FYI | Apr 05 2006
With merger fever breaking out across the Australian market following the announcement of deals such as Tattersall’s (TTS)/UNiTAB (UTB) and Australian Stock Exchange (ASX)/SFE Corporation (SFE), shareholders of companies involved in such deals should be smiling all the way to the bank.
But market consensus suggests shareholders of New Zealand-based Contact Energy (CEN.NZ) have reason to be unhappy with the proposed merger deal with major shareholder Origin Energy (ORG), not least because as UBS suggests, the deal is essentially a takeover offer minus any premium.
UBS is not the only broker to suggest Contact shareholders may be less than thrilled with the terms of the deal, though as it and most of those covering Origin point out it is a good one for Origin shareholders.
At JP Morgan the analyst noted earlier the merger proposal helped draw attention away from the fact Origin reported a profit result for the December half that was below market expectations, resulting in the broker trimming its profit forecasts. Others followed suit, with ABN Amro, GSJB Were and Merrill Lynch also reducing forecasts in future periods following the result.
Current recommendations reflect the fact the result was somewhat disappointing, with the FN Arena database showing Origin is currently rated as Buy by only three brokers and equity researchers, compared to six Hold ratings.
The proposed merger would see Contact holders receive 7.2 shares in the new structure for every 100 shares they currently hold as well as NZ5c/share in cash, while Origin shareholders will receive 18.3 shares per every 100 currently held.
Prior to the merger announcement Origin held a 51.4% stake in Contact, with the current terms to increase this to a 75.5%/24.3% respective stake in the merged company, which would have a dual-listed structure and be traded on both the Australian and New Zealand exchanges.
According to GSJB Were this is one problem with the deal, as the merged group would see Contact’s weighting in the Kiwi market decline to under 4.5% from just over 9% currently, increasing the potential the stock could trade at a discount to its Aussie-listed counterpart.
More to the point though, the broker suggests there is no strong reason for Contact shareholders to want to merge with Origin, as it notes management of both companies have stated the synergies from any merger are minimal and it doesn’t address the main issue facing Contact, that of maintaining its gas supply given scarcity in the New Zealand market.
ABN Amro agrees the deal seems to favour Origin in its current form, as the parent gets access to Contact’s strong cash flows and undergeared balance sheet without having to pay a control premium.
The broker also points out Contact has some upside potential from its growth options in areas such as LNG tariff pricing and new generation options in geothermal and thermal areas, but is being asked to share this with Origin without getting sufficient compensation.
Macquarie agrees an improved bid will be required, as on its expectations the merged company will have a payout ratio below Contact management’s stated target of 80%, while agreeing with GSJB Were’s view the New Zealand stock could trade at a discount post the merger. Additionally it notes on its calculations the company’s valuation is in excess of both the current share price and its VWAP (Volume Weighted Average Price) for Contact, which is the basis being used for the merger terms.
GSJB Were offers some possibilities for how the deal could be improved, suggesting the terms could be made more attractive for Contact shareholders by either altering the merger ratio, paying a special dividend to utilise excess franking credits, or making a capital return to shareholders.
Regardless of the form any improvement to the deal might take, opinion is almost universal among analysts an improvement to the current terms will be necessary to gain the approval of Contact’s minority shareholders.
It is no surprise then most ratings for Contact Energy are positive, with Macquarie, GSJB Were, UBS and ABN Amro rating the stock as Buy, ABN Amro having upgraded its recommendation following what it regarded as a first-class profit result in February.
Share price targets for the stock range from NZ$6.53 to NZ$8.24.