Saturday, April 01, 2006

Brian Gaynor: Merger process neglects shareholders

The proposed Waste Management/Transpacific Industries deal raises a number of important questions about the decision-making of our company directors, particularly as it comes hot on the heels of the Contact Energy/Origin Energy merger announcement.

The Waste Management story began at 9.48am on Monday when the company told the NZX it had agreed to merge with Brisbane-based Transpacific, subject to shareholder approval. Waste Management shareholders will receive $8.642 a share, representing the agreed price of $8.80 less the 15.8c dividend paid on Thursday.

The term merger was used 13 times in the NZX release, yet it is not a merger in normal conventional terms, such as with the proposed Contact/Origin deal in which all shareholders will continue to have an economic interest and the two shareholder bodies have to approve the deal.

The merger structure being used by Waste Management and Transpacific means that Transpacific will require only 75 per cent approval at a Waste Management shareholders meeting to gain full control, whereas under the Takeover Code it would have to receive 90 per cent acceptance to achieve the same goal.

As the 75 per cent approval threshold only applies to shareholders who vote, the actual threshold level will be well below 75 per cent.

There are three main ways that an acquirer can gain control of a target company.

* Through a takeover offer under the Takeovers Code.

* Through a scheme of arrangement under Part XV of the Companies Act 1993.

* Through an amalgamation under Part XIII of the Companies Act 1993.

A takeover offer is clearly the best process as far as the target company shareholders are concerned because the bidder can only move to compulsory acquisition once it reaches 90 per cent. It also allows some shareholders to accept and others to hold on to their shares.

It is easier to block a takeover offer under the code, as a spoiler only has to purchase 10.1 per cent to achieve this aim.

Under a scheme of arrangement, a transaction has to be approved by shareholders at a special meeting. This arrangement also has to be approved by the High Court and any dissenting shareholder has the right to appear before the court.

Schemes of arrangements are complicated because they can require a special resolution, which requires a 75 per cent majority when related parties can vote, plus an ordinary resolution, which requires a 50 per cent majority but related parties cannot vote.

The amalgamation provisions of the Companies Act have left a sour taste in investors' mouths because they were used in the GRD/Macraes merger in 1998. Approval is required from 75 per cent of votes cast, and at an acrimonious meeting in Dunedin, the merger was approved. However the proposal would not have been passed if GRD, which was a related party, had not voted its 35 per cent stake in favour.

The amalgamation provisions are particularly attractive to Australian companies because they don't operate under the Companies Act 1993 and don't have to hold a shareholders' meeting to approve the transaction.

This may seem like a technical issue but, in the GRD/Macraes situation, a number of institutions had shareholdings in both Macraes and GRD with a bigger stake in the former. They would have voted against the merger if GRD had been required to hold a special meeting because the terms of the agreement were seen to be extremely unfair to Macraes' minority shareholders. There was a strong possibility that GRD shareholders would have rejected the merger because there wasn't a large related party block vote that could effectively control the outcome.

Shareholders also have the right to appeal to the court against any of the provisions of an amalgamation proposal.

The Waste Management/Transpacific merger proposal got off to a dreadful start on Monday because the New Zealand company didn't hold a briefing for shareholders, analysts and the media and chairman Jim Syme was unavailable because of other director commitments.

The New Zealand company admits it made a botch of the situation as it focused on informing its employees and neglected the investment community.

The amalgamation process also annoyed a number of large shareholders because the compulsory acquisition threshold is lower and they have less chance of blocking the bid.

The two major shareholders, ING with 6.7 per cent and Fisher Funds Management with 6.2 per cent, have the ability to block the bid if there is a low voter turnout, but the important point is that they could definitely block an offer under the Takeovers Code if they wanted to.

Another aspect of the deal is that Transpacific has got around section 221(5) of the 1993 act, which requires both merging companies to have shareholder meetings, by forming a separate, fully owned New Zealand company and merging this company with Waste Management. The Australian parent owns all the shares in this new company and there is no requirement for Transpacific's public shareholders to vote on the amalgamation.

The amalgamation process is being used because Waste Management's directors believe they have negotiated a great price that reflects full control and Transpacific should be given every opportunity to reach 100 per cent.

This sounds like a reasonable argument, but this column has persistently argued that New Zealand directors are poor judges of long-term value and they consistently advise investors to sell their shares at below full value. In almost all the situations where shareholders have rejected directors' sell advice, the share price of the target company has appreciated after the bid lapsed.

The other point is that New Zealand directors don't seem to understand that most investors, particularly institutions, are portfolio investors rather than shareholders in a number of separate companies.

The objective of a large and prudent investor is to construct a portfolio of companies in diverse industries with different risk profiles. The New Zealand sharemarket won't be much use to these investors if most of our companies are taken over and there are only a few electricity, port and property groups left.

Waste Management is an important portfolio holding because it has strong defensive features, has an excellent profit record and has good growth prospects. It was ridiculous for Waste Management's chief executive director, Kim Ellis, to tell the Business Herald that investors "can go and buy a bach or invest in Transpacific or take a holiday" when most of them, particularly New Zealand-orientated retail and wholesale funds, will either have to, or want to, reinvest in NZX companies.

The problem with this is that many of the larger listed companies are trading on a higher P/E or EV/ebitda multiple than Waste Management at its takeover price. These include Pumpkin Patch, TrustPower, Ryman Healthcare, Vector, Infratil, Sky City, Sky TV, Fisher & Paykel Healthcare, Auckland International Airport, Port of Tauranga and Michael Hill International.

Our company directors don't seem to realise that portfolio investors have to look at the wider picture, including the diversification of their portfolio and the valuations of the companies they will have to reinvest the proceeds in.

On this basis, the offer for Waste Management does not look overly generous and there was no need for the company's directors to agree to an amalgamation process that reduces the rights of their shareholders.

* Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management.

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