Shoeshine: A dangerous game

By Shoeshine

Friday 4th October 2002

Judging by the fuss made in some quarters about even the possibility of electricity lines outfit Vector floating a minority stake, its spin doctors have a lot of work to do before next June 15.

That's the date on which Vector starts paying an additional 1.5 percentage points of interest on its capital bonds, taking the coupon rate to 9.75%.

The howls of outrage from the public ownership lobby are a little hard to understand. Any float will be limited to 24.9%, leaving the Auckland Energy Consumer Trust with 75.1%, enough to carry special resolutions.

There's no reason that a float of that amount would make it any more, or less, likely Vector will eventually fall into private hands. If the trust was hell-bent on privatisation it could arguably more easily sell 100% than 75%.

At board level the float decision will be driven by the markets.

With the interest rate top-up the company has as good as admitted its gearing will be too high after buying United Networks (UNL), even if the sales to Powerco and Hawke's Bay Network go ahead. That's if there's no float.

Rating agency Standard & Poor's has acknowledged this too. It says the recent downgrade to BBB plus will probably stay if the asset sales go through or fall another notch but remain at investment grade if they don't.

But Vector won't be desperate. Provided it gets 100% of UNL it will have torrents of cashflow with which to pay off bank debt.

The size of any float will be determined by what value the markets place on Vector's equity next June. The directors will want to float into a strong market. The trade-off for waiting for better times if need be is the extra 1.5%, or $5.2 million a year pre-tax, not a heavy burden.

From bond investors' point of view the top-up is a bit curious.

The higher coupon is there to reflect Vector's higher risk profile if there's no float. But that profile will also apply until the decision is made. What's compensating bondholders in the meantime?

According to the company it's the possibility of a preferential allocation of Vector shares, at a 2.5% discount to the issue price.

This isn't very convincing. For one thing, not all the investors who buy the bonds will necessarily be interested in owning Vector shares. And even if they are, the issue price may not be attractive to them even at a slight discount.

One issue Vector will want sorted out well before then is the UNL Shareholders Society's 10.7% holding, a stake that can block Vector from reaching 100% and going to compulsory acquisition.

The shares vest with the Waitakere City, North Shore City and Rodney District councils in July 2004, about a year after the float decision.

Vector professes itself unbothered if it doesn't reach 100%. But if it doesn't it won't be able to access UNL's cashflows to service its debt and will be reliant on dividends which, admittedly, it will set itself.

On the face of it this gives the councils leverage to extract a higher price for their shares than the $9.90 Vector is offering. But that game is complicated and dangerous.

The likelihood if they hold out until Vector's current offer closes is that the shares will fall steeply in value. A few speculators are bound to come along for the ride but the stock may not be traded or even quoted and would face delisting if it didn't meet spread rules.

Vector might then be prepared to make a clean-up offer at a higher price. But with fresh equity aboard it wouldn't be in any hurry and would more likely want the holdouts to cool their heels, at least until the July 2004 vesting date.

At that point the councils will get UNL shares pro rata according to the size of their local body electoral roles.

Going on the 2001 census population data North Shore would get 4.6%, Waitakere 4.2% and Rodney 1.8%.

This is where life could get interesting for an entrepreneur with the money, time and balls to tag along with the councils. Vector would probably pursue a divide and conquer strategy.

Under the Takeovers Code's creep provisions it could bid for a further 2.5% of UNL's shares. If the councils were the only holdouts, and if any one of them accepted, that would be enough to take it from 89.3% over the 90% compulsory acquisition threshold.

If it bid under a code offer that is, if it offered all the minorities the same price it would have to get acceptance for at least 50% of the outstanding shares for the price to be binding for compulsory acquisition. If it didn't get 50%, or if its offer was non-code, then the Takeovers Panel would appoint an independent adviser to give a binding "fair and reasonable" price.

A further complication is the $390 million UNL share buyback Vector has determined will take place when it gets into the driving seat if it doesn't get 100%. (This was "disclosed" on page 48 of the bonds prospectus.)

This will furnish it (at 70.2%) with $274 million of UNL cash, further strengthening its own balance sheet to the detriment of UNL's. It would also lift the percentage shareholding of anyone who didn't participate.

All this of course assumes the councils won't simply take the bird in the hand and accept Vector's current offer. Given how hard Vector and ABN Amro have made the holdout option this would be eminently sensible.

It doesn't in any case make much sense to have an investment in the shares of a single company, as Auckland City has recognised with the proposed sale of its Auckland Airport stake.

But that's mere financial reality. Politicians play on a far grander stage.

Comments from our readers

No comments yet