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GPG: Buying a bargain or a black hole?

By Shoeshine

Friday 6th June 2003

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The irony of Tower's choice of July 4 for a shareholders' meeting to vote on the share placement to Guinness Peat Group must surely have been unintentional.

If you're American July 4 is Independence Day but that's a quality Tower's board has shown remarkably little of lately. It's an additional irony that shareholders will be asked to sell the company, for better or for worse, into GPG's control.

That, of course, may not happen. A "yes" vote will effectively require support from 75% of the non-GPG shares and rebellious rumblings have been emanating from some of Tower's institutional owners, notably AMP Henderson with a little under 5%.

And the Tower board could surely not be brazen enough to vote the 6.6% Tower itself holds.

Fronting up to the media in Wellington last week, via satellite from Sydney, chairman Olaf O'Duill faced predictable questioning over whether the board was selling control cheaply. His answers were exceedingly unconvincing.

Not too many people, he said, were willing to make out big cheques to insurance companies right now.

Maybe. But why, AMP for one wants to know, could Tower not have raised the same amount from its existing shareholders through a pro rata rights issue, without a big placement to GPG first?

Tower's answer to this appears to lie in the necessity to raise capital quickly ­ the company has to repay A$100 million to its bankers in August.

GPG was simply first up and best dressed, Tower argued. There had been "approaches from the investment banking community" but no bank had been able to present a plan to raise the money in time and at the right price.

These arguments are so laughably thin they insult shareholders' intelligence.

Tower is a financial institution, for heaven's sake. It has an investment-grade credit rating from Standard & Poor's. It is, as it has assured its financial intermediary network, "an operationally profitable and sound New Zealand company."

Banks are scarcely inundated with credit demand these days. Tower could surely simply have rolled the debt over ­ unless its bankers are a great deal more spooked than the company is letting on.

As for a pro rata rights issue, any investment bank with sufficient capacity would have fallen over itself to underwrite it ­ at "the right price," of course.

A third option would have been non-core asset sales. Tower Insurance, for instance, has a carrying value of $103 million but could raise a lot more. Shoeshine hears AMI was close to buying it only last year.

That question ­ what the company's bits are worth versus what they're carried at in Tower's balance sheet ­ is, from the shareholders' point of view, arguably the most contentious aspect of its current troubles. That's because shareholders are concerned with the price of Tower's equity and whether GPG is buying in at a price that's fair to the rest of them.

It's of little interest to its banks, which are interested only in whether the cashflows generated from those operations will be sufficient to service the debt Tower owes them.

The ever-shifting goalposts of accounting standards are, as ever, of very little help here.

The vast bulk of last week's $200 million of write-offs was due to a change of accounting policy dictated by Tower's new auditor, PricewaterhouseCoopers (PWC).

Shoeshine has no argument with PWC's authority. But the change sheds an interesting light on Tower's previous practice, its previous auditor, Deloitte, and the board's competency.

The rules Tower used up until now to account for the value of its subsidiaries have been in place since the company demutualised and listed four years ago. For all this time it presumably had the backing of the board, Deloitte's and the chief financial officer, now the chief executive, Keith Taylor.

Of course, a lot has changed since 1999, most spectacularly, the demise of Enron and a host of other US corporates amid a wave of "accounting scandals." None of the Final Four big accountancy firms wants to go the same way as Arthur Andersen, so auditors have been getting very tough with companies where they previously were prepared to adopt something of a laissez-faire approach.

This mostly manifests itself when the auditor changes as Tower's did only a few weeks ago. O'Duill has been at pains to give the impression Tower was under no pressure from PWC and that the change responsible for the lion's share of last week's $190 million of write-offs was entirely a board decision taken to be "prudent and conservative."

Anybody swallowing that version of events, and Shoeshine isn't one of them, will have to ask themselves this question: why didn't the 1999-2002 board, some of whose members are still serving, have prudent and conservative accounting policies? Did Tower mislead the market about the true value of its assets for all that time?

Views around the market of Tower's net tangible asset backing vary enormously. Some brokers put it at $3 a share, in which case GPG has got itself a true bargain, paying only half that much for its placement. Tower itself has a figure of $531 million or $3.20 a share, being the carrying value of its various subsidiaries less head office and eliminations, and corporate debt of $420 million.

Others think the figure is very much less and may even be close to zero.

One analysis just before the latest result put NTA at $63 million or 36c a share. That's derived by subtracting from shareholders' funds of $767 million the "directors' excess market value over the book value of assets" of $634 million, goodwill of $4 million, net deferred tax of $62 million and capitalised acquisition costs of $66 million, leaving just $1 million. Added back is a $62 million deferred tax benefit.

Who cares? GPG certainly does. If the analysts are right and even the heavily written-down values Tower's carrying its Australian assets at are still too high, more hefty writedowns can be expected, eating away the equity GPG and subscribers to the rights issue are about to pump in.

So the corporate raider can be expected to act quickly and ruthlessly as soon as it has its shoes under the desk.

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