Richard Inder: Trust in Hart put to test

Graeme Hart faces a critical test of his reputation on public markets this year.

Justifying his spinoff of Goodman Fielder from his Australian venture Burns Philp last year, he claimed the transtasman food business was off the sick list.

He said he had made a good return on his investment in Goodman Fielder by instituting a radical programme of reorganisation.

But, Hart said, public market investors should not expect the same reward as they were not prepared to take the same risks. Public markets served the interests of pension funds, mum and dad investors, and investors who were interested in stable solid returns. Goodman would deliver this now, he said.

The argument was not without flaws.

Public markets are a broad church, offering a framework for vehicles pursuing perhaps infinite combinations of risk and reward. Public market investors just require clear guidance on the approximate levels of risk and the likely rewards and that management delivers on its public promises.

But set that aside. The second part of Hart's argument is still relevant - that Goodman possessed in spades the potential for solid stable returns.

The prospectus sets out the case. June 2005's A$376 million ($406 million) trading profits would grow to A$417 million this year and A$466 million in 2007.

Goodman Fielder brings together Burns Philp's baking spreads and oils business with the dairy and cured meat businesses Hart's private company Rank acquired from Fonterra in August last year. The costs saving of this merger are still to be fully realised.

However, the consequences for Hart of a Goodman failure to deliver on its promises would be significant.

For a start, there are the direct financial consequences. Hart - through his 54 per cent stake in Burns Philp, which retains a 20 per cent cornerstone holding in Goodman Fielder - has an economic interest in the company equal to A$302 million at yesterday's share price.

But the potential damage to his reputation is perhaps of greater issue. New Zealand institutional investors were cool on the Goodman IPO because they feared Hart was pulling a quick flick. They had seen Hart get the better of Fonterra. Businesses Hart acquired last August from the dairy giant have been sold to the new Goodman Fielder for a minimum gross profit of as much as $256 million.

Hart's play at Burns Philp had shown that there was money to be made only by following his investment strategy. Just after Hart made his first investment, Burns Philp's shares plummeted. Those who lost their nerve also lost big time. However, Hart has since more than doubled his A$500 million investment.

Meanwhile, Hart is renowned for his ability to cut costs. Investors feared Goodman had been hollowed out, its strong earnings temporarily boosted at the expense of investing in growth for the long term.

This fear was reinforced by Burns Philp's decision to hold on to the fast-growing Uncle Toby's snack business, originally part of the Goodman Fielder operation Hart acquired in 2002. It is no surprise that Burns Philp disclosed this week that it was examining strategic alternatives for the business, code language for a sale.

Institutional investors worried about Goodman's ability to hold its own against the burgeoning power of the supermarkets. The company has a sizeable exposure to mature categories such as white breads and cooking oils, products that are vulnerable to supermarkets' own brands.

As a consequence professional investors acquired only $50 million of Goodman shares, just 17 per cent of the more than $300 million raised in New Zealand. Those who bought the shares partly did so on Hart's assurance that growth would be robust.

As a result, a failure by Goodman to match its promises will entrench investors' original fears and potentially limit Hart's ability to use public markets as an exit strategy for his investments in the future.

For instance, Hart has more than 85.6 per cent of Carter Holt Harvey (and is likely to take full control over the long term) after bidding $3.3 billion, or $2.50 a share.

He is most likely to push through a break-up. Analysts are betting the forests will go to the big US pension funds that have shown a robust appetite for such assets, and the manufacturing operations are likely to go to a variety of trade players.

However, it is not inconceivable that some of the Carter business will return to the public market. For instance, Carter's building supplies chain seems a contender.

But even if Hart is not eyeing public markets immediately, the break-neck speed with which he struck deals last year across his portfolio of interests suggests he is not going to retire to the beach just yet.

He is more than likely to appeal again to public markets before his days are done.

It is early days, but it is reassuring that Goodman has so far delivered.

Aussie investors who bought the shares at A$2 are sitting on a gain of 5 per cent as the shares trade at around A$2.10.

Goodman's New Zealand investors who bought into the float at $2.13 are doing better, with shares now trading at around $2.29, an 8 per cent gain.

They have benefited from a weakening of the kiwi against the aussie as well as New Zealand institutions' failure to get shares in the initial public offering.

The leading indicator of Goodman's performance in this story will be the attitude of professional investors. Many are now underweight relative to Goodman's position in the index and face the unpalatable prospect of buying well ahead of the price they could have paid during the float.

They face a choice of waiting to buy in until Goodman releases its earnings later this year. But that may only exacerbate what now appears to be a bad bet.