A fast track to holding Leighton

The writing was on the wall for Leighton Holdings a year ago when three independent directors, including the chairman, quit over a dispute with their majority shareholder over governance protocols. Today that shareholder, the Spanish-controlled but German-domiciled Hochtief, made it very clear those protocols will no longer apply.

For nearly a decade and a half Hochtief has been bound by a series of protocols agreed with Leighton, the key element of which was that, despite Hochtief eventually gaining a majority stake in the construction group, there would be a majority of independent directors on Leighton’s board.

The protocols were designed to reassure Australian investors that Leighton, which was larger than Hochtief, wouldn’t be pillaged by its major shareholder. While there have been a number of discussions initiated by Hochtief about merging the companies over the years, nothing eventuated.

A dispute last year saw three directors resign after Hochtief rejected the independent’s preferred candidate to fill a casual vacancy on the board and nominated its own candidate. It also told then chairman Stephen Johns he no longer had Hochtief’s support and should consider resigning. Johns, former Reserve Bank governor Ian Macfarlane and Wayne Osborn departed.

Hochtief made it clear at the time it believed the protocols were informal and non-binding principles which it could observe, or not, as it wished. It then used the "creep" provisions of the Corporations Act to lift its shareholding, which now stands at almost 59 per cent. It has, however, only three directors on the 10-seat board.

Late last week Leighton’s share price surged more than $2, prompting an ASX query and a Leighton response that it had no information to explain the rise. Today, of course, Hochtief unveiled a proportional bid for Leighton that if completely successful would increase its shareholding to 74.23 per cent. That might explain the market movements last week.

In announcing the three-for-eight offer, Hochtief made it very clear what its objective was and very clear what would happen if the offer - pitched at an 18.8 per cent premium to the five-day volume-weighted average price of Leighton shares - wasn’t successful.

It said it had previously informed the market and Leighton that it reserved the right to depart from the "informal and non-binding corporate governance principles that have arisen between Hochtief and Leighton over time." Subject to the Corporations Act and Leighton’s constitution, it said it intended to increase its representation on the board to reflect its shareholding.

It also said it planned to work with the board to complete its current review of the Leighton operating model. A particular focus of that review, it noted, was whether Leighton’s existing businesses could be more efficiently structured – Hochtief has just completed a restructuring and business simplification program of its own.

In other words, it will take control of the board, decide the future structure of Leighton and do so regardless of the outcome of the offer. It noted it could continue to use the creep provisions of the Corporations Act. In effect, the proportional offer is simply a faster way to achieving its objective of clear control of Leighton than buying three per cent of the company every six months.

It was always probably just a matter of time before Hochtief tightened its grip on Leighton after Spain’s ACS crept its way to control of Hochtief in 2012. The level of debt within ACS and Hochtief delayed the move but a series of assets sales and restructurings have lowered the groups’ debt levels and enabled Hochtief to move on the most significant business within the group.

That Hochtief isn’t making a full bid for Leighton probably signals that it doesn’t have the capacity to refinance Leighton’s own borrowings and therefore plans to stop short – below 75 per cent – of the level that would trigger their early repayment. The bid will involve a cash commitment of $1.2 billion from Hochtief.

The hard-nosed attitude of the Spaniards who direct Hochtief puts Leighton’s minorities in an invidious position.

With Hochtief making it clear it is going to tear up the governance protocols regardless, they can get a relatively modest premium for just under half their shareholdings. But whether or not anyone accepts the bid, they are going to be locked into a minority position in a company clearly controlled and directed by ACS through Hochtief.

ACS has used share buy-backs to strengthen its control of Hochtief and so could resort to both creeping up the register and using its soon-to-be-gained control of the Leighton board to accelerate that process via "capital management."  The nature and value of the offer – and Hochtief’s announced intentions – are going to make for a difficult discussion and recommendations from the independent directors who, for now at least, represent the majority of the board.