Saturday, May 6, 2017

Brian Gaynor: No reason to go back to the bad old days


Rodney Hide, the former MP and leader of the Act party, says “we need the wild west back in New Zealand’s capital markets”.

He believes the wild west NZ sharemarket of the 1980s was not “a bad thing. It wasn’t. It was a time of the greatest and best transformation of business and organisation in the country’s history. It was possible then. It’s not now.”

Hide took a big swipe at the Takeovers Panel and Takeovers Code in his April 13 National Business Review column: “We especially need more aggressive and hostile takeovers.

Nothing spurs entrepreneurship and innovation like competition. And the Takeovers Panel and Code knock competition on the head”.

He believes “there are managers and directors of large companies not doing their jobs but protected by the crazy restrictions on takeovers”.

Hide is incorrect, there were no restrictions on takeovers in the 1980s and there are none today.

However, we now have rules that protect minority shareholders and make it harder for controlling shareholders to plunder companies at the expense of other shareholders.

The Business Roundtable opposed the introduction of a Takeovers Code but Kirin’s 1998 purchase of 45 per cent of Lion Nathan, where the late Sir Douglas Myers and his fellow directors jumped to the top of the queue to accept ahead of other shareholders, was a major catalyst for the introduction of takeover rules three years later.

Ironically, Myers had been chairman of the Business Roundtable from 1990 to 1997.

A look back at the wild west days shows there were a huge number of scandals regarding the change of control of listed companies.

Readers will be spared this depressing exercise but the story of London Pacific illustrates why takeover rules are important to protect investors’ interests and the sharemarket’s integrity.

The company, originally called Teltherm Industries, listed on the NZX in 1976. It had a number of diversified activities including importing, manufacturing and distributing audio and electrical equipment, business machines and car and television aerials.

In March 1983, Equiticorp acquired a majority interest and in October 1984 Teltherm changed its name to JEDI Corporation. Two years later its major assets, which were controlling interests in A.M. Bisley & Co and the seed company Yates Corporation, were sold to Equiticorp. As a consequence, JEDI Corporation was a listed shell company with $33 million of cash and no debt.

In 1986 the company changed its name to London Pacific and in December 1988 announced that Equiticorp had transferred its 69.5 per cent stake to Singapore and Malaysian interests.
The purchase price, which was not revealed at the time, was $23.3m or 22 cents a share. This compared with London Pacific’s cash asset backing of 22c a share and a market price between 9c and 11c a share in the weeks preceding the transaction.

The company’s share price high was 77c in 1985, after adjusting for a 10 for one share split.

Under current takeover rules the Singapore and Malaysian purchasers would have to make an offer to all London Pacific shareholders but there was no requirement to do this before the introduction of the Takeovers Code in mid-2001.

London Pacific, which had $33.4m of cash at the time of the Equiticorp share sale, said it had acquired timber interests in Malaysia for $4.2m that were expected to generate earnings of $40m over the following five years. This earnings forecast was later increased to $60m.

A 210-page report by the Securities Commission concluded:
  • The purchase of the London Pacific shares for $23.3m from Equiticorp was paid out of the $33.4m of funds held by London Pacific.
  • The Commission could not find any evidence that London Pacific had purchased timber interests. Thus, the $60m earnings forecast was fictitious and the company announced the purchase of timber interests “to hide the ransacking of the company’s funds on or immediately following” the share sale by Equiticorp in December 1988.
In mid-1989 London Pacific announced it would acquire the Matakana Island forestry resource from Elders Resources NZFP for $36m.

The funding, which was finalised in April 1990, was through a vendor financing arrangement but when London Pacific failed to meet its first payment it was placed in receivership on October 11, 1990.

The company’s shares were worthless and it was delisted from the NZX on July 31, 1991.

The Commission’s report concluded: “This case indicates, yet again, the need for an effective takeover regime in New Zealand which will adequately protect the interest of minority shareholders.

The ability of an offer to be made for a controlling parcel of shares without the need to also provide minority shareholders with the opportunity to sell their shares on the same terms, or even to be consulted on the proposed transfer of control, is indicative of the highly deficient state of our takeover law”.

London Pacific was not an isolated case: week after week NZX listed companies were plundered by their controlling shareholders during the NZX’s infamous wild west era.

This was a major contribution to the huge fallout from the 1987 sharemarket crash and is one of the reasons why New Zealanders now have a strong bias towards residential property.
Although the introduction of a Takeovers Code has been a major step forward, shareholders have to remain vigilant as far as majority shareholders are concerned.

This is clearly the case regarding next week’s special meeting of shareholders in Future Mobility Solutions (FMS), the company formerly known as Sealegs.

In May 2010 Sealegs issued 14 million new shares at 20c to Avenport Investment Corporation, an overseas based private equity investment company. This gave Avenport a 15.0 per cent stake in the company.

Avenport’s Eric Series was appointed Sealegs’ chairman two months later. Two weeks later Sealegs announced that Avenport had purchased a further 31 million of new shares at 20c each.

This issue had to be approved by shareholders as it raised Avenport’s stake to 39.9 per cent. Under the Takeovers Code a purchaser must receive shareholder approval if it wishes to go above 20 per cent without making an offer to all shareholders.

In August 2011 Sealegs Europe was sold to Avenport for $620,000. FMS is now proposing to buy Sealegs Europe back from Avenport for $1,337,500 through the issue of 5.35 million new shares at 25c each.

Sealegs Europe sold 41 boats between October 2010 and December 2016 but only seven boats in the past two years when it had total operating losses of $208,000.

The independent report, which has determined that the offer to buy back Sealegs Europe from Avenport is fair, is forecasting 14 boat sales this year, 17 next year and 20 in 2019.

These forecasts seem to be on the optimistic side in light of Sealegs Europe’s poor performance in recent years.

The independent report notes that if the Sealegs Europe purchase is not approved by shareholders next week “the board may subsequently decide to renegotiate the terms of the Sealegs Europe acquisition (for example, structuring the consideration in the form of cash rather than the issue of shares), thereby alleviating the need for shareholder approval”.

I find this a disturbing comment because it indicates to me that the board may disregard the voting intentions of shareholders at a special meeting and find other ways to purchase assets from a major shareholder.

The FMS development is another reminder that shareholders have to scrutinise any sale of company assets to controlling interests and the purchase of assets from these parties. The Takeovers Code has significantly reduced the ability of major shareholders to plunder their companies but investors shouldn’t be complacent when it comes to related party transactions with major shareholders.

Brian Gaynor is an investment analyst and the Executive Director of Milford Asset Management.

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