When hedge funds steer clear of a takeover offer it is a fair bet that a second bidder, a takeover battle or a counter offer has Buckley's chance of happening. In the case of APA Group's all scrip takeover offer for Envestra on Tuesday the hedge funds showed minimal interest.
The reason is simple: APA's offer is about taking control of a group of assets that it already effectively controls. APA holds a 33 per cent stake in the gas distributor and is the external manager of the Envestra portfolio of assets.
In listed infrastructure language that makes it a poison pill against potential takeover offers. It means that Envestra trades without a takeover premium and it means that while Envestra's second-biggest shareholder, Hong Kong-based Cheung Kong Infrastructure (CKI) which owns just over 17 per cent, could block the deal, it is unlikely to make a counter offer.
Indeed for CKI, which is generally not a passive investor, it could facilitate an exit plan. If the deal goes through at the current offer of 0.1678 new APA stapled securities for each Envestra share, it would reduce CKI's shareholding in the merged entity to around 5 per cent.
It explains why APA's offer at first blush might look meagre - a 1¢ premium to Envestra's last closing price before the merger proposal was announced and a discount to where the stock closed post the announcement. It also explains why APA can make a non-binding and highly conditional offer to the board that is so aggressive and why the hedge funds decided that even if APA comes back with a better offer, it won't shoot the lights out.
One of the conditions is getting full board approval, while another is being able to refinance Envestra's $2 billion of debt, which is unlikely to pose a problem. For APA it is about taking an asset it controls and merging it to create a top 40 company that will attract more foreign investors and make it easier to access the global debt markets.
APA got a taste of "big is better" almost a year ago when it won control of the Hastings Group, which created the country's biggest gas pipeline operator and put it on the global index fund map.
If it can pull off Envestra it will turn it into a $6.6 billion entity, which is a far cry from the $200 million business it was just over a decade ago when it was spun out of AGL. It will also claim immediate cost savings of an estimated $13 million by removing internal management costs at Envestra, which is equivalent to 1¢ a share.
Mopping up Envestra, which is 90 per cent regulated assets, would rebalance APA's portfolio of assets, making it a 50:50 mix of regulated and unregulated assets. APA's portfolio is heavily skewed towards unregulated assets (70 per cent unregulated) following the merger with Hastings. While unregulated assets provide a better return, they are more volatile than regulated assets which have price controls and therefore regular income streams that more investors are showing an appetite for.
Envestra is one of Australia's largest natural gas distribution companies, owning networks in South Australia, Victoria, Queensland and NSW, serving an estimated 1.2 million gas consumers.
In a conference call to investors and analysts on Tuesday, APA chief executive Mick McCormack stressed that the merger proposal was always on the agenda, it was just a matter of timing. He also reminded investors that during the GFC, APA underwrote a rights issue for Envestra, "which no other institution was willing to support". This saw APA's interest increase from 19 per cent to more than 31 per cent.
McCormack has been with the company since it listed in 2000 and has overseen a total return of 845 per cent compared with 173 per cent from the ASX200. He will no doubt be using this along with the company's effective control of Envestra as key weapons in his artillery when he tries to get shareholders to back his plan to create the biggest infrastructure company on the ASX.