Why Brickworks and Soul Patts are merging and what it means for shareholders

Soul Patts chairman Rob Millner, left with CEO Todd Barlow. Picture: NewsWire / Christian Gilles

Project Hawk has been five decades in the making and after many attempts it has finally taken off.

The stunning $14bn merger between Brickworks and Soul Patts formalises the marriage of one of the ASX’s most enduring couples. The combination or unwinding of the cross shareholding arrangement has been tried many times before, both internally and through a string of outside agitators, but could never pass the tax hurdles. If it moves ahead it is expected to trigger a further shake-out among Australia’s fund managers, with Perpetual also a big part of Soul Patts history and potentially its future.

Both chaired by Rob Millner, Brickworks and Soul Patts seemed destined to be locked in an embrace forever. Soul Patts holds a 43 per cent stake in Brickworks and Brickworks in turn holds 26 per cent of Soul Patts.

The cross deal between both companies was struck in 1969 as a defensive measure to ward off against stockmarket raiders looking to build empires. At the time the cross shareholding was pretty standard practice across Australian business, but eventually fell out of favour given the large amount of capital it tied up. But the longer both companies held on, the harder it became to unwind, given the potential for a massive tax liability.

When they started out both companies were evenly matched but Soul Patts soon outpaced its partner, helped by its own bets in coal mining through New Hope and telcos via TPG. In more recent years it has been expanding in private credit.

Ultimately Brickworks’ holding in Soul Patts had delivered outpaced growth, and it now represents more than half the $4.2bn value of the brick maker.

Brickworks had been pushing growth through its own vast holdings of property, where it was becoming a developer of commercial property in its own right. There’s also opportunity for it to expand its US building products business with the backing of Soul Patts.

Soul Patts’ own efforts to expand through a string of acquisitions including fund manager Milton, prompted dusting off Project Hawk, as it was codenamed. Brickworks had been trading below fair value for some time, which also prompted Soul Patts to move. The bid has been structured so Brickworks shareholders get a 10 per cent premium for their holdings.

“After 56 years of courtship, we decided the time was right to come together,” Soul Patts chief executive Todd Barlow tells The Australian.

“There are periods in time when the planets align, and we can generate an outcome that’s positive for both sets of shareholders.”

Barlow will be CEO of the new entity while Brickworks CEO Mark Ellenor, who only last year took charge from long-serving boss Lindsay Partridge, will run the building products business in the new entity.

The planets aligned for the merger, said Todd Barlow. Picture: John Feder

The problem was the cross-shareholding between the two seemed more impenetrable as time went on. The reason being the huge capital gains tax liability the unwinding would have triggered for both shareholders, but Brickworks investors were particularly vulnerable.

The way to get around the problem of the tax leakage needed a novel solution. This involved the creation of TopCo, a new entity that acquires both companies through a tax neutral share-based merger, allowing it to proceed by way of a scheme of arrangement and a separate shareholder vote.

A merger turns it into a top 40 ASX company, bigger than the likes of Qantas. It also makes it a cleaner investment proposition for big funds. (Some have been cool on the idea of lazy capital being locked away on a defensive play).

It also puts the prospect of another run at Perpetual in play. Soul Patts made a $3bn approach for the blue chip fund manager two years ago that was rejected. The fund manager is seen to remain a live target and Soul Patts has a cornerstone stake.

Barlow describes the structure of the merger as “mechanically compliant” on tax issues and is confident the tax office will give the proposal its blessing. This needs to be finalised and until then this remains a key risk.

TopCo needed its own balance sheet strength, and it was here Soul Patts’ stockbroker Angus Aitken of Aitken Mount Capital Partners spent the weekend testing big investors for support. He underwrote the entire $550m but didn’t have to work too hard at it. All of the funds were committed at a nil premium, with investors essentially willing to back a company that didn’t exist for a deal that still needs to be done.

Ironically it was Perpetual, one of the biggest agitators of unwinding the crossholding, that was one of the biggest supporters for the raising. Perpetual launched an unsuccessful legal bid to unwind the structure some 15 years ago, but even then the crossholding held like an iron grip.

The lesson here is Aitken’s boutique firm Aitken Mount Capital Partners ran rings around a long line of Wall Street investment banks who had been pitching to unwind the two over the decades, but could never find a way to make it work.

Barlow has been with the company for more than 20 years and for every one of those years the unwinding has been examined.

“Obviously there’s been periods where there’s been heightened level of attention around it. And so we’re always trying to think about the best way to do it. We took our time with it, and our patience was rewarded.”

Barlow too was quick to defend the cross-shareholding, saying it helped cultivate a long-term mindset across both companies.

“It enabled us to take long-term strategic decisions without worrying about short termism. And I’d like to think that without the cross shareholding, Brickworks rather than have an industrial property portfolio, that they might have succumbed to selling off surplus assets. And equally, on Soul Patts side, we’ve been able to make some sensible long-term decisions.

“That culture of long-term decision making and not giving in to short termism that’s prevalent in the markets is so embedded in our culture now that I think that the we no longer need the cross shareholding to continue that.”

The structure of the new entity is important with Soul Patts investors they will own 72 per cent, Brickworks 19 per cent and the new shareholders in TopCo hold the balance.

Under the merger Brickworks will be effectively carved up with the building products and brick business sitting under Soul Patts’ private equity arm and delivers Barlow a substantially bulked-up property investments book. Soul Patts trophy investments in New Hope and stake in TPG started out as private equity investments.

The new entity really sees the creation of the ASX’s newest conglomerate. To be eventually named Soul Patts, it will be largely a diversified investment house ranging from funds management, property to brick making. And like any conglomerate, this will be the challenge in making the sum of the parts work without running a discount.

Collapsing the cross shareholding deal is poised to release $1bn in shareholder capital, and importantly it puts to work funds otherwise locked away forever. For investors that’s what counts. Already Soul Patts has seen its shares surge more than 16 per cent. Brickworks meanwhile has rocketed 27 per cent on just a 10 per cent premium. That’s the $1bn in value and more that’s been long overdue for takeoff.