SHAREHOLDERS in Kingspan Group, a Cavan based building materials company, will be asked to make a momentous decision at the long awaited extraordinary general meeting tomorrow.
The agenda calls for the approval of three acquisitions. The first two (S & D Group and the bulk containers business of Armet), are straight forward. The third (Thermal Product Developments) is by far the most important. Indeed, the sanction of this acquisition will result in the four Kingspan executive directors - Mr Eugene Murtagh, Mr Brendan Murtagh, Mr Eoin McCarthy and Mr Dermot Mulvihill - receiving one of the highest ever payouts by an Irish company.
That payment will amount to £4.3 million tax free between them, over a four year period. And relative to the size of the company, it will be a record payment.
The proposed payment is in lieu of the directors' patent rights to certain Kingspan products. It follows the non disclosure of the royalty payments which was robustly criticised. The 1994 annual report, for example, contained an assurance, under the heading of material contracts, that "there had not been any contract or arrangement with the company or any subsidiary in which a director of the company was materially interested". Yet the four directors received a royalty payment of £1 million between them in 1994. This loomed large when compared with the group's pre tax profit of £4.7 million and dividend payments of £0.8 million.
So how has Kingspan arrived at the proposed payment figure of £4.3 million? The takeover document, circulated to shareholders, for consideration at tomorrow's meeting, indicates that the royalty payments to the directors have a 13 year life. The document, however, does not produce any accounts for Thermal. Neither does it contain a copy of the valuation carried out by accountants, Cooney Carey. However, this valuation can he viewed, by the shareholders, on request, and will be available for inspection at the meeting.
The accountants used two methods, a multiple of earnings and discounted cash flow, to value Thermal. They used a price earnings ratio of 10, on maintainable weighted earnings calculated at £0.87 million per annum, and arrived at a value of £8.7 million. As the entitlement to royalties has a finite life (13 years), this method unduly inflates the value.
In contrast, discounted cash flow takes full recognition of the life of the royalties. Using a discount factor of 10 per cent was fair enough (to the outside Kingspan shareholders), considering the low underlying rate of inflation. The valuation on this basis came to £7.4 million.
Despite these valuations, the accountants recommended a consideration of £4.3 million. While no explanation for this lower figure is given, it is clear that the independent nonexecutive directors of Kingspan - Mr Kevin O'Connell, Mr Danny Kitchen and Mr Rory O'Hanlon - who had set up a committee to examine the issues of executive remuneration, would not have recommended a much higher figure than £4.3 million.
Indeed, in issues like this, directors who have benefited, often waive their entitlements. This happens when they have received substantial benefits in the past.
The four directors receive the royalties as they own Thermal. Under this arrangement, they have already received £2.4 million tax free. This will rise to £6.7 million, or a whopping £12.9 million gross, if the Thermal deal is sanction by the shareholders.
The proposed payout of £4.3 million is particularly large when compared with the size of Kingspan which has a market valuation of just £66 million. It represents a four times multiple of the directors maximum entitlement of £1.1 million per annum under the royalty agreement. And, significantly, that payment is 1.4 times greater than the total dividends paid to the Kingspan shareholders last year.
However, the Kingspan board is now proposing an end to what was an untenable situation. Untenable because the directors were getting royalties on the patents to certain Kingspan products, and there was something incestuous about that. Also, with royalties exceeding the dividend payments, the structure was lopsided.
On strictly financial criteria, the proposed payment of £4.3 million is not high. But as the executive directors have been, and will continue to be the main beneficiaries, it is a very full price. The deal will he earnings neutral until the £4.3 million has been paid but thereafter will be earnings enhancing which should benefit both the outside shareholders and the four executive directors who own 54 per cent of the equity.
