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Appetite for destruction

As many shareholders have learnt from bitter experience, some takeovers come at a greater cost than others, Colin Kruger reports.

As many shareholders have learnt from bitter experience, some takeovers come at a greater cost than others, Colin Kruger reports.

Leave it to the investment legend Warren Buffett to best explain how companies can go looking for corporate love in all the wrong places. In his 2008 missive to fellow Berkshire Hathaway investors, Buffett underlined his folksy charm with a lyric expressing his regret over a rare dud deal: "I've never gone to bed with an ugly woman, but I've sure woke up with a few".

Such charm is rarely on display when your average denizen of the corporate jungle confesses that blood was pumping to all the wrong organs when a disastrous corporate deal was consummated.

Of course not all disasters rank equal. Billions in losses are easily hidden by a corporate balance sheet the size of News Corp's.

Conversely, a more modest acquisition can climb above larger deals with sheer outrageousness as Allco showed with its takeover of Rubicon prior to its collapse.

The difference between a cash deal and scrip is another saving grace. Westpac's $18 billion acquisition of St George in May 2008 at four times book value looked rather shabby when just months later the financial crisis cruelly exposed Australia's second-tier financial institutions and allowed Commonwealth Bank to snap up BankWest for $2.1 billion - less than its book value.

It probably helps that Westpac transacted in its own shares rather than cold hard cash. To understand the difference, just think of the effect of Rio Tinto's acquisition of Alcan for cash. The subsequent debt load almost broke the company when the financial crisis hit.

It is why Rio ranks highest in our list of Australia's corporate takeover turkeys since 2000. While the top five pick themselves, we must admit that the competition was much closer for the remainder.

In some cases, the misery is best judged through the eyes of investors who bore the loss, and management obfuscation that frequently precedes a mea culpa, and usually, the head of the corporate chief responsible.

Rio Tinto and Alcan

Even before the financial crisis made its presence felt, Rio Tinto's $US38.1 billion offer for Alcan was considered a tad generous.

The rival suitor, Alcoa - which could generate hundreds of millions more in annual synergies from an Alcan merger - couldn't justify a price tag of more than $US27 billion.

It probably should have been a hint at the time that Alcan's 2006 profit barely covered the interest bill on Rio's cash payment for it.

Did Rio know something the rest of us didn't?

No, but they thought they did.

Rio's offer appeared to be based on the time-honoured assumption "this time is different" and the presumption that commodity prices would continue to rise to the heavens and beyond.

At the time, the Rio Tinto chief executive, Tom Albanese, said he had unrivalled exposure to the China boom.

"There will be three big metals in the China story: steel, copper and aluminium," he said.

Since the acquisition, the price of aluminium has fallen from more than $US2800 a tonne to $US2200, with a detour to $US1290 in February 2009 when financial market panic hit commodities.

The big problem for Rio was the deal was paid for in cash and financed with debt just as the financial crisis was about to squeeze all forms of funding for everyone.

The additional $US38 billion of debt almost broke Rio as commodity prices followed the rest of the market into the doldrums. It first contemplated an embrace with Chinalco via a $US19.5 billion investment from the Chinese aluminium giant.

This was ditched in favour of a $US15 billion pro rata capital raising from existing shareholders after a potential merger with BHP Billiton was also ditched.

The only surprise is that Albanese has not been ditched as well, but a record full-year $US14 billion profit in February this year may have saved his hide. He has even retained his optimism for the aluminium sector despite more than $US9 billion worth of impairments against the Alcan assets and another restructuring of the business this week.

"If I look out beyond the next five years, I am probably reasonably optimistic with the forecast [for aluminium]," Albanese said last month. "But we have to be cautious within the next couple of years."

Foster's and

Southcorp

Nothing seems to linger like a bad corporate deal that continues to cripple a company year after year. Just ask Foster's.

The idea was to create a multi-beverage strategy to sell and distribute everything from a slab of VB to a bottle of Grange through the same sales force.

The Californian wine business Beringer Wine Estate was acquired in 2000 for $2.9 billion, followed by Southcorp in 2005 for $3.7 billion.

The spun-off wine division is now worth $2.5 billion.

"It's hard to look at the last 10 years of this company and not reflect upon the different points at which decisions were made, and if you had your time again you wouldn't make those calls," John Pollaers, the head of Foster's, which once again is a beer business, said.

But it was not always thus.

In 2001, the Foster's chief Ted Kunkel slammed analysts for not grasping the short-term turbulence from its initial wine experiment.

"Never make the assumption that people are intelligent enough to pick up on the nuances," Kunkel said at the time.

Foster's own investors were joining the rancour in 2005 when it went for a top-up with Southcorp.

"We think it is a stupid bid. It's ridiculous and we have told them that," Anton Tagliaferro, from Investors Mutual, said.

"What it's paying is just bull market madness."

Rancour reached its zenith when the next Foster's chief Trevor O'Hoy, who masterminded the Southcorp acquisition, had a public spat with the respected Merrill Lynch analyst David Errington. At the company's annual results briefing for analysts in Sydney in 2006, he hit out at Errington after the analyst questioned the poor growth in Foster's wine business.

"It might be best if you take a holiday, find yourself a therapist and come back and analyse it [wine sales] in 2008," he told Errington.

By June 2008, O'Hoy was gone after wine continued to sour.

Mind you, Foster's was not alone in seeing profits at the bottom of a wine bottle and waking up with a nasty hangover.

Constellation Brands had similar thoughts when it acquired BRL Hardy in 2003 for $1.9 billion. This year, Constellation sold off the vast majority of its British and Australian wine business for $290 million to the private equity group Champ.

Telstra and PCCW

Neither of the above deals captured the imagination in the same way as Telstra's ultimate jig with the dotcom era - its multi-billion dollar embarrassment with Richard Li and PCCW.

It was the deal of the cyber century by the nuclear physicist CEO, Ziggy Switkowski, and the wunderkind of Asia Richard Li.

Telstra got a once-in-a-lifetime opportunity to partner with PCCW, which needed some cash to finance its $US38 billion takeover of Hong Kong telco incumbent - Cable & Wireless HKT.

The wunderkind had lived up to his tag by getting the British owners to accept most of the funding in shares of his newly minted PCCW.

Telstra's deal with PCCW had many components, but the telco was upfront about one of the biggies behind the $5 billion price tag it was paying. "That $US1.5 billion is the price we had to pay for the relationship, which we are comfortable with," Paul Rizzo, the Telstra group managing director of finance, said when the deal was first announced in April 2000.

The dotcom crash was already under way, but nobody in the big chairs had realised PCCW was worthless without the Hong Kong telecom it was acquiring and Telstra's cash.

We told you Li was smart. Switkowski thought so too.

"We think in selecting Richard Li, we've picked somebody who has a very good sense about the future in an internet world and with very good credentials in China," the Telstra chief said at the time of the deal.

The asset trading and various write-downs make it hard to estimate what the final loss was for Telstra, but the carrier admitted to $2 billion in write-downs.

CVC and Nine Entertainment

"You only ever get one Alan Bond in your life and I've had mine," the late Kerry Packer famously said of the West Australian who forked out $1.2 billion for the Nine Network back in 1987 and subsequently lost the lot. Twenty years later, his son James had the private equity player CVC Asia Pacific, which effectively paid more than $5 billion for the network and its magazine division.

As with Rio's deal, 2007 was the magic year when deal flow exceeded blood flow to the brains of people who probably should have known better. CVC paid Packer's Publishing & Broadcasting Ltd (PBL) $1.46 billion in cash for a 75 per cent stake in the media assets and also took on $3.6 billion worth of debt from PBL.

A year later, the high debt and flimsy equity component meant the business was worthless.

Talk of refloating the business - now called Nine Entertainment - has to address challenges such as the fact that last year's underlying earnings barely covered the $400 million interest bill on its debt.

If it is any consolation, Packer subsequently blew a large part of the privateer's largesse on the US casino market. Crown shareholders walked away from that casino binge $1.4 billion lighter after the company wrote the investment down to zero in 2009.

Crown was saved from further loss when its lawyers successfully negotiated the exit of a $US1.75 billion deal to buy the entire Cannery Casino Resorts business in the US.

News Corp and

Dow Jones

Print was already on the nose in 2007 when Rupert Murdoch put down a contrarian bet to the tune of $US5 billion and bid for The Wall Street Journal publisher, Dow Jones.

It was a 65 per cent premium to Dow's share price - or in the more technical terms allegedly used by fellow News Corp directors - it was an "insanely high" bid.

In August, Rupert, for his part, said the acquisition, which had then been lifted to $US5.6 billion - would "position us to become the strongest company in the world in both information and entertainment". He said he had endured criticism "normally levelled at some sort of genocidal tyrant".

But it should have been some sort of warning that Buffett made millions from Murdoch's bid and gently suggested it was about more than money for the Sun King.

"I think Rupert would acknowledge that part of of his interest in The Wall Street Journal goes beyond economics" he said in May.

A year later, News Corp wrote off half the value of its deal, putting a $US2.8 billion price tag on Murdoch's uneconomic interest in the paper and its associated businesses.

At least it took the heat off his MySpace foray.

The $US580 million he paid in 2005 translated into a $US30 million sale price earlier this year.

Babcock & Brown and Alinta

The 2007 purchase of the West Australian energy business Alinta was the poison pill that not only knocked over the satellites of Babcock & Brown but also helped kill the parent as well.

Babcock & Brown entered a bidding war to buy the $7.4 billion asset in a pitched battle with Macquarie Bank.

In retrospect, the fact Babcock & Brown was fighting for the right to kill itself was an early sign of just how untethered from reality the market had become.

When Alinta was split up among its buyers, notably into B&B Power and B&B Infrastructure, the combination of debt and more debt was too great to bear.

As markets turned down in 2008, ambitious leverage levels in the satellites were exacerbated by taking on Alinta assets. The need to refinance became the subject of increasingly tense talks with the satellites' bankers.

In turn, the Babcock & Brown mothership found itself extending more and more leniency to the loans it was owed by its own satellites - a situation B&B's own bankers lost patience with in the end.

How far did the madness go? When Babcock & Brown Infrastructure sought to recapitalise its way out of its debt-laden mess, BBI shareholders found themselves being asked to swap 15,000 of their old shares for one new share.

BBI and BBP limped on through various name changes the parent went into liquidation in 2009.

Allco and Rubicon

Once again, 2007 was the magic year when everyone was obviously drinking the Kool-Aid - especially at outfits such as Allco Finance Group, which was readying to acquire the Rubicon property empire for $276 million just as the financial crisis gained momentum. The following year, the crisis would wipe out Allco, leaving creditors with claims totalling $1.1 billion.

Dr Gordon Fell was a director and shareholder of both Allco and Rubicon at the time, and the Allco chairman David Coe was also a Rubicon investor. About $63 million in cash was shared by Fell, Coe and a colleague, Matthew Cooper - along with Allco shares.

A public examination into the Allco collapse heard Fell say he was not aware if shareholders were informed of a pending $42 million debt repayment deadline for Rubicon when they were asked to approve the acquisition.

The Federal Court examination heard how a change in accounting practices caused "a significant negative outcome for the year [2007] to become a significant positive outcome". Dr Fell said he "couldn't recall" whether accounting practices had changed during 2007 that made Rubicon appear more profitable, and he could not explain why the change had been made.

Suncorp Metway and Promina

At Suncorp Metway's annual meeting in 2006, the chairman, John Story, told shareholders: "We believe that, of all the options available to us, this represented the greatest value to our shareholders."

"This" was the $7.9 billion acquisition of Promina just weeks earlier in October that year.

While most of it was acquired with Suncorp scrip, the banking and insurance group still had to hand over a hefty $1.9 billion in cash.

The merged group is currently worth $10.7 billion, but at the market depths was worth less than Promina's purchase price.

Even worse for Suncorp shareholders was the news that the board never saw fit to inform them of a takeover attempt from Westpac, which could have taken investor fortunes down an entirely different route.

For Suncorp, the height-of-the-boom price paid for Promina was only part of the problem. It subsequently botched the integration, and lost key executives.

The CEO who presided over the mess, John Mulcahy, was duly dispatched in February 2009.

Primary Healthcare and Symbion

Did we say 2007 was a stellar year for dealing?

Primary Healthcare was pursuing the rival health group Symbion with a $2.86 billion cash offer - although the deal was not consummated until February 2008.

Shareholders coughed up $1.2 billion to help fund the deal, but it required debt of course.

Primary was stuck with $2.3 billion of debt after the takeover.

At the time, it was a growth stock, profiting handsomely from the federal government's billion dollar health spending in its one-stop bulk-billing medical centres.

Then the crisis hit. In its wake, healthcare stocks were no longer viewed as a defensive sector with steady profit growth. Governments have been cutting funding for services outside hospitals.

The entire Primary group is now worth about $1.6 billion.

Centro and New Plan Excel Trust

The tale of woe that has been Australia's listed property sector in recent years is a story in itself, but if we have to play favourites, it is hard to go past Centro, the property group with aspirations to be bigger than Westfield.

The $6.3 billion takeover of the US-based New Plan Excel Trust in early 2007 by Centro Properties, and its associate Centro Retail Trust, was one of the best transactions of the past decade - as long as you were a shareholder in New Plan.

For Centro shareholders, the history is one they would all prefer to forget.

Most of them probably will, after November 22 when they are asked to vote on the creation of the new Centro Retail Trust Australia, which will kill off the former Centro vehicles.

The investors who heralded the 2007 move into the United States and took up the $1 billion capital raising to pay for it will get - if they approve the November vote - all of 5? on the dollar.


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