The Investment Column: A dairy deal worth co-operating with

With more than 40 dairy companies in Ireland and literally hundreds in the UK, it is scarcely surprising that analysts have been expecting consolidation in this fragmented industry for some time. Yesterday's proposed merger between Avonmore Foods and Waterford Foods will create an Irish giant to rival Unigate and Northern Foods and could well spark a wave of further merger and takeover activity. The industry has long been afflicted by over-capacity and pressure on prices exerted by the large supermarket groups.

For the two companies concerned, a merger has been a long time coming. Avonmore, the larger of the two, first proposed a deal in 1991 but found its terms rejected. Another approach was made last month valuing Waterford at Irpounds 281m but that offer was turned down too.

Now the boards have agreed a Irpounds 377m deal though it still faces a serious hurdle. The merger needs to be approved by 75 per cent-majority of the Waterford Co-op, which controls 68 per cent of its shares, and by a similar majority of the Avonmore Co-op members, who also own over 60 per cent of the company.

But the benefits of this deal are clear enough. Brought together, Avonmore Waterford will have sales of some Irpounds 2.5bn. It would be the UK's fourth- largest producer of liquid milk and have 20 per cent of the UK cheese market. There should be significant synergy, with analysts talking about potential cost-cutting of Irpounds 20m.

Shareholders in Waterford Foods ought to be delighted with this offer. The shares have been a poor investment and collapsed in March following a profits warning caused by delays in the company's rationalisation of its Irish milk business. Days later it announced it has also breached its bank covenants. From their March low of 73p, the shares have been rising following Avonmore's initial approach. But the proposed 142p per share offer still represents a 78 per cent premium to their 110p close last Friday.

For investors in Avonmore the picture is not so clear cut. Avonmore, which also has businesses in food ingredients, meat products, and animal foodstuffs, has been performing strongly of late with its shares rising from doubling since the start of last year. But investors should benefit from the economies of scale. And with analysts forecasting Waterford profits of around pounds 25m this year, the deal means Avonmore is paying a forward multiple of less than 12 times earnings for Waterford, which seems justified given the potential cost-savings.

The Co-op farmers have turned their back on deals like these before, but with the industry becoming ever more competitive this one should be accepted.

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