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Opinion: Local investors wants heads over Contact

By Simon Louisson of NZPA

Friday 30th June 2006

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The abandonment this week of the proposed merger of Contact Energy and its 51% owner, Origin Energy of Australia, surprised few investors.

Still it sent Contact shares down 4.5% to $7.17. The issue raised fundamental issues about the role of independent directors, the adequacy of the Takeovers Code and the future direction of Contact.

Institutional investors never saw merit in the deal for New Zealand investors and it was they who effectively scuttled it.

Emboldened by that victory, they demanded deputy chairman Phil Pryke and fellow independent directors Tim Saunders and John Milne resign.

These three came out in support of the plan when it was announced on February 20. The merger would have given Contact's minority shareholders 24.3% of the $8.5 billion vertically integrated entity, while institutions argued they should have 29%.

What vexed institutions was these three had also supported a $4.25 per share takeover bid by Contact's former owner Edison Mission in 2001, despite that offer being at the bottom, or below, independent valuations.

Subsequent share price rises showed the institutions were right and Pryke and co were wrong.

Tyndall Investment Management's Rickey Ward said he believed Pryke, chairman of the independent directors, should now step aside.

"He has lost the respect of the investment community. He's made a number of recommendations in the past that have proven to be inappropriate. Yet again, here is another recommendation which has failed."

But Pryke said none of the independents had any intention of doing so. Indeed, he was happy to take some credit for Contact's "stellar" performance since its listing in 1995.

Origin chief executive Grant King, who also chairs Contact, said because of the way the deal was structured, Origin's board had to know if the Contact board supported the deal before it was disclosed and a formal independent appraisal was published.

Pryke received advice from merchant bankers Cameron & Co and said he did not need to await First NZ Capital's independent appraisal.

"It is the job of the directors to take a view of what is in the best interests of the company," he said.

"I don't think independent directors should hide behind anybody else's view."

However, fund manager John Southworth of the New Plymouth District Council believes it is uncommon for independent directors to express their views ahead of an independent appraisal.

Southworth believes the independents' main obligation is to protect minority interests - "therefore they should hold off until an independent report was published".

"The whole issue here is the nature of an independent director," he said.

That Pryke had the confidence of King and Origin was irrelevant. What bemused analysts was Pryke's refusal to release either the Cameron & Co advice, or the draft independent appraisal.

All he would say was that the draft report had no influence on the decision to abandon the merger.

Tyndall's Ward said it was strange the proposed deal had been abandoned before the report was even published.

"Most people wait for that to occur and then form a view afterwards and that hasn't happened in this case.

"That draft copy could only have highlighted the fact that Contact's worth potentially more than what the deal was offered," Ward said.

The sceptic's view was they didn't want the public to see the report "and that unfortunately is the way that I can but ... look at it".

Pryke argued institutions were barely influenced in their valuations by the independent report. He also criticised the level of long-term strategic analysis undertaken.

However, BT's Paul Richardson said investors were never given enough information to make a decision. Investors needed to know what Origin would bring to the mix and it needed to pay a premium for full control.

Because the companies opted for a merger rather than a takeover, Origin only required 75% shareholder support, rather than 90% required had it made a takeover. They originally wanted to proceed without giving shareholders a choice.

In an editorial calling for Pryke and co to resign, The New Zealand Herald yesterday (Thursday) said that "unsavoury course" was foiled in May when the Takeovers Panel refused to grant the directors a waiver on shareholders' rights. Contact's 94,000 shareholders had previously rejected two takeover bids.

The newspaper later "unreservedly" withdrew the words, saying the comments were based on a misunderstanding of the exemptions sought from the Takeovers Panel.

The rational for the merger was that Contact is running out of gas to power its generators. Origin had surplus gas both here and in Australia and a merger would both align its interests with Contact's and reduce save Contact from having to indulge itself in the risky business of exploration.

However, local analysts believe that while the benefits for Origin shareholders were clear - it would get access to Contact's strong cashflows and customer base - Contact shareholders would be stuck with a riskier company exposed to high risk exploration and the vagaries of the oil market.

The fact that Origin on Thursday decided to proceed with its partners in a $1 billion investment in the Kupe gas field in Taranaki shows the merger collapse has not stopped it investing here.

Pryke said Contact would now have to review its dividend and investment policy and capital structure over the next couple of months.

Moving "upstream" to secure energy would take time, skill and hundreds of millions of dollars.

But institutions were sceptical of this as well, noting that Shell and others had energy assets for sale, so a complete operation could be bolted on, and if dividends were cut, the cash would not evaporate.

Fund manager John Norling of Alliance Capital believes Origin, having shown its hand, will eventually make another tilt. He doubts the status quo will remain for long, otherwise Origin itself could become the target of a predatory attack.

"They will either want to gain control, or get out, and they were not interested in getting out."

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