Opinion: Local councils may be stuck with junk after Powerco debacle

By Simon Louisson of NZPA

Friday 1st October 2004

Like a lot of cock-ups, the Takeover Panel's decision on Prime Infrastructure's takeover bid of networks company Powerco started with a small miscalculation.

It's a cock-up from which lots of professional investors and broking houses will make money while public local bodies in Taranaki and Wanganui look likely to be fleeced. Read what you will into the fact that Prime is an Australian company.

Sydney-based Prime in early August won the tender to buy a 53.65% block in Powerco owned by New Plymouth District Council (NPDC), Taranaki Energy Trust and Powerco Wanganui Trust.

By agreeing to buy that stake, Prime was obliged under the Takeovers Code to make a full takeover to all shareholders on the same terms - valuing Powerco at $680 million.

Its $2.15/share offer comprised 62.5% cash and 37.5% of unsecured, unrated 8.5% perpetual bonds - known in the trade as junk bonds.

Prime then applied to the Takeovers Panel for a waiver to pay out the then just 0.3% of Powerco shareholders in cash, rather than pay the seemingly unjustified expense of having to issue prospectuses in Australia and other jurisdictions.

The panel saw no apparent harm in this and granted the waiver despite it contravening the most basic tenet of the Takeovers Code - that all shareholders be treated equally.

Before the waiver, Powerco shares had been trading 10c below Prime's bid price reflecting the risk attached to the bonds in Prime's offer.

On the face of it, Prime's offer was $1.34 in cash and 81 cents in 8.5% bonds for each Powerco share. But a fish-hook was that Prime put a 62.5% cap on the amount of cash it would pay, so if more investors are paid cash, others would have to accept more bonds.

Once the waiver was granted, clever professional investors spied an arbitrage opportunity - register shares at an overseas address and get $2.15 cash guaranteed.

What started as a trickle last Monday-week turned into a stampede this week. By today, a massive 44% of the company - a staggering 95% of the shares available excluding the council blocks - had changed hands in a matter or 10 days, nearly all shares going to overseas addresses, if not to foreign ownership.

The panel admitted there had been "unforeseen implications" from its waiver. It attempted to partially rectify the situation for shareholders owning less than $1000 of shares, forcing Prime to set up a re-sale facility to pay them cash. That affects 25% of the 20,000 shareholders.

The shareholders to suffer most from this fiasco will be the council and trusts. Their motive for selling was they reckoned they had too many assets locked up in Powerco ($365m). But ironically, they look like swapping a majority stake in a strongly growing company, for $137m and $228m of perpetual bonds that will be virtually impossible to sell at face value.

AMP Capital chief investment officer Tore Hayward believes the yield on Prime's bonds is way too low for the risk attached.

Powerco has assets of $1.7 billion and is itself 60% geared.

Given that Prime will itself be heavily geared, it is easy to see why analysts are wary. A more realistic yield would be 10% or 11%.

Unsurprisingly, NPDC and the trusts have been bemused and confused by these shenanigans. They thought they had a clear, fixed legal agreement they would get 62.5% of the $365m in cash.

New Plymouth Mayor Peter Tennent and his chief executive Rodger Kerr-Newell were adamant they had a watertight deal, having taken advice from top law firm Simpson Grierson and PriceWaterhouseCoopers.

But Takeovers Panel chairman John King ironically invoked the Takeovers Code that expressly prohibits one class of shareholder getting preference over another.

"They will be treated the same as any other investor. They have to be, otherwise they will be in breach of the law," he told NZPA.

Any agreement to the contrary would be null.

"The law is the law is the law, which says they have to be treated the same as anybody else. They will be scaled in exactly the same way as everybody will be scaled and they cannot have any side benefits."

Hello to the real world New Plymouth District Council.

It is doubtful the palliative available to others - registering its shares overseas - is available to the local authorities as they have already agreed to sell to Prime.

Others unable to mitigate are passive funds, which are not allowed to respond to news events. No doubt there will be lots of small shareholders who, for various reasons, will be caught flat-footed and lumbered with the bonds.

Prime chief executive Chris Chapman met Tennent yesterday to shore up the deal but it appeared little resulted from the meeting. Both parties have clammed up to the media. The deal is particularly embarrassing for the council with elections this month.

Tennent said following his discussion with Chapman that he remains convinced the council would get its promised cash payment.

But independent analyst and commentator Brian Gaynor said Tennent was wrong, saying there was a side letter to Prime's offer documents that clearly spelt out the council would be scaled with other shareholders.

"From what we're hearing, and certainly from the way the market is responding - because you wouldn't get the volume of shares trading if the council was going to get the deal that it once thought it was going to get - the clear implication is, I'm afraid in this particular situation, that the mayor is wrong," Gaynor told National Radio.

Prime is 13% owned by global investment bank Babcock and Brown, which is also Prime's adviser. A worrying sideshow to this fiasco is an Australian report that Babcock and Brown's success fee for the Powerco deal was $25.5m, paid by Prime. That's at least twice the going rate.

Chapman said the fee equated to 1.5% of Powerco's $1.7 billion asset value and had been approved by an independent expert engaged by Prime.

The Shareholders Association has been surprisingly muted during this controversy. Director of advocacy Ross Dylan said the massive trading had demonstrated the sharemarket's efficiency in ironing out inequalities in a differentiated offer.

"It shows the downsides of differentiating when you are making an offer, because the market might just react to it."

He commented that the panel might have considered the interests of residents rated above those of foreigners.

Of greater concern would be if local bodies end up getting special treatment or if Prime is able to vary its offer.

"When you have takeover bids that reserve powers unilaterally to the party making the bid to change the deal, that is just objectionable.

"I don't know whether you would get away with that anywhere else in the world," he said.

Gaynor said that the panel's waiver had been its first major mistake since its inception three years ago, but it was a significant one - one King vowed would not be repeated.

Gaynor said council officers could not be expected to have foreseen what has happened. He said they appeared to have been poorly advised.

There was a slim possibility the local bodies would can the deal but if they did "it's going to be a legal bunfight", Gaynor added.

As Powerco's share price fell back to $2.08 today there was market talk that Prime might vary its offer.

"Prime are in jam," said First NZ Capital broker Don Leithwaite.

"The council says they have a binding agreement, that they won't be scaled, and yet the terms that have been put out so far say that all acceptances including the council's are subject to scaling. If they have a binding agreement that they are not subject to scaling, then Prime has to make the same bid to all comers ... something's got to give."

As Gaynor says: "We haven't heard the end of this story yet."

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