A premium test for Envestra's independent thinkers

You don’t see too many nil-premium mergers, but effectively that is what APA Group’s Mick McCormack has proposed with his all-scrip $1.98 billion proposal to Envestra directors and shareholders.

APA isn’t presenting the proposal as a nil-premium merger, saying that it represents a 10.6 per cent premium to the one-month volume-weighted average price of 99.5 cents at which Envestra shares have traded. At yesterday’s closing prices for the two groups, however, APA’s proposal is valued at one cent more than Envestra’s market price and at today’s prices it represents an eight cent discount.

There’s nothing necessarily wrong with nil-premium mergers and, indeed, if there are sufficient synergies on offer, an all-scrip nil-premium merger can be the fairest way to share the benefits between two sets of shareholders.

It isn’t clear, however, that the synergies involved in putting the two together are that compelling. APA already operates and manages Envestra’s pipelines so the conventional cost and revenue synergies shouldn’t be particularly meaningful.

Instead the case for the merger is reliant on portfolio and financial market benefits. A combined APA/Envestra would have greater scale, greater diversification, a bigger market capitalisation and therefore greater liquidity in its securities and better access to capital. There would, as APA says, be a more balanced mix of regulated and unregulated assets within the combined portfolio of pipelines.

No doubt the independent directors of Envestra will want to try to understand the value of those benefits in order to determine whether there is a sufficient up-lift in value for them to recommend the proposal to their shareholders despite the absence of a change of control premium.

Given that APA is proposing that the transaction should be effected via a scheme of arrangement, the stance of the independents will determine its fate.

One of the major reasons why nil-premium mergers are rare is that they are dependent on the support of the target’s directors and are also acutely vulnerable to a counter-bidder.

APA won’t be worrying too much about a counter-bid. Apart from the fact that it has management control of Envestra’s assets it also has a 33 per cent shareholding. The combination makes it near-impossible for a third party to gatecrash its proposal.

The very low probability of a competing alternative may have been a factor in APA’s decision not to offer a meaningful control premium, if any. It can keep its powder dry for any negotiation with Envestra without pushing up the opening offer.

APA, however, might argue that Envestra’s sharemarket rating – its one-year return is almost 50 per cent – means that it is already fully valued and that the absence of large-scale synergies makes it difficult to justify a materially higher price.

Envestra does have another major shareholder on its register and the APA proposal is conditional on Hong Kong’s Cheung Kong Infrastructure, part of the conglomerate controlled by Asian billionaire Li Ka-Shing, supporting it with its 17 per cent shareholding.

Even if CKI does agree to back the deal, however, with APA unable to vote its holding at a scheme meeting and no other substantial shareholders on the register the independent directors’ recommendation to the remaining shareholders would almost certainly decide the outcome.

The long-standing relationship between the two groups – APA acquired its initial shareholding in 2007 when it contracted to manage Envestra’s networks and has two representatives on its board – means that the proposal, while unsolicited and handed to Envestra on Monday without any warning, is not quite a hostile bid.

Given its nil-premium nature, however, that doesn’t necessarily guarantee it a smooth and successful outcome.