Packer takes a punt on Echo

PORTFOLIO POINT: James Packer will have some hoops to jump through if he wants to take over Echo Entertainment, but there's no doubt it's a natural fit for Crown.

Echo Entertainment Group (EGP). James Packer’s raid on Echo’s share register is an unmistakable example of why you should always watch those strategic stakes – they can be telling if you’re in the game of predicting takeovers.

On Friday, Packer’s Crown Casino lifted its stake from 4.9% to 10% in Echo, and it’s fairly obvious he wasn’t doing it for the staff super fund.

Packer is now applying to the NSW Casino, Liquor and Gaming Control Authority to lift the 10% ownership cap on the casino company in order to lift his stake to 19.9%. The plan is to build a $1 billion hotel and second casino on the Barangaroo site, across Darling Harbour from Sydney’s Star casino. The Townsville, Brisbane and Gold Coast casino are equally attractive because entire entertainment complexes can be targeted towards either high rollers or local punters.

But it’s not a takeover yet. In the long run there’s probably more to this, but right now it’s definitely just a target. The main thing about strategic stakes is that they represent a commitment of money: it has to be around 5% or more and owned by an industry player or someone who’s going to do something with it.

Packer fits the bill of industry player because he already owns the other half of Australia’s casino market, but I don’t think he’ll make a takeover offer immediately because he has some hoops to jump through first, including ACCC approval and getting rid of the ownership cap.

I don’t think the removal of the 10% share ownership cap will be a problem because Packer already has probity for casinos in other states in Australia.

The ACCC shouldn’t be a problem either. The only casinos in Australia that compete with each other are on the Gold Coast and in Brisbane – and they’re both owned by Echo. Each casino in Australia is a regulated monopoly so there’s no reason why the competition regulator should oppose a Crown takeover of Echo.

The third thing is why Packer would want to own his only rival in Australia. Crown has chucked a lot of money away on overseas markets, including Macau and Las Vegas, and the great thing about Australia is that there will only ever be one casino in each city so there isn’t the hard-core competition here that there is in those other markets.

Echo chairman John Story, known for being a hard negotiator, is opposing giving Packer a board seat if he gets to 19.9%, on the grounds that it amounted to giving him control without a premium being paid for the company.

This is rubbish. If you own over 15% of the stock you can legitimately demand a board seat but these two things do not amount to control – you have a say but all board members’ votes are equal. And if Packer chooses to make a bid, then it’s up to the shareholders, not the board.

As for Story’s claim that a foreign outfit could be interested in Echo, a lot of people have burnt a lot of money on overseas gambling ventures – just look at Chinese billionaire Stanley Ho and Las Vegas entrepreneur Steve Wynn. But even more than that, although it’s not impossible for a foreigner to own Australian casinos, it would be difficult for them to pass the probity test. Crown is the natural owner of Echo.

Ludowici (LDW). Ludowici is the gift that just keeps on giving. Last week, UK company Weir Group not only matched the FLSmidth cash offer of $10 a share, but the Danes then countered with a dollar more to bring their proposal to $11.

Technically, all FLSmidth bids are subject to a Takeovers Panel decision on whether the company’s CEO wrecked its chances to make a counter bid, by indicating to Reuters that the initial $7.20 may be final. Weir keeps saying the bids from its rival aren’t valid – but they obviously are because otherwise Weir wouldn’t keep matching them. Now that there are three bids above the starting offer, the argument over whether FLSmidth should be allowed to counter Weir has been lost.

As I said last week, the Takeovers Panel will err on the side of getting a better deal for shareholders, so if Weir wants Ludowici, they’re just going to have to pay up.

And I know I said last week that while you could still buy in at $9.70, it wasn’t as good as when I initially spotted it at $6.77 – but there’s a 50/50 chance that Weir will make an offer higher than $11. The stock is trading at $11.04, so you’ve got very little downside if they don’t.

I’m starting to lose track of what it is that makes Ludowici so valuable. It’s a well-run company but is it worth 30-35 times earnings?

In saying that, Weir Group and FLSmidth are large businesses and this whole deal is only worth $388 million so they can easily afford it.

Hastings Diversified Utilities Fund (HDF). This deal has been slumbering along, but perhaps awakened by two events last week that may get things moving again.

Gas pipeline infrastructure owner APA Group made a hostile cash and scrip bid for Hastings back in mid-December of 50c cash and 0.326 APA shares for every one of the target’s; it’s worth about $2.06 by today’s share price. This was rejected by the Hastings board as being inadequate, which says that decision is supported by Hastings’ smaller full-year net loss ($29.8 million, reported last week).

Furthermore, APA also said last week that Hastings’ debt refinancing of $1.375 billion fulfilled a key condition of the bid and that it might think about raising its offer after the competition regulator announces its decision on the deal.

I think there’s a reasonable chance of a higher offer here. It won’t be massively higher because unlike Ludowici, the intrinsic value of Hastings lies in the infrastructure it owns and that’s priced into its shares, but the value it could create as part of an Australia-wide monopoly is where the premium lies.

Where that extra compensation for a higher offer comes from depends on APA’s balance sheet. If they decide to offer more scrip, they run the risk of diluting their own share price by the value of the raised bid; it’s like printing money – you can’t do it without consequences.

Target boards can also cast aspersions on the value of their suitor’s scrip, but you can’t argue with cash. I think APA will be more likely to put some more cash in front of shareholders to get this deal across the line.

The ACCC will probably approve the deal because like telecommunications businesses, pipeline owners are heavily regulated. It may not be desirable to have a monopoly, but it’s not going to do anyone much harm either.

The key problem here is that three quarters of the bid is scrip. If you want to play this one conservatively you have to be able to short APA and buy Hastings shares and if you can’t do that, I’d question whether it’s worth getting into.

Billabong International (BBG). As everyone expected, the Billabong board has rejected the $3-a-share takeover proposal put to it from TPG Capital, effectively accusing the US private equity group of making a low-ball bid that didn’t contain a change of control premium. Founder and 13% shareholder Gordon Merchant also refused to accept the offer for a company that’s seen $9 a share within the past 12 months.

I think $3.50-4 will be enough to tempt the board into acquiescence, but there’s always the unknown of whether TPG is prepared to pay more – we all know how leery private equity is of lifting their offer and paying too much.

Nevertheless, I can see now why private equity groups (including Kohlberg Kravis Roberts, according to the rumours) might be interested in a clothing wholesaler and retailer.

Billabong made a wrong turn when it decided to own its own stores. Not only has bricks and mortar retailing been on the nose for some years, but the company also stocked rival brands in the stores it owns such as Surf Dive 'n’ Ski, which to me is ridiculous. What I think these private equity groups are looking at is taking the company back to being a wholesaler and reducing all costs and overheads.

This one is not for the fainthearted and there is considerable downside to the share price if TPG walks away. The fact that Billabong just sold half of one of its best brands, Nixon, to save it from destitution shows that the takeover and the company are not without risk.

Virgin Australia Holdings (VBA). We usually think of duopolies as a licence to print money, but airlines are always the exception to that rule.

During its results announcement, CEO John Borghetti said Virgin Australia was thinking about splitting the company into an unlisted international carrier and a domestic carrier, and opening the way to a takeover offer appearing.

Ultimately the reason, so the media says, is to make it possible for Etihad Airways, or any other overseas party, to get around the 49% foreign ownership laws and fund an “assault” on Qantas’ stranglehold on Australian domestic routes. This is why Virgin is attractive: it’s the only way another airline can buy access to the Australian market without going down the painful route of setting up their own carrier. Moreover, 26% owner Richard Branson is probably a seller.

But I’m sceptical that the companies touted are going to be allowed or willing to buy it.

Air New Zealand owns 19.9%, giving it the all-important strategic stake. However, people keep forgetting that it was bankrupt just a few years ago and is still 75%-owned by the New Zealand government, which bailed it out and wouldn’t be overly impressed to be bankrolling an acquisitive business operating in one of the riskiest industries available.

For people out there interested in speculating on a takeover of Virgin, I’d ask whether in the absence of a real bid this is a company they want to own.

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

*News Bites' Takeover action will return next week.