SATS is aiming to acquire Singapore Food Industries (SFI) via the initial purchase of 69.7% from TemasekHoldings at $0.93 a share in cash, conditional upon minority shareholders’ approval for a mandatorygeneral offer. The purchase will cost some $334m initially with a 100% acquisition costing $509m to befinanced entirely from net cash reserves of $528m. The EGM is expected by end-Jan 2009 with public offerin Feb.

SATS believes the acquisition will speed up its expansion into food services, particularly non-aviation, andoverseas markets. SFI fits that bill. It caters to 100% non-aviation markets with the Singapore armed forcesa substantial customer. Further, overseas markets accounted for 65% of sales in FY07. SFI is alsoexpected to be EPS-accretive immediately. According to SATS, it is acquiring SFI at 7.4x FY07EV/EBITDA vs a peer average of 9.2x and median of 8.0x.

While SFI may be an attractive long term addition, we are concerned about the higher risks of the non-aviation food services business in the short term, particularly since PBT margins (6.4%) for its fooddistribution and manufacturing businesses are much lower than SATS’s own group average of 26%.Currency volatility will also start to feature to a much larger extent, given SFI’s substantial exposure to theUK.

We are also concerned that SATS is not leaving any reserve for a second shot by using up all of itssubstantial net cash, which had previously been a cornerstone of its dividend policy. SATS may not be ableto maintain its historical 70-80% payout ratio without increasing debt. As it is, it will move from a net cashposition to a small net debt position with the acquisition.

We are putting our recommendation, forecasts and fair value under review pending an update with SATS’smanagement. Of particular interest would be the reliability of SFI’s earnings viz its governmental contractsand the extent that its overseas losses have or could be curtailed (eg Shanghai, Australia fishingoperations and Cresset, the chilled ready meal subsidiary in Ireland).