The Distillery: Envestra confidence

APA Group chief executive Michael McCormack has built the company up from single digit employees to something jostling for a spot in the top 40 listed Australian companies. The gas pipeline operator’s merger proposal with Envestra is a logical next step and is unlikely to be derailed by a rival proposal.

Also in this morning’s edition of The Distillery, the politics of climate change and the carbon tax get some much needed attention from the business writers.

But first, The Australian Financial Review’s Michael Smith notes that after getting the hard-fought acquisition of Hastings Diversified Utilities Fund down, it was only a matter of time before APA’s McCormack made his next move.

“It is easy to see the logic in McCormack’s move, which would give him control of Envestra’s 22,500 kilometre gas distribution network which APA already operates and manages. Envestra only has 14 employees while APA has several hundred staff who look after the assets. This means cost savings, which McCormack expects will come in under $5 million, have very little to do with this deal. It is all about getting the critical mass to give APA more muscle to raise capital and invest in future growth.”

Smith also notes that before McCormack took over at APA, he was a professional musician. Perhaps he knows how to play 'Classical Gas’.

The Australian Financial Review’s Chanticleer columnist Tony Boyd similarly remarks on the achievements of McCormack and the managerial philosophies that have driven him.

“At a time when the predominant capital flows in the world of funds management are shifting from active stock picking to index tracking, McCormack shows the wisdom of backing a quality management team and sticking with it. Investment fundamentals cannot be ignored, including analysing balance sheets and profit and loss statements for signs of looming problems or confirmation of past mistakes. But those seeking to build their retirement assets through investment in the sharemarket should not ignore the simple strategy of doing due diligence on the managers, buying the stock, then never selling.” 

The Australian’s John Durie recounts that APA was spin-out of AGL Energy, while Envestra, which is very much a regulated business, came from Origin Energy.

“This is what attracted Hong Kong-based CKI to the stock, which raises the question just why it would now want to swap its 17 per cent Envestra stake for roughly 3 per cent of APA. It just depends on who you talk to, but if McCormack can swing the deal he will be able to swing the balance at APA back to about 50 per cent regulated and 50 unregulated. His Hastings deal pushed the balance to about 30 per cent unregulated. Regulated assets are favoured by some as providing more consistent cash flows because, by definition, they are mostly monopoly assets with predictable cash flows. But a balanced portfolio makes sense.”

Business Spectator’s Stephen Bartholomeusz has quickly run the numbers and uncovered that this is a nil-premium takeover, which presents the target’s board with some difficult questions.

“No doubt the independent directors of Envestra will want to try to understand the value of those benefits in order to determine whether there is a sufficient uplift in value for them to recommend the proposal to their shareholders despite the absence of a change of control premium. Given that APA is proposing that the transaction should be effected via a scheme of arrangement, the stance of the independents will determine its fate. One of the major reasons why nil-premium mergers are rare is that they are dependent on the support of the target’s directors and are also acutely vulnerable to a counter-bidder.”

Bartholomeusz knows full well that there’s little chance of a counter-bid, but we’re going to leave that explanation to Fairfax’s Adele Ferguson, who has a great approach to it.

“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, which owns just over 17 per cent, could block the deal, it is unlikely to make a counter offer.”

The other big issue doing the rounds this morning is the scrapping of the carbon tax in favour of an early introduction of an emissions trading scheme.

While the general opinion pages are chock-a-block with political analysis, the business pages tackle the obvious economic and budgetary implications of this political move.

Fairfax Media’s Malcolm Maiden explains how the promises from returned Prime Minister Kevin Rudd for lower electricity prices aren’t in step with the goal of reducing emissions.

“Bottom line: if carbon dioxide emissions reduction is the end game, significantly higher energy prices are inevitable, with the steepness of the curve dependent on emissions targets, and how heavily the supply of permits is restricted – here, but also in Europe, where emissions targets so far only stretch to 2020. Any short-term relief that flows from an early link to Europe's system will be a political fig leaf.”

The European system is a disaster as everybody knows and The Herald Sun’s Terry McCrann puts Labor’s current senior members to the test for their claims that electricity prices will be lower under the European carbon price.

“Who knows what that will be? Well, apparently the prime minister, the treasurer Chris Bowen, and the climate change minister Mark Butler do. The trio put their names to a statement which contained quite possibly the most fatuous sentence ever included in a formal Australian government statement: ‘Under a floating price, the (carbon price) figure (next July) is expected to be around $6 a tonne.’ Perhaps Messrs Rudd, Bowen and Butler would be so kind as to tell us what the price of a BHP Billiton share will be next July, so we can all profit by buying or selling now.”

And The Australian Financial Review’s economics editor Alan Mitchell is at a loss to explain why the compensation for the Carbon Tax is being kept in place if the tax itself is being removed.

“…Kevin Rudd’s carbon tax package is symptomatic of a problem that shows too little sign of taking care of itself. Like Tony Abbott, Rudd is proposing to cut the Gillard government’s carbon tax without cutting the compensation to lower income households. The resulting revenue cost to the budget is to be covered by a raft of savings that should have been made anyway. Yet again, Rudd is making savings only to use the money to buy votes – in this case, with an effective tax cut. And why are households to be compensated for a tax that no longer exists?”

Meanwhile, The Herald Sun’s McCrann says in a separate piece this morning that the Reserve Bank’s latest minutes confirm his view that the central bank still has an easing bias, but there has been an “easing of that easing bias”.

In company news, Fairfax’s Elizabeth Knight has thought about it a little bit more and she’s just flabbergasted that Treasury Wine Estates could have thought that millions of litres of wine had been sold to US consumers when it was actually sitting in warehouses and on supermarket shelves.

“How do you misplace that much wine without management knowing? Surely the chief bean counter should know, but he was quietly replaced last month with no explanation.”

And finally, Fairfax’s Michael Pascoe savages Queensland’s Sunshine Coast Council for locking the Woolworths Masters hardware chain out of Noosa, which is de-amalgamating from the Sunshine Coast, and protecting Coles’ Bunnings and Metcash’s Mitre 10.