) Grifols has saved the furniture in a very complicated year.
After the Gotham storm, the company has renewed its management team, removed the family from management, partially improved its corporate governance, refinanced debt and improved communication with the market. The quote is waiting for a new stage that demonstrates the ability to grow organically with profitability. You just need to change your name.
#Grifols #emperors #clothes
