Challenger in remarkably good shape, but shares need a shot of confidence

COMPARED with the more aggressive boom-time asset packagers, Challenger Financial Services has incurred remarkably little balance sheet damage in the credit squeeze.

Managing director Mike Tilley's early departure reflects that fact and the paradoxical one that Challenger's share price has been hammered anyway, losing almost $5, or 76%, from a $6.55 high last October to $1.595 in mid-March. After rising 16 to $2.41 yesterday, it was 63% below its peak.

It was only last October that Tilley's contract was extended until 2011, but that was before Challenger's shares dived, and before he raised new capital and cemented alliances with Japan's Bank of Tokyo-Mitsubishi and US-based asset manager Colony Marlin to put the 20% Packer-owned group in a position to endure the downturn.

Now, with Challenger's position stabilised but its shares still in need of a confidence rebuild, a baton change from Tilley to his deputy, Dominic Stevens, makes sense. Chairman Peter Polsen copped some flak about it at yesterday's press conference, but to paraphrase Keynes, the facts have changed, and the board and Tilley have changed their mind, too.

Challenger's move from a $255 million profit to a $44.2million bottom-line loss in the year to June 30 seemed to vindicate the share price plunge, but it mainly reflected mark-to-market changes in the running value of investments, and the numbers underneath the headline loss were healthier.

Assets under management were down only 1% to $43.5billion, normalised profit after tax was up 20% to $218million, and earnings per share on an expanded capital base were 12% higher.

The share price descent was associated with questions about the complexity of the asset packaging and managing model. But Challenger's asset mix now looks conservative, and Tilley leaves a group that can inspect a menu of potential acquisitions that the credit squeeze is producing.

It does have carte blanche, because its shares are heavily discounted, useful one would think only in an acquisition or merger with a group that is similarly discounted.

But its ability to pay cash for assets that have been driven into the bargain bin is not insignificant.

Almost $250million cash is sitting on the balance sheet, enough to leave Challenger with net debt of only $9 million, and gearing of less than 1% after the share placements to Mitsubishi and Colony in November that raised $270 million.

Undrawn loan lines total $350 million, and the group's life company has $750 million of capital above its minimum regulatory requirement after a $400 million issue of subordinated notes into the US private placement market in November.

Current market atmospherics militate against a big single acquisition and dictate that the full $750 million regulatory surplus in the life company not be tapped. Optimism and aggressive expansion are not being rewarded in this bear market, particularly if they involve major balance sheet re-gearing.

However, Tilley's precautionary balance sheet work late last year does allow the group to consider selective bolt-on acquisitions if it sees value, and to spend up to $1billion on expansion.

Asset sales can be considered, too, of course, but the thinking behind Challenger's recent successful recent defence against the attempt by British investor Vincent Tchenguiz to force a liquidation of the assets of Challenger's 32% owned Challenger Infrastructure Fund still hold. Asked at yesterday's analysts briefing whether Challenger would set a new course at the end of this month when Tilley formally steps aside for Stevens, Polsen said the board had signed off on Tilley's strategy, "and I can't see anything that would change".

Mind you, he also signed Tilley on for four more years less than a year ago - nothing is cast in stone in a market like this.

A separation payment of $1.75 million comprises most of Tilley's cash payout of about $1.9 million. Share-based entitlements that flowed in previous years (the 2007-08 share component will be reversed) are technically worth another $8 million - but only if Challenger's shares recover.

Chinalco hiccup

TREASURER Wayne Swan's clearance for Chinalco to own up to 14.99% of Rio Tinto plc and, by implication, 11% of the dual-listed Rio group, does not change the dynamics of BHP's bid for Rio.

They were set by early February, just after Chinalco acquired its initial 12% stake in Rio plc, equal to a 9% group shareholding. BHP boosted its offer to 3.4 shares per Rio share at that time, and said

that its bid would be conditional on acceptances of only 50%.

Chinalco can stop BHP moving to full ownership, but it cannot stop control passing - that was true in February and remains true today.

Swan's statement warned that "foreign sovereign ownership" raised particular concerns, and the clearance has if anything increased the degree of difficulty for those wishing to get in BHP's way, because Chinalco agreed not to go above the approved stake without asking again for approval, and not to seek Rio board representation for its approved holding.

The initial barrier for any group wishing to intervene

in the BHP-Rio takeover is therefore now 14.9% of

Rio plc, and 11% of Rio-at-large.

Stakes of that size can transfer into meaningful holdings in the merged group, and give customers a natural hedge against high commodity prices - but they can't on their own decide the outcome of the battle itself.

The Maiden family owns BHP shares.

mmaiden@theage.com.au