Alarm at Leighton after puzzling power plays

The shock resignations of three of Leighton Holdings’ independent directors, including its chairman Stephen Johns, has revealed a deep fissure in the relationships between the independents and the group’s majority shareholder and created a major and unsettling question-mark about its future.

Johns, former Reserve Bank governor Ian Macfarlane and Wayne Osborn all resigned today, setting off an implosion in the Leighton share price after they cited a perceived ‘’breakdown’’ in relations with Germany’s Hochtief, which has a shareholding of about 54 per cent in the giant construction group. They said it was their view that Hochtief no longer supported an independent board at Leighton.

That issue of independence is a very material one for Leighton and its shareholders, particularly given the debt-laden state of both Hochtief and its own controlling shareholder, the giant Group ACS of Spain.

Since 2000 Leighton has had a formal agreement with Hochtief under which its shareholding was restricted and its board representation was limited to four of a maximum of 12 Leighton directors, with the rest independent directors or executive directors. The chairman was to be one of the independents and have the casting vote in any deadlock.

That agreement was reaffirmed through formal undertakings given to Leighton by ACS in 2010 after it acquired controlled of Hochtief in a bitter takeover battle, an acquisition that generated concern among Leighton shareholders that ACS would try to take control of the one strong business within a construction empire reeling under the weight of its debts in the aftermath of the global financial crisis.

Leighton didn’t explain the precise reason for the rift between Hochtief and the independents although there are suggestions that it was sparked by the refusal of Hochtief’s chief executive, Marcelino Fernandez Verdes, a Leighton director, to accept the board’s nomination of a new independent director to fill a vacancy on the board.

Verdes became chief executive of Hochtief last November as ACS, which had seen Hochtief’s value decimated since it took control in 2011, decided it needed to pursue a more urgent and radical strategy.

Hochtief’s rejection of the proposed new independent would clearly have signalled to Johns and his fellow independents that the governance protocols ACS had agreed to were being challenged.

It is believed that Verdes refused the independents’ request for assurances that ACS/Hochtief would continue to abide by their undertakings and subsequently asked Johns to consider resigning, telling him that he no longer had Hochtief’s support.

The independents declared their support for Johns, asked for an explanation of Hochtief’s reasons for its request for his resignation and sought confirmation that Hochtief would abide by the undertakings but apparently couldn’t get a response – even though Leighton’s statement today said the arrangements with Hochtief were expected to continue.

That does sit oddly with the other statement in the announcement that the resignations followed a ‘’perceived breakdown’’ in relations with Hochtief, given that the independents did control the boardroom as long as Hochtief abided by the undertakings and didn’t use its majority shareholding to exercise control.

The market’s response – it fell nearly 7 per cent almost immediately – would indicate that investors interpreted the resignations as a threat to Leighton’s independence and value.

There has long been a concern, assuaged by the undertakings, that Hochtief and/or ACS would try to get direct access to Leighton’s earnings and cash flows and stabilise their own balance sheets by merging it with Hochtief.

Hochtief’s shareholding in Leighton represents something approaching the entirety of its value, generating almost all its earnings. ACL lost almost $2 billion last year and despite halving its debt is still carrying about $6 billion of net debt. There is good reason for Leighton shareholders and lenders to be concerned about today’s developments.

The resignations cast some light on the status of the Hochtief undertakings. If they were legally enforceable the independents could have stared Verdes down. While there are differing view about that status it would appear the independents weren’t confident they could be enforced.

Unless there is a larger corporate strategy at work in the confrontation with the independents it is hard to understand why Hochtief would choose to flex its muscles now, with Leighton under Hamish Tyrwhitt and the Johns-led board having put its recent problems – mainly the losses on the construction of Victoria’s desalination plant and Queensland’s Airport Link project – well behind it. Its share price has bounced about 44 per cent in the past six months, or at least it had before it lost about $1.50 today.

Under Johns’ chairmanship the company has stabilised, new board committee and oversight structure have been introduced and Tyrwhitt has developed a new structure and strategy for the group that has been embraced by the market.

There will be some who will look to the role that former long-time Leighton chief executive Wal King might have played in the boardroom confrontations, or might play in future, given that he has been said to have a strong relationship with ACS. There is, however, no evidence that suggests King has been involved and indeed strong suggestions to the contrary.

The resignations today raise more questions than they answer and until Hochtief’s motives for refusing the board’s nomination of a new independent and for pressuring Johns out of the boardroom – and its preparedness to confirm to the letter and spirit of the undertakings become clearer will remain a major concern to the market.

It would be contrary to the intent of the undertakings – and of grave concern to shareholders and lenders – if Hochtief used its shareholding to appoint new directors who weren’t clearly independent.

Given Leighton’s significance within the national construction sector, the interest in what occurred and what it might mean for Leighton’s future, of course, won’t be confined to shareholders and lenders.