Vice President : Sahil Kumar
Analysts : Luca Moretto, Alessandro Bosco, Abhishek Gopinath, Seva Mytsyk, Yuen Shii Lim
Deal Overview
Acquirer: Barratt Developments plc
Acquiree: Redrow plc
Deal Size: £2.5 billion
Buy Side Advisors: UBS AG, London Branch, Morgan Stanley & Co. International plc, Linklaters LLP, PricewaterhouseCoopers LLP
Sell Side Advisors: Eversheds Sutherland, Barclays Bank PLC, Peel Hunt LLP, Slaughter and May
Introduction
Barratt Developments plc (LSE: BDEV) entered into a scheme of arrangement to acquire Redrow plc (LSE: RDW) in an all-stock deal for £2.5 billion on February 7, 2024. Under the terms of the Combination, each Redrow Shareholder will receive for each Redrow Share 1.44 New Barratt Shares, in other words, Redrow Shareholders will hold approximately 32.8% of the Combined Group and Barratt Shareholders will hold approximately 67.2%.
The Combined Group will be renamed "Barratt Redrow plc" from Completion and is expected to become effective during the second half of 2024. It aims to deliver more than 22,000 homes each year in the medium term, or 57% to 63% more than the 13,500 to 14,000 deliveries Barratt expects to deliver by itself in fiscal 2024. After the announcement, Barratt saw its stock fall by almost 3% while Redrow's shares were 14% higher, reflecting the 27% premium offered.
Barratt Overview
Barratt Developments PLC is engaged in housebuilding and commercial development in the United Kingdom. The Company’s business is acquiring land, obtaining planning consents and building homes. The company was incorporated in 1958 and is headquartered in Coalville, the United Kingdom.
Its three consumer brands, Barratt Homes, David Wilson Homes, and Barratt London offer a variety of properties across the United Kingdom. It also has a commercial business, Wilson Bowden creating spaces from industrial and office buildings to retail and leisure. Barratt Homes focuses on providing homes for first time buyers and families, offering a range of properties across England, Scotland, and Wales.
Key Metrics
- CEO: David Fraser Thomas - Revenue: £4.39bn (TTM) - Net Income: £218.60M
- Market Cap: £4,612.0M
- TEV: £3,908.1M
- EBITDA: £485.7M
- TEV/ LTM Total Revenue: 0.89x - Number of employees: 6.73k
Redrow Overview
Redrow plc is a United Kingdom-based company, which is focused on housebuilding activities. The Company has approximately 100 live developments throughout England and Wales and has an integrated divisional network of 13 regional offices. It was founded in 1974 and is based in Flintshire, the United Kingdom.
The principal activity of the Company’s subsidiaries (Redrow Homes Limited, Redrow Real Estate Limited, Redrow Regeneration plc, The Waterford Park Company Limited, and The Waterford Park Company (Balmoral) Limited), is residential development. The principal activity of its subsidiary, Harrow Estates plc is land acquisition, development and resale. Its subsidiary, HB (HDG) Limited, is an intermediate holding company. Its subsidiary, St David’s Park Limited, is engaged in business park maintenance services.
Key Metrics
- CEO: Matthew Brennan-Pratt
- Revenue: £1.85bn (TTM)
- Net Income: £208.00m
- Market Cap: £2,142.6M
- TEV: £2,021.6M
- EBITDA: £289.0M
- TEV/ LTM Total Revenue: 1.09x
- Number of employees: 2.27k
Industry Analysis
British housebuilders have struggled for the past couple of years as high-interest rates dented demand and building costs rose. However, there have been signs of stabilisation in the wider housing market, including a rise in home prices last month, spurred by cheaper mortgage loans.
Barratt CEO David Thomas, who will lead the combined company, said there had been some improvement in demand at the start of 2024, helped by expectations of lower interest rates.
The Bank of England is also likely to start cutting rates later this year and there have been signs of growing confidence in the construction sector.
Recent data shows that a recovery is on the way - the agreed sales in the first 6 weeks of this year are 16% higher than the same period in 2023, buoyed by growing interest from buyers, sellers are listing their homes in increasing numbers.
However, significant economic risks that could reduce buyer demand remain. Escalating conflict in the Middle East threatens global growth. The speed and size of interest rate cuts this year are still unclear. After January’s 4% inflation figure was published on Wednesday, traders in swap markets, from which lenders price their fixed-term deals, increased the number of rate cuts they expect before the end of the year. But their forecasts remain more pessimistic than they were in December.
In general, the consensus is that the UK housing market is expected to stage a recovery in 2024 as a slowdown in the housing sector in 2023 triggered by rising mortgage costs may be over, and a downward trend in house prices has bottomed out. Pent-up demand from cash buyers and first-time buyers who can access much cheaper mortgages than they could in 2023 is expected to push up prices back towards their peak this year.
Financial Analysis
Accretion/Dilution Analysis
In order to determine whether the merger was value-adding over the long term, we proceeded to conduct an Accretion/Dilution analysis using past and future estimates of both parties’ income statement and balance sheet. This analysis determines whether the post-merger EPS has increased or decreased. An increase in pro forma EPS is regarded as an accretion, while a decrease is regarded as a dilution.
As seen above, the merger is expected to be accretive to Barratt and Redrow's respective adjusted earnings per share in the first year after completion (as forecasted by Barratt official announcements), and to maintain approximately the same EPS as Barratt without the merger in the following years.
Comparable Company Analysis
In the comps approach, we selected 7 companies within the same industry as Redrow, ensuring that these entities share similar business models and revenue structures. We focused on three key valuation multiples: Price to Earnings (P/E), Price to Sales (P/S), and Price to Book (P/B). These multiples were chosen for their relevance in evaluating a company's market value relative to its earnings, sales, and book value, respectively.
The calculation of these multiples involved dividing the market value metrics (Price) by the company's earnings, sales, and book value per share. The averages of these ratios were then computed across the selected comparable companies. By applying these average multiples to Redrow's financials and dividing by the number of shares outstanding, we derived the implied value per share for Redrow under each multiple:
● The average P/E ratio was applied to Redrow's earnings, yielding an implied share value of £17.57. This suggests that, based on earnings, Redrow is significantly undervalued in the market.
● Similarly, using the average P/S ratio gave an implied share value of £7.50, indicating undervaluation based on sales.
● The P/B ratio analysis resulted in an implied share value of £8.78, further supporting the undervaluation thesis based on book value.
The consensus from these analyses suggests that Redrow's current market price of £8.5 significantly undervalues the company, potentially due to the market not fully accounting for the anticipated decrease in capital requirements stemming from a forthcoming merger.
Precedent Transactions Analysis
For the precedent transactions analysis, we examined 6 recent transactions within the same industry. This method provides insight into the valuation metrics that acquirers are willing to pay for companies, offering a benchmark for what Redrow might be worth in a similar transaction scenario. We calculated the Price to Earnings (P/E) and Price to Sales (P/S) ratios from these transactions, which represent what has been paid in the market for companies comparable to Redrow.
● P/E multiple yielded an implied share value of £15.75, suggesting that, in a transaction scenario, Redrow could be valued much higher than its current market price based on earnings.
● P/S multiple provided an implied share value of £6.11, indicating a potential undervaluation based on sales in the context of precedent transactions.
Both the comparable company analysis and the precedent transactions analysis indicate that Redrow is undervalued by the market. The discrepancy between the current market price (£8.5) and the implied values obtained through these analyses suggests significant upside potential. The undervaluation could be attributed to market inefficiencies or a lack of recognition of Redrow's future prospects, particularly the expected benefits from a decrease in capital requirements due to an upcoming merger.
Deal Rationale
Revenue Synergies
The strategic move of merging Barratt Developments and Redrow to form Barratt Redrow aims to establish dominance in the UK housing market by offering a significantly wider selection of homes. In order to directly address the predicted housing shortage in the UK, this recently established company will provide a wide range of customer needs, from larger family homes from David Wilson Homes to affordable homes for first-time buyers from Barratt Homes, and now, luxury options through Redrow.
It is expected that the strategic integration of Redrow into Barratt's brand portfolio will maximise the efficient use of their combined land pipeline. This includes launching multi-branded websites, which have a track record of increasing sales volumes and reservation rates. The Greytowers Village development serves as evidence of the effectiveness of this approach. By offering a wider variety of homes, such dual-branding initiatives are anticipated to increase appeal to a wider spectrum of buyers in addition to expediting the delivery of homes.
Barratt has demonstrated a commitment to brand investment and growth through its track record of promoting and growing the brands it acquires, as exemplified by David Wilson Homes. It is anticipated that the Redrow brand will follow suit, strengthening its standing as a high-end product in the combined company's line of business. As a result, the merger is ideally situated to leverage a larger customer base and spur more home deliveries in order to more successfully address the UK's diverse housing demands.
Cost Synergies
Barratt Redrow is expected to benefit from significant cost synergies and aim to save at least £90 million annually by the end of the third year following completion. The main factors contributing to this cost efficiency are anticipated to be the rationalisation of divisional and central functions and the strategic consolidation of overlapping office locations, which will expedite building processes and streamline operations.
David Thomas, the Chief Executive of Barratt, has emphasised the potential for savings by cutting back on unnecessary office space and the need to keep the best employees within the combined company in order to minimise job losses.
The anticipated savings will come from a number of sources, such as procurement, where combining purchasing power can result in lower material prices, and office and support structure optimization to get rid of redundant work and save on maintenance and leasing. Barratt Redrow is expected to become a more efficient and competitive player in the housing market as a result of these initiatives, which are expected to significantly reduce the cost base of the combined group.
Other synergies
The merger of Barratt Developments and Redrow into Barratt Redrow is a strategic move aimed at capitalising on the anticipated recovery in the UK's housing market, related to the prediction of stable or decreasing interest rates which will increase mortgage access and consequently house demand. David Thomas hopes that the expected national elections this year will incentivize politicians to reform Britain's complex planning system which can delay projects.
Another reason can be found in the the removal of the Help to Buy scheme which has eliminated an important help for first-time buyers, inducing Barratt in diversifying its business also in more premium options through the merger with Redrow.
Beyond financial synergies, the merger brings together two companies with a shared commitment to quality, service, and sustainability, setting a new standard for excellence in homebuilding. Both companies have a history of high customer satisfaction and have been recognized for their commitment to sustainable development.
Together, they aim to leverage their combined strengths to accelerate the delivery of over 22,000 homes annually, enhancing their strategic positioning in the market while maintaining a strong balance sheet and improving margins. This merger not only promises to meet the UK's urgent housing needs but also to drive innovation and excellence in the sector.
Risks
1. Regulatory and Compliance Risks
The deal requires clearance from the Competition and Market Authority (CMA), which is currently studying the housebuilding market for issues related to land buyers and housing quality. Given the size of the merged entity, regulatory approval is not guaranteed and represents a significant hurdle.
2. Financial and Economic Risks
The announcement of the deal led to a decline in Barratt's share price by 5%, while Redrow's shares climbed nearly 15%. This volatility reflects market concerns about the merger's implications. The all-share nature of the deal also exposes both sets of shareholders to market risks and the performance of the combined entity.
Although annual cost savings of £90 million are anticipated, achieving these savings will require substantial integration efforts. The one-off cost for realising these savings is estimated at £73 million, which could impact short-term financial performance.
3. Operational Risks
The merger aims to combine two companies with potentially different corporate cultures, systems, and operational processes. This integration poses significant risks in terms of maintaining operational efficiency and minimising disruptions to ongoing projects.
Moreover, the merger could lead to the loss of more than 800 jobs and the closure of around nine offices due to overlapping roles and efforts to consolidate office space. Such reductions could affect morale and lead to a loss of key talent, impacting productivity and innovation.
4. Strategic Risks
The decision to retain Redrow as an upmarket brand while continuing to market Barratt Homes towards first time buyers could lead to challenges in brand positioning and customer perception. Ensuring the coexistence of these brands without cannibalising each other's market share requires careful strategic planning.
Similarly, both companies have been navigating a downturn in the housing market, with reduced profits and output. The strategic focus on cost-cutting and reduced land buying before the merger could impact the combined entity's ability to capitalise on market recoveries.
5. Reputational Risks
The potential job losses and the scale of the merger could lead to negative perceptions among the public and employees. Managing these perceptions while ensuring transparent communication about the merger's benefits will be crucial to maintaining reputation and trust.
Conclusion
The merger of Barratt Developments and Redrow into Barratt Redrow, through a strategic £2.5 billion all stock transaction, represents a significant consolidation within the UK's housing sector. This merger is poised to create a formidable entity within the industry, targeting an ambitious output of more than 22,000 homes annually in the medium term. This represents a substantial increase over Barratt's solo projections for fiscal 2024, thereby underlining the merger's potential to significantly enhance production capabilities and market reach.
The combined entity's enhanced scale and diversified portfolio are expected to deliver improved financial performance through identified revenue and cost synergies. Notably, the merger anticipates achieving at least £90 million in annual savings by the end of the third year post-completion, stemming from operational efficiencies and streamlined processes.
In conclusion, the Barratt-Redrow merger represents a strategic pivot towards growth and market dominance in a recovering housing market. If navigated successfully, the merger could set a precedent for industry consolidation, driving innovation, and operational excellence.
References
Financial Times, (2024). Barratt to buy rival Redrow for £2.5bn. [online] Available at: https://www.ft.com/content/e1ac99b3-2d18-406b-a272-cfc4ba759ecf
Sky News, (2024). Barratt and Redrow £2.5bn merger to accelerate delivery of homes this country needs. [online] Available at: https://news.sky.com/story/barratt-and-redrow-2-5bn-merger-to accelerate-delivery-of-homes-this-country-needs-13065848
Reuters, (2024). UK's Barratt to buy Redrow in £2.52 bln pound deal. [online] Available at: https://www.reuters.com/markets/deals/uks-barratt-buy-redrow-252-bln-pound-deal-2024-02-07/
City A.M., (2024). Barratt and Redrow announce £2.5m megamerger. [online] Available at: https://www.cityam.com/barratt-and-redrow-announce-2-5m-megamerger/
Drainfast, (2024). Barratt Redrow Merger. [online] Blog. Available at: https://www.drainfast.co.uk/blog/barratt-redrow-merger
Yahoo Finance, (2024). Barratt Redrow merger: Highlight for investors. [online] Available at: https://uk.finance.yahoo.com/news/barratt-redrow-merger-highlight-investors-145647192.html
MSN, (2024). Merger of housebuilders Barratt and Redrow could put hundreds of jobs at risk. [online] Available at: https://www.msn.com/en-gb/money/other/merger-of-housebuilders-barratt and-redrow-could-put-hundreds-of-jobs-at-risk/ar-BB1hV3Lh
The opinions expressed in the reports are those of the members of the Junior IB team and are not affiliated with any university or institution. The financial recommendations provided are for educational purposes only and the Junior IB team takes no responsibility for any losses that may occur from implementing any ideas presented in the reports. The Junior IB team is not authorized to provide investment advice. The information, opinions, and estimates presented in the reports reflect the Junior IB team's judgment at the time of publication and are subject to change without notice. The price, value, and income of any securities or financial instruments mentioned in the reports may fluctuate. The Junior IB team has no business relationship with any of the companies mentioned in the reports and does not receive any compensation for their inclusion.
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