Brian Gaynor: Watson's listed firms flabby performers

Eric Watson is an enigma.

He is one of the country's wealthiest individuals yet most of his listed companies have performed poorly.

He has played a big role in the New Zealand business sector, yet a web search of his name mainly generates hits on his friendship with Nicole Kidman and his fracas with Russell Crowe.

A survey last year by NBR-Phillips Fox showed that he is both respected and criticised as he ranked near the top in terms of both positive and negative responses.
This week's Pacific Retail result - the company is 81.3 per cent owned by Watson - highlights the British-based businessman's unconventional approach towards listed companies.

Watson first became involved with Pacific Retail at the end of 1998, when he made a takeover offer at $1.30 a share.

Farmers Deka made a counter-offer at $1.45 a share, which was subsequently raised to $1.60. But Watson ended up with 73.7 per cent because the two major shareholders, Murray International (58 per cent) and Roger Bhatnagar/Greg Lancaster (12 per cent), had a prior arrangement to sell to him.

In April 2000 Pacific Retail had a one-for-nine bonus issue and in 2001 Watson made another offer at $1.76 a share but received minimal acceptances. In 2002 Watson made a third bid, this time at $2.25 a share.

Grant Samuel valued Pacific Retail between $4.31 and $4.81 a share and Watson raised his stake to 77.0 per cent. After the third offer Watson converted Pacific Retail into an investment company and acquired interests in RMG, Burns Philp and property development.

Pacific Retail has performed poorly as an investment company and hasn't paid a dividend since Watson first became involved.

This is a warning to unitholders of Kiwi Income Property Trust, which is being converted from a property investor into one with a stronger development bias, that changes in corporate direction are not always successful.

Pacific Retail made a disastrous acquisition in Britain and its market capitalisation yesterday was just $122 million compared with the Grant Samuel's 2002 midpoint valuation of $236 million (the number of shares on issue has increased through a 21-for-100 bonus issue in late 2002).

As the accompanying table shows, Pacific Retail reported an operating loss (earnings before interest, tax and amortisation) of $20.2 million for the latest March year compared with a loss of $2.1 million the previous year.

The main contributor to the dreadful operating performance was PowerHouse, the British electrical retailer which has had total losses of $97.9 million since it was acquired in September 2003. These losses are substantial as Pacific Retail had shareholder funds of only $100.3 million when it bought PowerHouse.

Pacific Retail has been able to include the $86.7 million profit from the sale of its New Zealand appliance and furniture retail operations as a non-operating item because it is an investment company. This has enabled it to report a total net surplus of $46.6 million for the latest year compared with a loss of $22.6 million previously. But the sale of Noel Leeming, Bond & Bond, Big Byte and Noel Leeming Furniture will reduce earnings in the years ahead.

These operations contributed operating earnings of $6.3 million before they were sold on July 31.

Living & Giving, the only remaining retail-focused operation, has not performed well. It had an operating loss of $1.7 million for the latest year compared with a loss of $2.75 million previously.

 

Pacific Retail Finance is the group's star performer. Its latest earnings were $28.2 million, a near twofold increase over the previous year.

Last year the listed company announced it was investigating a listing for the finance company with Pacific Retail keeping a majority shareholding. The plan was to have an initial public offering in the first quarter and to list before June 30.

On March 31 it was announced that Macquarie New Zealand had advised that a successful listing would require a 100 per cent sale in order to optimise the marketability of the offer, generate strong institutional support and maximise the value for Pacific Retail Group.

In other words, Macquarie believes that an IPO would not have strong institutional support if Pacific Retail and Watson remained involved.

This conclusion was not a surprise as Watson is not highly regarded by the investment community. He is a major shareholder and played an important role in the formation of RMG, which is now in administration (Pacific Retail wrote off a $1.7 million investment in RMG in its latest result).

He also played a key role in the formation of Abano Healthcare but reduced his stake from 55 per cent to 19.9 per cent last year through the sale of shares at $1.10 each.

Abano's share price has risen dramatically since it announced the sale of its retirement villages on May 24. (The villages were 79 per cent owned by Watson, who sold them to NZ Petroleum in 1999. NZ Petroleum, which was 63 per cent owned by Watson at the time, changed its name to Eldercare and later to Abano.)

One of Watson's main non-listed entities, the Hanover Group, appears to be doing very well. Its four main finance companies, Elders Finance, United Finance, FAI Finance and Nationwide Finance, had combined net earnings of $26.5 million for the year to June 2004 and paid dividends of $20.8 million.

Why do Watson's non-listed companies pay dividends but not his listed ones?

Hanover is a listing prospect but would not receive widespread institutional support if Watson continued to play a major role.

As far as Pacific Retail is concerned, the future is uncertain. It will be left with Living & Giving, PowerHouse, Bendon and its property activities if the finance company is sold. PowerHouse is not expected to break even until the March 2007 year and Bendon operates in a competitive sector.

But what will Pacific Retail do with the proceeds from the finance company sale? Investors aren't getting too excited as Pacific Retail hasn't been generous to shareholders. Its last dividend was for the six months to September 1998, just before Watson became the controlling shareholder. The proceeds from the sale of the New Zealand retail operations were not distributed.

Directors stated this week that any decision on a dividend had been deferred pending the finance company sale.

Meanwhile, Watson continues to buy shares under the creep provisions of the Takeovers Code (a controlling shareholder may purchase up to 5 per cent in a 12-month period). In the past 12 months he has raised his stake from 76.9 per cent to 81.3 per cent.

When Watson reaches 90 per cent, which could be in 2007, he can move to compulsory acquisition. By that stage remaining shareholders may be so fed up and frustrated that they will sell out to him at a low price without a fight.

* Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.