Gaynor: Independent yes - infallible no

By BRIAN GAYNOR

The independent advisers' reports will probably determine the outcome of the Contact Energy and Frucor takeover offers.

With Contact's share price well above the $3.85 a share offer and Frucor trading in excess of its $2.35 offer, shareholders are expecting that the independent reports will conclude the offers are too low.

But independent reports are not infallible. Their valuations are based on earnings forecasts that can be overly optimistic or pessimistic. An offer may be withdrawn if the valuations are too high and the share price can fall dramatically in the following months.

Pacific Retail is a good example of this. It has been subject to several takeover offers, including the latest from Logan Corporation, a subsidiary of Eric Watson's Cullen Investments.

None was successful because the earnings forecasts and valuations were too high.

Logan and Pacific Retail's independent directors are now involved in a public stoush over the latest offer.

At the centre of the conflict are the target company's profit forecasts, the most important ingredient in an independent adviser's report.

Pacific Retail, formerly known as Noel Leeming, was established by Roger Bhatnagar (now Sir Roger) in 1991 to acquire the business assets of Noel Leeming Television from Smiths City's receiver.

The original shareholders were Sir Roger, his wife and Greg Lancaster, the managing director of Noel Leeming Television.

Two years later, shares were issued to the public at 95c each and the company was listed on the Stock Exchange. The Bhatnagar/Lancaster interests retained a 70 per cent shareholding.

In November 1994, Murray Bolton's Skellerup offered two Skellerup shares and $1.20 cash for every three Pacific Retail shares.

The takeover bid valued the company at $1.88 a share, but the independent directors advised shareholders to reject the bid after Southpac Corporation determined that the shares were worth between $2.45 and $2.60.

A huge rift developed on the Pacific Retail board.

Four independent directors, including Jock Irvine who is one of the two independents on the current board, recommended rejection.

But Sir Roger and Greg Lancaster accepted on behalf of their shareholdings.

The two largest shareholders continued to reiterate that the offer was in the best interests of shareholders.

A week before the closing date the four independent directors changed tack. They advised that the offer was inadequate for long-term shareholders but short-term holders should accept.

But the advice was too late. Murray Bolton withdrew his bid and all shares offered to Skellerup were returned to their original owners.

Although Skellerup subsequently went bust, Southpac's $2.45 to $2.60 a share valuation was far too optimistic and Pacific Retail's share price dropped below $1 within 12 months of the bid lapsing.

The retail chain was then subject to a bewildering number of shareholding changes. These included:

* In March 1995, Singapore-based Lion City Holdings bought a 40 per cent holding at $1.50 a share, 30 per cent from the Bhatnagar/Lancaster interests and 10 per cent from the public.

* A few months later, Sir Roger bought back a large number of shares in the $1.25 to $1.30 price range.

* In mid-1996, Bond and Bond was bought from Murray International. The consideration was 17.6 million Pacific Retail shares at 97.3 cents each, giving Murray International a 37 per cent stake and reducing Lion's holding to 21 per cent.

* At the end of 1997, Lion sold its shareholding to Murray International for $1.19 a share.

In December 1998, Eric Watson's Logan Corporation announced an offer to all shareholders at $1.30 a share.

Grant Samuel concluded that Pacific Retail was worth between $1.49 and $1.60 a share and said the offer was not fair.

But the independent directors took a different view and recommended acceptance because Murray International (58 per cent) and Bhatnagar/Lancaster (12 per cent) had already sold their interests to Mr Watson.

The independent directors also believed a competing offer was unlikely.

Yet 12 days later, Farmers Deka made a counter bid at $1.45 a share (subsequently revised to $1.60).

The Farmers Deka offer lapsed because Mr Watson already had effective control with 73.7 per cent.

Logan launched its latest offer on September 24 when it announced a full takeover at $1.76 a share - which is equivalent to $1.96 after the price is adjusted for a one-for-nine bonus in April last year.

The independent adviser's report, prepared by Arthur Andersen Corporate Finance, concluded that Pacific Retail was worth between $2.13 and $2.95 a share and the two independent directors, Richard Reilly and Jock Irvine, have advised shareholders not to sell.

The company's share price has since jumped well above the $1.76 offer.

On Thursday, Logan went on the offensive and accused Arthur Andersen of using earnings forecasts compiled by management that had not been approved by the full board.

This attack is easy to understand, because earnings forecasts determine valuations and these have a huge influence on the independent directors' recommendation.

Logan has few grounds for complaint because the two independent directors and Andersen scrutinised the figures and it is inappropriate for a bidder-controlled board to approve forecasts that form the basis of the independent valuation (management forecasts in the Southpac and Grant Samuel reports did not have full board approval but were scrutinised in a similar manner).

But Pacific Retail did not achieve the profit forecasts in the Southpac or Grant Samuel reports and there is no guarantee that the company will meet the latest projections.

Management is expecting strong earnings growth in the 2002 to 2004 period, mainly due to a huge increase in net interest income from its retail finance company.

Arthur Andersen believes that these forecasts are unrealistic because they do not include the costs of achieving this growth.

The independent adviser has adjusted the forecasts and has based its $2.13 to $2.95 a share valuation on more conservative predictions.

Independent reports are important, but shareholders are well advised to pay more attention to the actions of major shareholders with board representation.

All three major Pacific Retail independent reports have concluded the offers were not fair, yet the Bhatnagar/Lancaster interests accepted the unsuccessful Skellerup offer, Murray International and Bhatnagar/Lancaster sold into Logan's 98/99 bid and Platinum Retail will accept the latest offer.

Platinum Retail, which is controlled by Pacific Retail director Mark Hotchin, is one of the company's largest shareholders.

Platinum sold 4.4 per cent to Logan this month and will accept Logan's offer for its remaining 4.2 per cent.

Mr Hotchin, who has been on the Pacific Retail board since July 1999, should have a clear view of the company's worth.

The Contact Energy and Frucor independent reports are awaited with great interest.

The highly regarded James Miller, energy analyst at ABN Amro, valued Contact Energy at $5.31 a share before yesterday's profit announcement.

This figure, which is well in excess of the $3.85 a share offer price, is based on extremely bullish electricity price forecasts.

Credit Suisse First Boston and Salomon Smith Barney, the joint global coordinators to Frucor's public float last year, value the beverage company at $3.00 and $3.04 a share respectively.

These valuations have given the bulls plenty to cheer about. But what happens if the independent valuations are too high and the bids lapse?

Bain Pacific, Frucor's largest shareholder with 31.2 per cent, has granted the bidder an option to purchase 20 per cent at the $2.35 a share offer price. Although Bain Pacific may have been under some pressure from its American shareholders to sell, its willingness to accept indicates it is reasonably comfortable with $2.35.

* bgaynor@xtra.co.nz