Friendly? I don't think so

PORTFOLIO POINT: Hastings shareholders are being told to sit tight and anyway APA can afford to sweeten the offer.

Hastings Diversified Utilities Fund (HDF). One side is trying to claim it’s a friendly bid while the other says it’s decidedly hostile, so who’s right? It’s all in the detail.

In this case pipeline owner APA Group tried to spin its roughly $2 per share cash and scrip offer as a friendly approach, but the Hastings board firmly rejected it and told its own shareholders to sit tight. The difference is whether anything has been sorted out in advance and if it hasn’t, if the two parties are close to agreement. Obviously in this case, neither clause was fulfilled so it’s hostile.

The $1 billion bid for the infrastructure fund consists of 50¢ cash and 0.326 APA shares for every Hastings share, and is a small 12.5% premium to the five-day volume-weighted average before it was revealed on Thursday.

The good thing is that I think APA can easily afford to increase the offer by another 20¢ cash to sweeten the Hastings board and shareholders. APA has plenty of cash and because it already owns 20.7% of Hastings it’s a deal that makes a lot of sense to complete now that it’s in the ether.

But there are two big details that could hold it up, and one less important one to think about if you’re planning on doing some Christmas M&A trading.

The first is that to get the most value out of this deal you have to be able to short APA because otherwise you’re exposed to a very nervous sharemarket through the scrip part of the deal. APA is not easy to short because it’s not widely available to borrow. Having said that, APA is also essentially an infrastructure fund so its share price is relatively stable.

The second factor is the ACCC. As I’ve discussed before, the competition regulator is considerably more unpredictable than it was before chairman Rod Sims took charge.

The deal is conditional on ACCC approval but by combining the two companies APA will create monopolies in certain areas of southeast Australia. We already know the regulator doesn’t like non-competing monopolies trying to band together (Foxtel and Austar, for example) so while APA and Hastings operate separate gas pipeline cartels in different regions, the merger would combine those two monopolies into one.

The third detail is that there is a market condition where if the ASX 200 falls below 3800 points APA has the option to pull out. These options aren’t exercised very often but a market fall of that extent would rule out a higher offer. You’ve also got to look at why the market has fallen: if the ASX 200 is just slumming it down in the mid-to-low 3000s then that may just be a low point in its trading range. It’s another thing entirely if the market falls because Europe has been declared fundamentally insolvent.

Nine Entertainment. You can’t play CVC’s problems with Nine on the market, nor the fallout when an agreement over what to do with the $3.6 billion of debt is reached, but you can learn a few lessons from it.

For a start you can forget about James Packer repeating history by buying Nine back on the cheap after selling it at the top of the market. His father Kerry sold the network to West Australian Alan Bond for $1.05 billion in 1987, then effectively bought it back for quarter of the price in 1990 (by converting the $250 million of the sale price that he’d left in the company as subordinated debt, for a 37% stake).

But James won’t do this and his exclamation last week that he’s not interested and that Seven is a much stronger TV network is not evidence of shadow boxing. In 1987 and 1990 the fundamentals of television were similar, whereas today’s free-to-air TV environment has changed massively compared to when James sold out of Nine in 2006. The internet, for example, is now a real competitor. The private equity syndicate that owns Nine has only just realised the world is changing underneath it, and I’m astonished it didn’t see this earlier.

What will happen now is that the circling hedge funds like Apollo Global and Oaktree Capital, which are buying up Nine debt, will force a restructure and probably a conversion of some of those loans into equity. This way they’ll wipe out the private equity holders in the hope that the sum of Nine’s parts really is worth more than the total debt.

What vulture funds have worked out is that if a company is heavily indebted, the debt holders can have far more power than equity holders – the owners of the company. What is odd about this is that while there are stringent rules around how much equity one entity can own before having to make a declaration or some kind of move, such as a takeover, or who can own what without getting the Foreign Investment Review Board involved, there are no rules around how much debt can be owned by a foreign company or one entity.

It’s rare that listed companies (and their shareholders) get into this kind of trouble, because if they need to raise debt usually the debt holders demand that they raise equity as well, diluting the power of the lender but also their total liability.

However, the two companies that I think will have trouble raising equity in the future are BlueScope Steel and OneSteel. BlueScope already had problems with its $600 million capital raising in November and both operate in a sector that, under the current circumstances, I just don’t see able to survive in Australia.

Flinders Mines (FMS). Last week I said the situation over at Flinders Mines HQ was looking shaky and any shareholders in the stock should sell as Russian bidder Magnitogorsk Iron and Steel Works comes under pressure from legal action, markets shudder and iron ore prices come off their highs, possibly for good.

I’ve had a think about it this week and my opinion has firmed. In a normal market you’d have the chance of another countering bidder entering but I think this opportunity has flown and given my concerns about how much we can trust the current bidder, which is being sued by a supplier, I think you should just take the 28¢. It’s not far from the 30¢ per share offer and I really don’t think you’re going to see those last two cents.

Bannerman Resources (BMN), Sundance Resources (SDL). And how about this for an unreliable, unconvincing bidder: everything I read about Sichuan Hanlong either argues that the company should be prosecuted for insider trading, as opposed to the executives, or reports that ASIC can’t get hold of some executives and has lost the managing director after he refused to return from a quick trip to China.

That Bannerman is undertaking a capital raising at 22.5¢ a share, when Hanlong has a 61¢ a share bid on the table, shows just how little confidence the board itself has in the offer and the suitor, while I think Sundance is the same.

I said not long ago to sell out of Sundance when it was at 43¢. Now it’s closed at 34¢ today (December 19), and I don’t think you’re going to see that 52¢ offered by Hanlong.

Ivanhoe Mines. Rio Tinto made it clear last week that it has no immediate plans to take over dual-listed Ivanhoe despite lifting its stake to 49% and after a ruling that the Canadian company can’t dilute Rio’s stake by issuing new shares.

Ivanhoe is Rio Tinto’s partner in the enormous Oyu Tolgoi copper and gold mine in Mongolia. Ivanhoe founder and CEO Robert Friedland struck a deal with Rio in 2006 to fund the mine (not the company’s only project, but certainly the biggest), which effectively handed the Australian miner the keys to the company with an initial 19.9% of Ivanhoe, the rights to acquire more shares in the future and a promise not to dilute Rio’s shareholding if it wanted to raise more equity in the future. Rio has slowly crawled up the register, though not without opposition as Friedland did his best to try to create a “poison pill” with a dilutory rights issue circumventing Rio.

Last week the independent arbitrator upheld the contract and said Ivanhoe couldn’t do this, and in doing so effectively gave Ivanhoe to Rio.

As a result, even though Ivanhoe’s Australian listing is quite small it’s definitely on my list of takeover targets, but – and this is important – just because Rio has the opportunity doesn’t mean it has to take it up.

When a company owns half of another, it doesn’t mean it has to make a move. It effectively has control (if not majority control) without the need to impose its own management or financing, rather than just account for it on the books as a shareholding.

Christmas M&A. It used to be the case that no one would do anything before Christmas because everyone would go away for a month and nothing would get done. Nowadays if a company wants to take another over, it will hire the advisers and lawyers and if they have to work on New Year’s Eve and Christmas Day, so be it.

I think this season will be quieter, though. The market feels pretty ugly as a pervading fear of Europe and the ill-fated steps its leaders might take over the festive season permeates sentiment. In certain resources sectors, such as coal, you may see a takeover lobbed on the quiet as Dai-ichi Life did with Tower Australia between Christmas and New Year last year, but taking a punt this time around, I’d say there won’t be so many popping up.

* China's fourth largest coal producer Yanzhou Coal is reportedly in takeover talks with Gloucester Coal, one of the companies I mentioned last week as one of my top 10 takeover picks for 2012. The local arm Yancoal Australia is discussing a backdoor listing of its Hunter Valley coal assets via a cash and stock bid that values Gloucester Coal at more than $2 billion. If it goes ahead, a merger could create the biggest independent coal producer in the country with a value of $8 billion. However, remember the track record of Chinese bidders. Yancoal is only talking to Gloucester at this stage and I've said many times before that suitors from China are not quality bidders and tend to run at the first sign of trouble; just look at Hanlong's offer mentioned above, China Guangdong Nuclear Power's not wholly convincing attempts to buy Kalahari, and Wah Nam's piecemeal takeover of Brockman Resources. Nevertheless this is an interesting situation: it's in a booming resources sector, it involves a company that fulfils the criteria on my potential takeovers list, and the major shareholder, Hong Kong's Noble Group, has tried to sell before, to Macarthur Coal before bidders became interested in it instead.

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

-Takeover action, December 12-16, 2011
Date	Target	ASX	Bidder	(%)	Notes
13/12/11	Adelaide Energy	ADE	Beach Energy	94.79	Ext to Jan 9
07/12/11	Anvil Mining	AVM	Minmetals Resources	40.10	Lock up deal on 40.1%. Ext to Jan 11
09/12/11	Contango Capital Partners	CCQ	Contango Micro Cap	72.82
16/12/11	Gold One International	GDO	BCX Gold Investments	82.80	Unconditional
15/12/11	Hastings Diversified	HDF	APA Group	20.71
21/11/11	Laguna Resources	LRC	Kingsgate Consolidated	97.06
18/07/11	Mintails	MLI	Seager Rex Harbour	37.33
16/12/11	MSF Sugar	MSF	Mitr Phol Sugar	22.01	FIRB approves
05/12/11	NSX	NSX	Financial & Energy Exchange	50.80	Closed
13/12/11	oOh!media	OOH	Champ III Funds	19.60
14/10/11	Signature Metals	SBL	LionGold	19.90
12/05/11	Sphere Minerals	SPH	Xstrata	75.29	Unconditional
Schemes of Arrangement
12/12/11	Aston Resources	AZT	Whitehaven Coal	19.99	Vote late Mar
08/12/11	Austar United Communications	AUN	Foxtel	0.00	Vote Feb 17
16/12/11	Bow Energy	BOW	Royal Dutch Shell/PetroChina	0.00	Vote Dec 21. Cleared by ACCC, FIRB, PRC
29/08/11	Auzex Resources	AZZ	Bullabulling Gold	0.00	See GGG Resources - 50/50 merger
25/11/11	Flinders Mines	FMS	Magnitogorsk Iron and Steel Works	0.00	Vote Mar 1
29/08/11	GGG Resources	GGB	Bullabulling Gold	0.00	See Auzex Resources - 50/50 merger
14/12/11	Souls Private Equity	SOE	Washington H Soul Pattinson	13.36	Approved
11/10/11	Sundance Energy	SDL	Hanlong Mining Investment	17.99
Reverse Takeover/Scheme
16/12/11	Bondi Mining	BOM	World Titanium Resources	0.00	Court approves
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-Nov
Foreshadowed Offers
27/09/11	Bannerman Resources	BMN	Sichuan Hanlong	0.00	Conditional proposal. Talks continue
05/10/11	Charter Hall Office REIT	CQO	Macquarie Capital consortium	0.00	Indicative offer. Further due diligence
29/09/11	CSG	CSV	Unnamed party	0.00	Indicative offer
07/10/11	CSG	CSV	Other unnamed parties	0.00	Expressions of interest
17/10/11	Customers	CUS	Unnamed party	0.00	Non-binding discussions
08/12/11	Endocoal	EOC	Unnamed parties	0.00	Unsolicited approaches
05/10/11	New Hope Corp	NHC	Unnamed parties	0.00	Proposals invited
06/06/11	Pulse Health	PHG	Unnamed party	0.00	Expression of interest
01/12/11	Spotless Group	SPT	Pacific Equity Partners	19.64	Revised proposal

Source: News Bites