Shortening Packer's Echo odds

It's not the ideal way to mount a takeover defence. Under siege from James Packer, Echo Entertainment has foreshadowed a lacklustre full-year trading result that will be studded with some big buckets of non-trading red ink, including $30 million of losses that are a gift to the Packer campaign.

With Packer requisitioning an extraordinary meeting of shareholders earlier this week to try to remove Echo's chairman, John Story, and insert former Victorian Premier Jeff Kennett into the Echo boardroom, the last thing Echo needed was more bad news.

Packer's strategy for getting control of Echo without actually making a takeover bid is based on his assertions of poor management and governance within Echo and its poor performance relative to his own casinos in the past.

It is a campaign with shallow foundations, given that Echo, spun out of the Tabcorp group last year, is in the final phase of a near $1 billion redevelopment of its flagship casino complex, The Star in Sydney, as well as in the relatively early phase of a push into what was once a Crown stranglehold, the international VIP gambling market.

In the absence of a meaningful control premium, that was a campaign that was going to struggle to gain traction, particularly as an inquiry into the sacking of The Star's former managing director after sexual harassment claims made no adverse finding against Echo and, indeed, said it had acted appropriately.

Packer's best shot is to convince enough shareholders that he can compensate them for the absence of a control premium by creating enough extra value by managing The Star and Echo's Queensland casinos better than Echo to get to get effective control of the board and management off a less-than-controlling stake.

In the longer term, assuming he could also convince the NSW and Queensland governments to let him get to that first base, he could cement that position by "creeping" his way to unchallengeable control.

Unhappily for Echo, it has just given Packer some more ammunition for the advertising campaign that started yesterday.

After the close of trading yesterday, and following an apparently unscheduled board meeting held to respond to the requisitioning of the EGM, the Echo board put out a statement announcing the EGM would be held on 20 July and that it would recommend shareholders vote against both the resolution to remove Story and the proposed appointment of Kennett.

It also, however, provided a trading update. Trading conditions in the second half remained difficult and revenue had been affected by soft consumer sentiment and weak demand.

Gross revenue was up 3.1 per cent in the year to 28 May and The Star's revenues were up 5.5 per cent, with trading in the third quarter negatively impacted by the (extremely) negative media exposure that accompanied the inquiry. Gaming volumes and revenue growth had accelerated in May and the company remained optimistic about the Star's outlook, while the Queensland casinos' revenue growth remained subdued.

That's not very exciting, coming off the relatively ordinary results Echo produced in the first six months of the year, but it is consistent with what the market might have expected as The Star redevelopment progresses and Echo management had publicly referred to the impact of the inquiry on the business.

The unexpected development relates to $29.9 million of losses that appears to have come out of the blue.

Echo directors said one of the group's marketing partners for international rebate players, SilkStar Global Marketing, had been placed in liquidation in March. Echo had paid it a development fee and pre-paid commissions when it launched its international rebate business in January last year. As of March, $7 million of these fees had not been amortised or repaid. Echo will provide for the loss of the $7 million.

Worse, some of the international VIPs introduced to Echo by SilkStar owe money to Echo. After a review Echo decided to increase its impairment provisioning against those customers. The write-offs and provisioning against those customers amounts to another $22.9 million, bring the total of losses/provisions to almost $30 million.

As previously foreshadowed, Echo has started a cost reduction program, which will result in a $10 million charge against pre-tax profits this year, while pre-opening expenses relating to opening of The Star have increased from $28.6 million at the half-year to $38 million for the full year.

In other words, the Echo full-year result, already lacklustre at best, is going to be disfigured by the SilkStar fiasco and the other significant items/losses.

While the underlying story (no pun intended) Echo has to tell its shareholders as it attempts to fend off Packer isn't altered by the disclosures – what matters is how The Star performs once it is fully operating and how well the international business fares once it is more mature – there is no doubt that Packer will seize on the disclosures to buttress his claims of mismanagement and incompetence.

His campaign as it currently stands might still have the odds against it, but they have been shortened a little by the nasty surprise Echo provided last night. Some guys have all the luck.