Jenny Ruth: Reality behind the AWM-Tower split

The sharemarket has already delivered its verdict on whether splitting its Australian Wealth Management businesses out into a separately ASX-listed vehicle is a good idea for Tower shareholders.

From below $2 before the mid-September announcement, the shares shot up to almost $2.50 before disappointment with the company's annual results, announcement in November, took some of the gloss off. They were trading at $2.11 yesterday.

There is also no doubt that, as the company claims, the resulting two companies will be more focused and easier to understand. AWM will focus on financial planning and related services and its trustee activities, while Tower will concentrate on its core general, health and life insurance activities and its associated asset management business.

The deal, including the proposal for 19.9 per cent shareholder Guinness Peat Group to underwrite AWM's A$130 million ($141 million) rights issue, has been rated by expert Grant Samuel to be in the best interests of Tower's shareholders.

The split should mean that Tower can resume paying dividends. AWM's dividend policy is to pay out between 40 and 70 per cent of net profits.

But is it really a good deal for all shareholders?

Tower still has a large number of shareholders who gained their holdings through owning policies when the company was demutualised in 1999.

Grant Samuel's report shows that at October 30, about 11 per cent of all Tower's shares were owned by 98,094 individual shareholders and that 83,251 of them owned fewer than 1000 shares. Indeed, 22,044 of them own fewer than 99 shares. The bulk of the company's shares (88 per cent) were owned by just 18,048 holders.

While the policyholders aren't what you would call natural share owners, they have proved remarkably sticky. The 2002 annual report shows the company had 96,312 shareholders with 1000 or fewer shares at November 30, 2002, and that 26,135 owned 100 or fewer shares.

If you work through the mechanics for someone with 99 shares - many of those 22,044 people will own fewer - you'd have to wonder whether it was rational for that person to do anything.

Under the deal, that shareholder will get 0.2908 shares in AWM for every Tower share he or she owns. With rounding, that's just 29 AWM shares.

That person will also be entitled to subscribe for a further 1.355 AWM shares for every Tower share he or she owns. That's a further 39 AWM shares costing A$54.40 (the issue price is 80Ac), or $58.96.

If that shareholder opts to take up the rights, he or she will end up with 68 AWM shares. That isn't a marketable parcel. In New Zealand, a marketable parcel of shares worth 80c each is 500 shares.

If that shareholder thinks about selling the rights, he or she will soon find this is ridiculous.

Grant Samuel estimates a theoretical price for the rights will be between zero and 11c each. The maximum value of our Tower shareholder's rights would therefore be $4.29. The cheapest that discount broker Direct Broking charges is $29.50 a trade.

To add insult to injury for this shareholder, under the deal Tower will cancel 0.135 shares for every share held. That means our shareholder's holding will be reduced 13 shares to just 86 Tower shares. A marketable parcel of shares worth between $2 and $5 each is 100 shares.

To come out even fractionally ahead after brokerage to sell Tower rights, you would have to own at least 600 shares. Then your rights would be worth a maximum $25.96 or cost you A$188.80 to exercise. Since that shareholder would end up with 410 AWM shares, exercising the rights might be sensible.

Grant Samuel says AWM's nominal sale price of A$250 million is a multiple of 15.1 times its forecast earnings for this year - a 9.2 per cent discount to the theoretical price.

But Grant Samuel also cautions that how AWM shares will trade is uncertain.

It describes the timing of the rights issue as "unfortunate". The rights can be traded for just 10 days from February 15, the same day the AWM shares already issued will start trading.

"Ideally, the entitlements [rights] trading should take place after the head shares have had a reasonable period of trading to establish a fair market price for the shares," it says.

Small wonder that Grant Samuel warns that there could be a large number of rights not exercised.

It is only 18 months since Tower's last rights issue in June 2003, when just 35 per cent of shareholders took up their rights to buy shares at 90c.

That was a 36.6 per cent discount to where Tower's shares were trading before the rights issue was announced, so you might expect the smaller discount on offer with AWM would attract even less interest.

But Grant Samuel does point out that back then, Tower was in financial difficulty, in complete contrast to the market's apparent support of the current proposal.

GPG underwrote the 2003 rights issue and controversially ended up with its 19.9 per cent Tower stake.

Eventually, Tower's board decided GPG had broken the terms of the agreement, which had limited it to 13.75 per cent through the underwriting.

It did sell the excess shares, but to itself. The Tower board decided, though, that the prospects of suing GPG and winning were minimal or non-existent, said chairman Olaf O'Duill.

It is perhaps not surprising, then, that GPG has been criticised for looking after itself ahead of Tower's shareholders in framing the present underwriting proposal. If no Tower shareholders exercise their AWM rights, GPG could end up with as much as 66 per cent of AWM and, under Australian rules, would be able to keep them without having to make a full takeover offer.

But it is unlikely to get that much. Grant Samuel estimates it might get about 30 per cent.

On the other hand, you have to ask how Tower would have fared without GPG's involvement. After former managing director James Boonzaier left the company abruptly in 2002, it went on to report first a loss of $75 million and then a $149 million loss the following year because many of its assets were not worth what the company said they were.

The Bridges business is a case in point. The company paid A$168 million for it in September 2000. Tower wrote its book value for Bridges down by $36 million in 2002 and by a further $20 million the next year.

When Hanover Group sold its 9.5 per cent stake in Tower in September, director Mark Hotchin applauded GPG's "great job" in turning the company round. He had reason to be pleased: the stake was acquired for $1.17 a share and sold at $2.04 a share, netting Hanover a $35 million profit.

The underwriting agreementit needs - 50 per cent of shareholders voting in favour while the split requires 75 per cent in favour - does at least provide shareholders with certainty that the plan will proceed.

And it doesn't look like Tower is overpaying for the service. GPG will be paid a $2.275 million underwriting fee, 1.75 per cent of the total issue. Since it is committed to taking up its own rights anyway, that's an effective fee of 2.19 per cent to underwrite the 80 per cent it doesn't own.

Grant Samuel shows that recent underwriting fees ranged from as low as 0.6 per cent of the amount being raised (these were for large issues - AMP's A$1.19 billion issue and ANZ's A$3.6 billion issue) to as much as 4 per cent for the A$67 million ERG issue.

GPG director Tony Gibbs says it's "complete nonsense" that GPG is feathering its own nest with the underwriting agreement.

"The rights issue, the money that's being raised is completely pro-rata to everybody. If everybody takes up their entitlement, GPG's position won't change," he says.

"All we're doing is putting in a backstop to ensure Tower gets the money. We're looking after everybody's interests."

Gibbs also points to GPG's history of adding value for shareholders besides itself. A similar example of splitting a company in two to the benefit of all was the spinoff of Turners Actions from Turners & Growers, he says.

Turners floated at $1.50 a share in October 2002 and now trades at $4.15.

Tower does offer one piece of advice to its small shareholders: they might like to consider selling their shares ahead of the split.

Lovely to be wanted.

Tower briefing

Headquarters: Customhouse Quay, Wellington

Profile: Founded in 1869 as the Government Life Insurance Office, Tower is a general, health and life insurance company which operates in New Zealand, Australia and the Pacific Islands.

The deal: It is proposing to split off its Australia-based Bridges Financial Services Group of financial advisers and related services and its Australian trustee company into a separate vehicle, Australian Wealth Management (AWM), which will be listed in Australia. The deal involves $A120 million worth of AWM shares being distributed pro-rata to Tower shareholders who will then be asked to pay $A130 in a rights issue, the proceeds of which will be paid to Tower to finance its growth plans.

The Verdict: The move will make the two new companies more focussed and easier to understand and should see Tower resume paying dividends. But it leaves thousands of smaller shareholders out in the cold.

Financial stats: Tower reported a net profit of $55 million for the year ended September 2004 compared with net losses of $149 million and $75 million in the previous two years.

Key players: Sir Ron Brierley's Guinness Peat Group which owns 19.9% and its executive directors Tony Gibbs and Gary Weiss. GPG is seeking shareholder approval to underwrite the $A130 million rights issue which is part of the deal and which could see it take up to 66% of Australian Wealth Management.

Key executives: Group managing director Keith Taylor who has worked for Tower for 25 years. Andrew Barnes will become chief executive of Australian Wealth Management