Hughes Drilling (ASX: HDX) is acquiring its blast hole production rig supplier Reichdrill for US$8.9 million (A$8.57 million) and has received binding commitments for a placement to raise A$18.5 million in relation to the purchase.
Notably for Hughes, the acquisition is expected to be earnings accretive on a normalised 12 month basis and after the accounting elimination of profits on sales by Reichdrill to Hughes.
It also secures control of its largest supplier, allowing it to retain its longstanding discount and priority supply arrangements, both of which are important competitive advantages.
Westpac Banking Corporation, the company's key financier, has already given its approval to the key conditions of the sale and purchase agreement.
Managing director Bob Hughes said the acquisition gave the company control of its most important supplier, enabling it to respond to the increasing demand for high performance, reliable production drill rigs.
The acquisition will be funded through the placement of shares priced at A$0.32 each to existing shareholders and new institutional and sophisticated investors in Australia and overseas.
Proceeds from the A$18.5 million placement will also be used to acquire new production rigs to meet increasing production drilling demand.
"It is very pleasing to see the strong level of investor support, with Hughes receiving overwhelming interest in the Placement," Hughes added.
The company will also offer eligible shareholders the right to participate in a Share Purchase Plan with details to be provided soon.
Acquisition rationale and details
Reichdrill has been Hughes' exclusive supplier of blast hole production rigs and hence its largest single supplier for several years while the company has in turn being Reichdrill's largest client.
With Hughes having worked closely with Reichdrill on the advancement of its blast hole rig Designs; an active party in its recent success in securing large orders of production rigs for use in Africa; and acting as Reichdrill's exclusive agent in Australia, the acquisition is viewed as both a logical bolt-on and a defensive transaction.
The purchase price of US$8.9 million is equal to about 15% of Hughes' post placement market capitalisation and is equal or less than the purchase of 4.5 blast hole rigs, of which the company has 35 in its fleet.
About US$5.2 million is payable to the seller while another US$2.5 million will be used to pay out existing debt. The remaining US$1.2 million will be paid as deferred consideration.
The cash flow accretive benefit will be greater than the earnings accretive benefit reflecting retention by Hughes of cash margins on sales by Reichdrill to Hughes.
Recent sales and sales leads arising from changes to Reichdrill's international marketing strategies and non-Australian agency arrangements also provide confidence in the sustained growth of Reichdrill's business.
Hughes added the acquisition of Reichdrill, which will become part of its Express Hydraulics business, will not result in a major change in its business activities and that it will remain a coal production drilling specialist for the foreseeable future.
Reichdrill manufactures a complete line of rotary and down the hole drilling equipment for use in the open cut coal mining sector in particular and also to sectors including oil and gas, quarrying, construction, water well, and general mining industries.
The company was founded in the late 1940's by Wendell Reich and has roots leading back to the development of the first hydraulic top-drive rotary drill.
Hughes will carry out the $18.5 million placement in two tranches.
The first tranche of 30.6 million shares to raise $9.8 million will be issued on 21 March 2013 while shareholder approval will be sought at a general meeting on or about 22 April 2013 for the second tranche of 27.2 million shares to raise $8.7 million.
Hughes Drilling has built a thriving coal production drilling business that has delivered a net profit of $5.5 million for the half year ended 31 December 2012, up 161.6% from the previous corresponding year on its near 50% share of the Queensland and New South Wales contracted production drilling market.
With demand continuing to exceed availability of suitable equipment and a significant expansion of its contracted rig fleet expected during the 2013 financial year and beyond, the acquisition of Reichdrill is a missing link and a vertical integration that makes sound business sense.
The Reichdrill purchase will allow Hughes to acquire rigs at essentially cost price by allowing it to retain the cash margin on rigs it acquires from Reichdrill and grants Hughes priority on new units to meet demand.
It will also assist Hughes' Express Hydraulics business. Growth capex is also expected to be modest and self funded.
That the acquisition will be earnings accretive part of the business is also an added benefit while the expected growth of its rig sales will add an additional income stream.
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