Brian Gaynor: Sweet for Vector, risky for Powerco

Twenty-two minutes was all it took for UnitedNetworks shareholders to approve an important stage in the company's takeover. There were a few dissenting voices at the special meeting at North Harbour Stadium, but the outcome was a foregone conclusion because Vector was allowed to vote its controlling shareholding.

The takeover of UnitedNetworks has important implications for financial markets because investors have been asked to fund Vector and Powerco's involvement. The acquisition will also allow the Auckland electricity company to achieve its long-term ambition to control the North Shore-based group.

The deep-rooted antagonism between the old Auckland Power Board and Waitemata Power Board escalated during the 1980s, when John Collinge was chairman of the Newmarket-based utility. The North Shore company feared domination by its southern neighbour and when the utility was corporatised in the early 1990s and renamed Power New Zealand, it established two defensive shareholder groups.

One of these, now called UnitedNetworks Shareholders Society, still owns 10.8 per cent, but last night agreed to accept the offer. .

The defensive shareholdings didn't deter Mercury and it made an aggressive and unwelcome takeover offer before the North Shore company was listed in December 1994. This led to a long and acrimonious battle for control between Mercury and US-based UtiliCorp that was still unresolved in 1998.

Earlier that year, Mercury was the culprit in the Auckland power crisis. Its complicated ownership structure, which included the partners of Russell McVeagh having a 49.5 per cent voting entitlement, was also severely criticised.

In September 1998, the impasse over control of Power New Zealand was resolved when Mercury sold its 33.2 per cent to UtiliCorp to give the US group a 78.6 per cent controlling interest. Mercury lost the battle because of strong opposition from the Power New Zealand board and management and its own internal problems.

Under then Energy Minister Max Bradford's electricity reforms, which required firms to concentrate on line or retail operations, Power New Zealand focused on lines. The company sold its retail business and bought the Hutt Valley/Wellington and Bay of Plenty line assets from TransAlta New Zealand and TrustPower respectively. It also purchased natural gas distribution assets in Auckland, Hawkes Bay, Manawatu, Horowhenua and Wellington.

In the meantime, Mercury also decided to concentrate on lines. It sold its retail business to Mighty River Power and changed its name to Vector. Mighty River Power took over the brand name Mercury Energy and now trades its electricity retail business under that name.

Power New Zealand changed its name to UnitedNetworks and in 2001 Utilicorp sold 13 million shares at $8 each to reduce its holding from 78.8 to 70.2 per cent.

UnitedNetworks' controlling shareholder, which has been experiencing financial difficulties in the United States, announced on June 12 that it was seeking expressions of interest from potential buyers for either the whole company or individual assets.

More than 20 parties responded and on September 10 UnitedNetworks advised the Stock Exchange of the sale agreements:

* Vector, which is now 100 per cent-controlled by the Auckland Energy Consumers Trust, would make an offer for 100 per cent of the company at $9.90 a share and UtiliCorp would accept in respect of its 70.2 per cent holding.

* Simultaneously, UnitedNetworks would sell its Tauranga, Thames Valley, Coromandel Peninsula, Eastern and Southern Waikato assets to Powerco for $590 million; Rotorua and Taupo lines to Hawkes Bay Network for $195 million; and central North Island gas network to Powerco for $220 million.

The old antagonism between the North Shore and Auckland City utilities has dissipated and there is almost total acceptance of the latest offer. UnitedNetworks' independent directors support the offer and Grant Samuel believes the $9.90 a share offer is fair, as it is well within the $9.02 to $10.48 a share valuation range.

The only problem was the Shareholders Society and its 10.8 per cent stake. Under the society's rules the beneficiaries (North Shore City Council, Rodney District Council and Waitakere City Council) could not sell their shareholding unless all three bodies agreed.



Rodney and Waitakere quickly decided to sell but North Shore held out, costing the councils about $25,000 a day in lost interest from the proceeds of the sale.

Agreement was not reached until late yesterday when the three councils announced they would sell their shares to Vector.

The $160.4 million proceeds will be shared among the councils, with a portion remaining in trust for the councils' undergrounding programmes.

North Shore's acceptance means John Collinge, who is a trustee of the Auckland Energy Consumers Trust and Vector's deputy chairman, will finally gain control of his old adversaries on the northern side of the Auckland Harbour Bridge.

The acquisition should make a positive contribution to Vector, but it has risks. The company will have a much weaker balance sheet and the industry is not immune to operational and regulatory risks. Several large overseas electricity companies have been adversely affected by the purchase of overpriced assets, unexpected operational developments and changes in the regulatory environment.

But investors are rushing into Vector's $350 million capital bond issue, which will partially fund the acquisition. The offering is attractive because the bonds are paying 8.25 per cent a year and bondholders will be entitled to $500 worth of Vector shares for every 1000 $1 bonds in a public offering. If Vector does not have a public offering before September 2003, then the interest rate on the bonds will increase by 1.5 per cent a year.

The last component of this complex transaction, from a sharemarket perspective, is Powerco. The New Plymouth-based company will buy UnitedNetworks' gas network assets and some electricity line businesses for $810 million, not including transaction and integration costs.

Powerco will become the country's largest energy distribution company in terms of length and the second largest in total consumer connections.

The acquisition represents a huge risk to Powerco for several reasons:

* It is one of the highest-priced line companies (see accompanying graph). This makes it particularly vulnerable to the Commerce Commission's pricing review. Vector is in a far stronger position because it has relatively low line charges and its newly acquired UnitedNetworks (Waitemata) is in the middle of the pricing range.

* Although Powerco raised $102 million of equity at $1.60 a share this week, and will raise a further $48 million from retail investors at the same price, it will still have a relatively weak balance sheet. Following the completion of the deal, the company will have approximately $570 million of equity and $1.7 billion of assets. If the Commerce Commission introduces tougher price controls, the shareholders and not the lenders will bear the cost.

* Powerco shareholders will be able to exercise minority buy-out rights if they vote against the transactions at the special meeting on October 29. This could create an additional liability for the company, as the situation is similar to the Natural Gas/TransAlta transaction in 2000, where Infratil successfully exercised its buy-out rights.

The complex transaction is extremely beneficial to UnitedNetworks shareholders and should add value to Vector, which now owns 93 per cent of the North Shore utility and can now move to compulsory acquisition. The outcome for Powerco is much more uncertain, particularly if the Commerce Commission introduces price controls.

Powerco shareholders will be hoping that chief executive Steven Boulton can successfully integrate the new businesses but they will also be keeping a close eye on announcements from the Commerce Commission in Wellington.

* Disclosure of interest: none

* bgaynor@xtra.co.nz