KEY POINTS:
Recent developments at SkyCity Entertainment Group are a dreadful indictment of the New Zealand business, investment and media sectors.
The company has been put up for auction after woeful board governance, poor management, inadequate scrutiny by investors and soft media coverage.
The casino operator is expected to follow
a long line of New Zealand companies that fail to perform, the directors throw in the towel and sell out to foreign interests at well below long-term intrinsic value.
This is a sad reflection on our governance and management expertise as SkyCity has a monopoly position in its main market, a favourable tax regime and should be delivering above average capital and dividend growth for investors.
It will undoubtedly earn fantastic returns for any buyer with even a modicum of management expertise. It will also contribute to the country's escalating international investment deficit.
SkyCity's mediocre performance can be attributed to a number of factors including:
* It made a number of poor acquisitions, particularly Adelaide Casino and the Force cinema chain in New Zealand, while allowing its flagship Auckland Casino to become tired and dated.
* The wife of former managing director Evan Davies was appointed to a senior executive position. Davies seemed to lose focus when their marriage broke up.
* The board failed to develop a strong management team under Davies. This is reflected by the appointment of Elmar Toime, a non-executive director, as acting chief executive when Davies left.
* There are only five directors and one of these is the acting chief executive. None of the directors seem to have any in-depth casino expertise and the board is too small for a company with operations in New Zealand and Australia.
* None of the current non-executive directors live in Auckland, the home of the group's flagship operation, although Toime has moved from London to take up his acting chief executive position.
The company's share price peaked at $5.80 on May 10, 2006, but then drifted downwards as it became more and more evident that its financial performance was deteriorating.
Net earnings for the six months to December 31, 2006, were 23.2 per cent lower than the corresponding period in the previous year and the interim dividend was cut from 12c to 9c.
On June 25, chairman Rod McGeoch announced that Davies would "stand down as managing director and as a director effective immediately".
Eight weeks later it was revealed that net earnings for the full June 2007 year were down 18.2 per cent on the previous year and the final dividend was reduced from 14c to 12c. On the day of this announcement, SkyCity's share price slumped to a recent low of $4.16.
The drama intensified on September 21 when the casino operator said it had received an approach from a party expressing an interest in acquiring 100 per cent of the company at a significant premium to the share price.
A week later, McGeoch announced that SkyCity was effectively on the auction block. He wrote "the board plans to actively approach other parties to assess their potential interest in SkyCity" and First NZ Capital would be one of the board's advisers.
The appointment of First NZ Capital is definitely not best practice as Bill Trotter, executive chairman of the investment bank, is a SkyCity director.
Trotter has been a major driving force behind the success of First NZ Capital. He is a determined and skilful investment banker operating in an environment where shrinking violets are not successful.
The SkyCity board is at pains to point out that Trotter was not involved in the decision to appoint First NZ but that is not the issue.
SkyCity has appointed First NZ for most of its major mandates in New Zealand and Trotter would have expected the board to do so again if the company was put up for auction.
If this is so, it would be extremely difficult for Trotter to argue against an auction, particularly when First NZ's success fee could be well in excess of $10 million.
Would Trotter, or any other investment banker in his position, argue in favour of an auction if they knew that the mandate was going to go to one of their competitors?
Did the SkyCity board put the investment banking mandate up for tender to ensure there was no potential conflict of interests? If so, on what basis did it decide to appoint First NZ?
The problem is that many New Zealand boards adopt unsatisfactory processes when faced with a takeover offer and make hasty decisions to recommend a sale, often at low prices.
Directors strongly recommended takeover offers for Tranz Rail, Carter Holt Harvey, CanWest MediaWorks and Software of Excellence yet shareholders that held out eventually received higher offers. Metlifecare is selling well above the $3.90 a share 2005 bid price and Contact Energy directors have recommended a number of takeover offers well below the current share price.
The willingness of our directors to recommend takeover offers, and their reluctance to invest offshore, is reflected in the recently released data on New Zealand's international investment position (see table).
The country's international investment deficit - the difference between what we invest overseas and foreign investment in New Zealand - has surged from $87.5 billion in March 2001 to $143.1 billion at the end of the March 2007 financial year.
The main contributor to the escalating deficit is direct investment, which is where an investor has more than 10 per cent of a company, has a voice in management and is not a portfolio investor.
Our direct overseas investments have declined in recent years because of major write-offs - Telecom in AAPT for example - and the reluctance of our companies to invest internationally. In contrast, there has been a huge increase in direct investment in New Zealand as more of our major companies have been taken over.
The international investment deficit is the major contributor to the country's current account deficit as dividends and interest going out of New Zealand far exceeds the dividends and interest coming in.
New Zealand's international investment deficit has grown from 75.5 per cent to 87.5 per cent of GDP since 2001 while Australia's international investment deficit has increased from 53.8 per cent to 61.4 per cent of GDP over the same period.
But the big difference between New Zealand and Australia is that most of the growth in foreign investment in Australia is in the form of portfolio investment through the ASX rather than through direct investment. We attract much more direct investment, particularly in the form of 100 per cent acquisitions, because the NZX is extremely small.
A takeover of SkyCity will make the NZX even smaller and make us even more reliant on the less attractive direct investment.
New Zealand desperately needs a circuit breaker that stops the wholesale acquisition of our major companies by overseas interests, mainly because the subsequent dividend outflows have a negative impact on the current account deficit and foreign owned New Zealand companies are far less likely to invest offshore.
It is patently clear that Rod McGeoch, Bill Trotter and the rest of the SkyCity board have little interest in providing this circuit breaker.
* Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management.
