Conduct unbecoming

PORTFOLIO POINT: Two takeovers have been destabilised by bidders’ stupidity and greed.

Sundance Resources (SDL). The Hanlong-Sundance insider trading scandal that burst on to the Australian marketplace last week has emphasised some of the risks involved in trading a Chinese takeover – albeit one at the extreme end of the spectrum – and how little the Chinese understand the rules of the game.

Three executives of the Sydney-based subsidiary of Sichuan Hanlong Group – Hanlong Mining – were accused of using knowledge gained from the takeover talks with Sundance for the purposes of insider trading. ASIC said the managing director, vice-president and another employee used CFDs to make almost $2 million in profits.

So where does this leave the deal? The fact that the parent dispatched group vice-president Kang Huan Jun to sort out the mess tells me that the deal is still afoot, but while Sundance says it’s business as usual, Hanlong is now in a very uncertain position about whether it can close a deal.

Sundance never accepted this bid and said 50¢ a share ($1.44 million) undervalued the company. Reports are appearing that Hanlong doesn’t have financing in place to pay for Sundance, that the Chinese regulator may take another look at whether the company is best placed to make the bid (and whether it might allow another company to make an offer instead), and there will be considerable pressure on the company because this whole episode is embarrassing for China.

I would sell out now. If the bid doesn’t go through the stock will fall and although Sundance, being an iron ore miner with some very good assets, could be worth much more in the long run the Hanlong situation has just got murkier. The stock closed on Monday at 44.5¢, which is around where it has been since the bid was announced – bar one or two market shocks – so you can get out at no loss if you bought in for the takeover.

Hanlong had wanted to become the next big force in iron ore, following Fortescue Metal’s example, and I don’t think this will put other Chinese companies off investing here. What it reveals is that Chinese companies don’t understand the rules that Western companies take for granted, such as that insider trading is beyond the pale and will earn a prison sentence or a hefty fine.

In saying that, insider trading is more pervasive everywhere than has been revealed by regulators to date. Often in the days before a deal is announced there will be a spike in trade, so clearly someone is leaking, but it’s hard to prove whether people were using inside knowledge or just following a trend upwards. And, as in this case, they were smart enough (or stupid enough) to use derivatives and options to cover their tracks, because it puts another layer between ownership of the actual share and the person behind the trade.

ConnectEast (CEU). This deal has suddenly moved on to shaky ground. Up until last week all was well, until major shareholder Lazard, backed by long-term institutional investors Future Fund, Magellan and Colonial First State, made it clear they would not accept 55¢ a share.

Given these companies all bought in around 30-50¢ you’d think 55¢ would be a good deal for their combined 14% – unlike the retail shareholders who bought in at the IPO at $1. But they think ConnectEast is worth closer to about 70¢ and bidder CP2 is digging its heels in saying subsidiary Horizon won’t be offering any more.

If it were Transurban bidding they could be confident that the bidder could happily lift the bid using scrip knowing the combination of the two companies’ toll roads would eventually deliver a return on their investment. But CP2 is a private equity company, which means each investment must stand up on its own merits and they have to be highly disciplined. It may also fear that being forced into paying more for ConnectEast could mean future targets would try and dictate terms. The financiers behind the takeover – many of them being sovereign wealth funds – are probably not prepared to give up more money on the basis of what the investment fundamentals of the final business would look like.

But at this stage if I had bought in on the prospect of a quick gain I’d be selling out. The offer is 55¢ so your upside at Monday’s close is 14.58%, while your downside could be as low as 40¢ or 20%.

Given Lazard was the leader of the block that foiled CP2’s consortium bid for Transurban, it would be feasible that it might support a scrip bid by that company for ConnectEast. This is the advantage Transurban has over CP2: it can bid with scrip if it wants to; if you own both companies in a takeover it's effectively a consolidation so you don’t have to pay capital gains. I don’t know why Transurban didn’t counterbid this time, but it may be that they just didn’t want to have to go up against a 35% shareholder and create a bidding war.

Echo Entertainment (EGP). Another report came out last week from an investment bank trying to persuade James Packer that buying Tabcorp’s former casino arm, Echo Entertainment, would be an excellent idea for Crown.

This isn’t a new thing: the demerger took place to make Echo more attractive as a takeover target and being a third of Crown’s size, the bigger company could easily swallow it. They are also a natural fit and, as the UBS report said, could equal savings of up to $50 million each year.

The real questions are whether Packer with his 43% wants to entrench Crown’s position further in Australia or keep throwing money at the bright lights of Macau, and whether the competition regulator in its scatty state would let it through.

The reason why Packer might want to buy Echo is that each casino is an effective monopoly. This is in contrast to Macau where the market is incredibly competitive and each casino you build has to be bigger, brighter and gaudier than anyone else’s to attract attention. Australian casinos are lucrative money-makers with protected turf.

Ordinarily this deal shouldn’t worry the ACCC because each casino only competes for high rollers – it’s not like your average punter is going to jump on a plane to go to Star in Sydney instead of their local in Perth. Each one is also heavily regulated by the state governments too, which like to see them as money boxes. But then again, as I discussed last week, who knows what the ACCC thinks about things at the moment.

Keep an eye on both of these companies; this is a situation to watch.

Macarthur Coal (MCC). Some of you might be wondering whether this deal will ever end, and I’m afraid it’s just got slightly longer as PEAMCoal, the creature Peabody and Arcelor Mittal created to make the now $16-plus-dividend bid, has just extended the offer deadline to October 14 from September 27.

Inclusive of ArcelorMittal’s 16%, shareholders have turned over a mere 17.34% of the shares on issue to the bidders as of Thursday, so clearly Peabody wants to give the major shareholders as much time as possible to make their decision.

As a retail shareholder you’ve missed your chance to play this one. At $15.95 on Monday there is only 1.32% in it, and in this market when those are your returns, you’re better off keeping your powder dry.

Foster’s Group (FGL). SABMiller should produce its bidder’s statement for Foster’s this week and it will explain exactly why it thinks $4.90 a share is a decent price for the company.

Here’s what you can expect to see: it will take into account Foster’s historical price and the price/earnings multiple, and compare it to other international brewers, as well as compare it to the deal done for Lion Nathan a few years ago. It will say management is unproven (because Foster’s only demerged this year) and that past management wasn’t much good anyway.

SABMiller will talk the company down but not so much that people question why it wants to buy Foster’s, and will point to the brewer’s current share price and say it’s only the bid which is holding it up (which is true).

This is not a great deal now because, if SABMiller does lift it to about $5.20 as I think it will, you’re going to make about 5.91% if you buy in at the Monday close of $4.91. It’s good in that I still think it’s one of the few available where you’ll get something a bit more.

Tom Elliott, a director of Beulah Capital and MM&E Capital, may have interests in any of the stocks mentioned.

-Takeover action, September 12-16, 2011
Date	Target	ASX	Bidder	(%)	Notes
13/09/11	Crescent Gold	CRE	Focus Minerals	78.79	Unconditional.
16/09/11	FerrAus	FRS	Atlas Iron	74.17
17/08/11	Foster's Group	FGL	SABMiller	0.00
26/08/11	Geothermal Resources	GHT	Havilah Resources	42.32
26/08/11	Gold One International	GDO	BCX Gold Investments	19.88
12/09/11	Hunnu Coal	HUN	Banpu Minerals	0.00
12/08/11	Macarthur Coal	MCC	Peabody/ArcelorMittal	16.07	FIRB Clearance.
15/09/11	Minara Resources	MRE	Glencore	73.54	Unconditional.
18/07/11	Mintails	MLI	Seager Rex Harbour	37.33
29/08/11	Northern Energy	NEC	New Hope Corp	97.95
12/09/11	NSX	NSX	Financial & Energy Exchange	45.71	Unconditional.
02/09/11	QMastor	QML	Triple Point Technology	0.21	Ext to Oct 7. Unconditional.
12/05/11	Sphere Minerals	SPH	Xstrata	75.29	Unconditional.
x
Schemes of Arrangement
22/08/11	Adamus Resources	ADU	Endeavour Mining	0.00
22/07/11	Austar United Communications	AUN	Foxtel	0.00	ACCC raises competition issues.
29/08/11	Auzex Resources	AZZ	Bullabulling Gold	0.00	See GGG Resources - 50/50 merger.
22/03/11	Cash Converters	CCV	Ezcorp	33.00	Offer for controlling 53%.
26/08/11	Coal & Allied Industries	CNA	Rio Tinto/Mitsubishi	85.00
29/08/11	ConnectEast	CEU	CP2	35.01	FIRB clearance.
15/06/11	Conquest Mining	CQT	Catalpa Resources	0.00	Vote September.
01/09/11	Count Financial	COU	Commonwealth Bank	19.90	Incl deed with chairman for his 17.74%.
19/08/11	DKN Financial	DKN	IOOF Holdings	18.49	Vote September 27.
18/07/11	Eastern Star Gas	ESG	Santos	20.90
29/08/11	GGG Resources	GGB	Bullabulling Gold	0.00	See Auzex Resources - 50/50 merger.
31/08/11 x	Rock Building Society (The)	ROK	MyState	0.00
Backdoor Listing
14/09/11	Consolidated Steel	CGQ	CFT Holdings (HK)	0.00
12/08/11	Millepede International	MPD	Cool D'Fine	0.00	Marine HVAC provider. Vote mid-October.
Foreshadowed Offers
11/07/11	Bannerman Resources	BMN	Sichuan Hanlong	0.00	Conditional proposal
22/08/11	Bow Energy	BOW	Royal Dutch Shell/PetroChina	0.00	Indicative proposal.
29/08/11	Charter Hall Office REIT	CQO	Macquarie Capital consortium	0.00	Indicative offer.
10/08/11	Cooper Energy	COE	Unnamed parties	0.00	Preliminary talks.
02/09/11	Lochard Energy	LHD	Unnamed party	0.00	Takeover talks.
25/05/11	MacarthurCook Property Securities	MPS	P-REIT (BlackWall)	0.00
06/06/11	Pulse Health	PHG	Unnamed party	0.00	Expression of interest.
18/07/11	Sundance Energy	SDL	Hanlong Mining Investment	0.00	Proposed scheme.

Source: News Bites