Neptune Marine – Beware of “Growth through acquisition”

Growth by acquisition doesn’t work most of the time, and here’s a classic example. Companies seem to over-estimate the benefits of acquisitions and under-estimate the difficulties in integrating acquired businesses.

Neptune Marine (ASX code NMS) is an Australian company based in Perth. It provides services to global oil and gas, marine and renewable energy industries. It provides construction support vessels, underwater welding, surveying, commercial diving and many other sub-sea services. With the demand for energy and other sources of power expanding rapidly, you’d think that most companies wouldn’t have a problem making a decent profit.

However, Neptune Marine is yet another example of the importance of analysing a company’s cash flow statements, and not taking the Income statement at face value. In the table below, you can see the reported profit, the actual cash flow received, the amount that Neptune Marine has spent on capital expenditure (buying property, plant and equipment).

Cash Flow ($m)	Totals	2004	2005	2006	2007	2008	2009	2010
Reported Net Profit	18.7	-.45	-1	-2.74	-6.38	7.41	20.97	0.85
Operating Cash flow	37.4	–        0.4	–        0.9	–        1.7	–           3.3	10.9	35.4	–           2.7
Payments for property, plant & equipment (i.e. capital expenditure)	–       80.8	–        0.1	–        0.1	–        0.1	–           0.4	–         18.0	–         49.4	–         12.7
Free Cash flow	–       43.4	–        0.5	–        1.0	–        1.9	–           3.7	–           7.0	–         14.0	–         15.4

As you can see from the table, Neptune Marine has reported total profits of $18.7m, total operating cash flows of $37.4m, but has spent $81m in capital expenses. So the company’s actual cash flow over 7 years is negative $43.4m!

Other Cash flows ($m)	Totals	2004	2005	2006	2007	2008	2009	2010
New Share capital (from shares issued)	168.1	2.7	1.7	0.5	50.2	61.3	12.0	39.7
Proceeds from Borrowings	70.6	–	0.0	0.2	0.2	0.3	39.0	31.0
Repayment of Borrowings	–       27.9	–	–        0.0	–        0.2	–           0.1	–           2.5	–           8.5	–         16.7

In this table, you can also see that the company has raised $168m in additional capital from shareholders, plus net borrowings of $42.7m.  So the company has increased its employed capital by more than $200m, to produce a net cash flow of negative $33m, and net profits of only $18.7m.

Its average Return on Equity (ROE) is -31.6%. Thanks to the increase in debt, Neptune’s Interest cover is a very skinny 0.8X in 2010. Its current ratio is less than 1 for 2010. For the first time in the companies listed history, working capital was negative (-$4.6m) in 2010. The companies Z-score is 1.90 (only marginally above the threshold of 1.8 that indicates that a company is under financial stress). The company’s Net Assets total $221m include $164m in intangibles. I could imagine those intangibles might be worth slightly north of Zero, but not much more.

Any wonder that the company has had to go back to shareholders and ask for more funds.

Whilst the current share price may recover and Neptune Marine may go on to produce profits in the future, it’s also a very likely candidate to fall into the hands of receivers. The recently announced $80m capital raising may not save the company, and may be a case of “chucking more money after bad”.  There are also doubts about the capital raising and whether it will actually go ahead.

I for one, will be avoiding it.