Posted March 22, 2017 15:29:47

Photo: Spotless started as a dry cleaning store, it has expanded to include services including cleaning. (Flickr: BrittneyBush)

Engineering and contracting firm Downer EDI has offered to takeover cleaning and catering service provider Spotless for $1.15 a share, or around $1.27 billion.

The share offer is 59 per cent more than Spotless' closing price before the deal was announced.

It seems like a bargain on the face of it, but is it a good deal and does merging these two firms even make sense?

Downer has been plagued by weakness in commodity prices, and has looked to diversify from its mining services arm.

According to Reuters, the Spotless takeover would be Downer's largest acquisition to date and the furthest from its main business.

What do Downer EDI and Spotless do?

Downer EDI provides transport, technology, communications, engineering and construction services to customers, and operates in Australia, New Zealand, South America, the Asia-Pacific region and Southern Africa.

It has struggled with Australia's shift away from the mining investment boom and has been repositioning its business.

"[Downer have] been on this Spotless register for some time, but to move to control represents a diversification of their business and, in particular, a step into the services side," said Michael McCarthy, chief market analyst at CMC Markets.

CMC does not own shares in either Spotless or Downer.

"Downer have been making these moves within engineering, moving a little away from their dependence on the manufacturing of rolling cars as their main source of income," Mr McCarthy said.

"This represents a bigger and newer step for them. There's also some elements of opportunism here, clearly Spotless has been under pressure, with a number of missteps and number of lost important contracts."

Spotless started as a dry cleaning store in Melbourne in 1946 and since expanded to include services including catering, maintenance, security, laundry, waste management, environmental services and cleaning.

Spotless has previously come under fire after cleaners subcontracted through the company for Myer said they were being underpaid and denied entitlements.

What are the share prices doing?

Spotless shares surged by 49 per cent yesterday on the news to a five-month high of $1.08. Today it has slipped 2.1 per cent.

Spotless listed in 2014 with an issue price of $1.60, and the offer came a day after Spotless closed at $0.73, its lowest level on record.

Its share price, however, has been on a downward trajectory since late-2015 when it issued profit warnings because of tighter economic conditions and tender decisions being delayed or deferred.

Private equity firm Pacific Equity partners listed the company on the ASX in 2014, less than two years after buying it.

"It's still an open case as to whether or not the current management team are responsible for that," said Mr McCarthy.

"It's only natural that competition enters into areas and Spotless have done a good job of highlighting the profit potential in the spaces in which they operate.

"I think it can be argued that management have taken their eye off the ball ... it appeared that competition was able to sneak in under their guard."

Shares in Downer on the other hand, are in a trading halt. The company slipped 0.5 per cent the last time it traded on Monday, closing at $7.42, which is around a seven-year high.

"It's a win-win for Downer and strategically it's a very strong move," argued Mr McCarthy.

"If they get to buy the company at their takeover bid price, they bought an asset at what they believe to be a cheap price, and if the market doesn't allow them to do that, if the share price races ahead, they'll gain on their already existing stake."

Downer secured a 19.99 per cent stake on Monday in a transaction arranged by UBS, according to Bloomberg.

What's the outlook?

While investors cheered the move, piling into Spotless shares, Mr McCarthy said there are still some earnings concerns.

"Clearly, where earnings are in decline there are concerns, for the outlook for any company it's good to see management prepared to deal with the issues and take action on it, whether or not this is a right action, is harder to say at this stage," he said.

"Because we're not seeing signs yet of an earnings turnaround, it's very hard to get excited."

Topics: business-economics-and-finance, company-news, industry, hospitality, markets, multinationals, takeovers, telecommunications, electricity-energy-and-utilities, australia, melbourne-3000