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Apr 30, 1996

Thomson Goes West

Only time will tell whether Thomson Corp paid too much for West Publishing

Oh, to be in Canada now that spring is here - or any time of the year for that matter. In Canada, life is almost always springtime for investor relations officials, at least those who work for Canada's giant companies.

Many of these companies are owned primarily by Canada's big institutional investors and the relationship between the owners and the owned tends to be clubby. Unlike in the US, Canadian institutional investors generally take a long-term view; and they are not usually terribly demanding. As a result, the stock prices of large Canadian companies tend to remain relatively stable and their directors docile. Translation: compared with the US, life is mellow for Canadian IR professionals.

The differences between the challenges faced by US and Canadian IR professionals became especially apparent in late February when it was announced that Thomson Corp, the Canadian publishing behemoth, would pay $3.45 bn to acquire West Publishing Company of Minnesota. West, based in Eagan, a suburb of St Paul, is a large publisher of legal information.

Just about everyone agreed that the price was high - even Thomson itself. Of course Thomson argued that although the price was high, West was worth every penny. 'We don't believe that you can buy a good business too cheaply,' says Nigel Harrison, Thomson's chief financial officer, who also runs its IR function.

Others disagreed. Two Canadian credit-rating agencies - Dominion Bond Rating Service and Canadian Bond Rating Service, for example - downgraded Thomson as a result of the move. And initially, at least before Harrison got into the swing, the stock dropped to C$19.25, from C$20.125. But it quickly bounded back - topping the pre-announcement price. By the end of the first week of March, the share price more than recovered to C$20.625.

The strength of the stock was undoubtedly a coup for Harrison. Working quickly, he called a meeting immediately following the announcement to explain the deal to investors and sell-side analysts. About 40 people showed up in person at the Toronto meeting, with a further 100 or so linked to the meeting by teleconference.

Harrison also spoke extensively with the press. 'We spent quite a lot of time speaking with reporters and our own people, trying to be sure that they understood the strategic value of the acquisition. We wanted them to stick with us. I think they gave us a good hearing.'

And so they did. The quick recovery of the stock price indicated that Harrison succeeded in assuaging the fears of the market and, most importantly, the fears of Thomson's institutional shareholders.

The initial drop in the stock price 'didn't surprise me because the size of the deal was higher than the markets were expecting,' says Harrison. He also attributed the drop to the fact that investors 'didn't know the quality of West' which was a function of it not being publicly traded. 'As the people digested the presentation that we made on Monday, and saw the pretty positive impact the acquisition would have on our financials, the share price began to reflect that.'

No question about it, Harrison did a good job. But the task wasn't as difficult as it might have been. About 70 per cent of Thomson's shares are held by the Thomson family, and much of the rest is in the hands of big Canadian institutional investors. 'With 70 per cent owned by the Thomsons, it's not like we're in danger of being taken over,' Harrison concedes. 'So as a public company, perhaps we have less to worry about than some other corporations.'

Ownership of Canada's biggest companies by the country's largest institutional investors is a 'characteristic' of the Canadian market, Harrison says. 'I do think the Canadians, and God bless them for this, are far less focused on quarterly earnings' than US investors. 'I think the US market is nuts,' he says, which is one reason why Thomson's shares are not listed on the New York Stock Exchange. The company's main listing is on the Toronto Stock Exchange, but it is also listed in Montreal and London.

Whether Thomson overpaid for West depends, as ever, on one's predictions of the future. But most seem to agree that the two companies are a very good strategic fit.

Thomson is already a big publisher of legal material but its products focus on the so-called secondary market, providing analysis of existing laws and statutes. West, on the other hand, concentrates mainly on primary material, basically statutes and court cases. The fastest-growing part of its business, and probably the element that Thomson finds the most attractive, is its Westlaw online data service. Westlaw and West's CD-Rom businesses account for 54 per cent of its revenues, and that proportion is growing.

The debate over this deal focuses on the amount paid, and whether it was worth it. For one thing, it will reduce Thomson's per share earnings by about 5 per cent this year, but Harrison says that the acquisition will be accretive after that time.

Thomson paid more than four times West's annual sales of $825 mn, far higher than the two-to-three-times ratio recently paid for similar companies. The price was estimated by some analysts as 17 times West's pre-tax operating profits of $200 mn in the fiscal year ended last July. The typical ratio for specialised publishers has been ten-to-twelve times operating profits.

Particularly worrying to the credit-raters is the impact the deal will have on Thomson's balance sheet. The company plans to raise the money needed for the deal from a group of nine banks, which will increase its debt to $5.6 bn - or more than twice its $2.5 bn in equity.

Even taking into account Thomson's $1 bn in cash on hand, the net $4 bn in debt is far more than the one-to-one debt/equity ratio with which the market feels comfortable. Ben Dube, an analyst with Credifinance Securities in Montreal, thinks that Thomson will act to reduce its debt, although he notes that Harrison has indicated that the company does not plan to sell more equity. Dube says he suspects Thomson will sell its UK travel group. 'What's the strategy to be in travel when you're in newspapers and electronic publishing?' he asks. He points out that Thomson raised $1 bn last year by selling 25 newspapers in the US and 21 in Canada, as well as its British newspaper operations.

Thomson is in the habit of restructuring itself and its purchase of West Publishing and its sale of the newspapers indicates that the group is beginning to focus heavily on electronic rather than print delivery of information. Some years ago, Thomson was in the oil business. Then it moved into publishing and travel, with no hint any longer that it had been a big player in energy.

Its purchase of West represents its biggest acquisition ever. West Publishing has been extremely successful, regularly chalking up a 25 per cent profit margin. It has also been extremely conservative financially, with no debt and $100 mn in cash.

In recent years, however, West has made a number of acquisitions to stay competitive. It bought several companies, including ones that give it additional horsepower on the electronic publishing side. Apparently, it concluded that it would have to keep making acquisitions to match the growth and strength of its competitors.

As a result, chairman and CEO Dwight D Opperman announced last August that West would have to take a hard look at its options. 'We said we would sell it, merge it, go public or do nothing,' says spokeswoman Ruth Stanoch. Obviously the 72-year-old Opperman did not have the stomach to see West go deeply into debt, so in the end he sold it at a very handsome price.

It is estimated that Opperman holds about a third of West's stock, which means the sale would put more than $1 bn in cash in his pocket. Opperman's son, Vance, is West's president, and is believed also to hold a large amount of stock in the company. West has about 200 stockholders, many of whom are employees of the company. Anyone who has a 1 per cent stake stands to receive just over $34 mn.

Throughout the process, Opperman took pains to reassure employees and to keep morale high. West Publishing, with 6,700 employees, is one of the biggest employers - possibly the biggest - in Eagan. 'People don't leave West, they come here and they stay for their entire careers,' says Stanoch. 'It's a family type atmosphere. We wanted to be sure people had the information and were comfortable with it.'

Thomson appears to be furthering that policy. Opperman says that when the deal closes, each full-time West employee will receive a bonus ranging from $5,000 to $25,000, depending on years of service. And Thomson officials told the local press that, while poring over West's books, 'one of their most surprising discoveries' was that a recent 300,000-square-foot addition to the Eagan headquarters was largely unoccupied. Thomson, they said, would move workers from its other publishing ventures to Eagan.

The question now is whether Thomson will be able to sustain West's profitability. And that, of course, is the question Thomson's investors still must ask.

Again, being in Canada helps. 'Canadian investors are different from US investors, it's a different mentality and a different country,' says analyst Dube. 'Canadians are long-term investors; in the US, people like to trade a lot.'