THE DISTILLERY: Stoked

Today we revisit the commentary bacchanal swirling around Kerry Stokes first observed some eight weeks ago (THE DISTILLERY: The Seventh circle, February 23).

Today, high priest of ceremonies is John Durie of The Australian, who's suspicion of the deal to-date disappears behind a swish of robes, to be replaced with admiration for Stokes' deal-making: "Hats off to Team Stokes. It has run this campaign with perfect precision ... [t]he art of good deal-making involves ensuring the other side thinks it has won concessions when in fact it was nothing but a sham. Under the deal, if WesTrac – the Caterpillar franchise – doesn't deliver promised 2011 earnings numbers, then Stokes will cancel 15 million of the 115 million shares he will pick up in the trade and his ownership will fall from 68 to 66 per cent ... The chances of Stokes missing the earnings target is next to zero given some 75 per cent of the sales are already in the bag and the Chinese business is weighted heavily towards sales rather than after-market service.”

Softly ringing bells herald the arrival of Stephen Bartholomeusz of Business Spectator who regards the "... solution to the impasse on the value – as opposed to the concept – of the merger terms is ingenious because it doesn't require Stokes to compromise on the value he will receive for selling his WesTrac group into Seven, but rather ensures that Seven's non-Stokes shareholders will get what they are paying for.”

Some acolytes remain skeptical. Matthew Stevens of The Australian adjusts his diadem and maintains the line argued by Bryan Frith eight weeks ago that the only thing connecting Stokes' two businesses is the man himself. That and the arcane convergence  of Seven's $1 billion in cash with WesTrac's $1 billion in debt.

Adele Ferguson of The Age wails from the edges that "... behind the rhetoric of yesterday's amended proposal sits a Clayton's sweetener. The new terms don't include an increased valuation, nor a guarantee that investors will be compensated if WesTrac loses its main asset, the sole dealership of Caterpillar in Western Australia, New South Wales, the ACT and north-east China.” Moreover, she says, "... investors [are] between a rock and a hard place. On the one hand, they can see that Stokes gets the benefits up front – he gets to merge WesTrac into Seven through a share swap that will leave him debt free and lift his stake in the new Seven Group from 48 per cent to 68 per cent – while everyone else has to wait for a re-rating of Seven after the transaction is completed. But if they vote against the deal, shareholders will be faced with the double whammy of a lower share price and the prospect that Seven has $1 billion of cash to spend. Investors will be unlikely to get the chance to vote on how that money is spent because it won't be a related-party transaction.”

Likewise, Ian Verrender of The Sydney Morning Herald rages from the shadows that approval by the two large minority shareholders "... may not be the end of the matter. Any decision reached at next Tuesday's meeting will have to be ratified by Justice Peter Jacobson in the Federal Court. And that could well prove to be the bigger challenge. The judge had misgivings about granting approval for the meeting to be held in the first place. He then made it clear that his approval should not be taken as a signal that he will simply ratify a 'yes' vote and allow the merger to proceed.”

Verrender continues to rave even as he storms to the neighbouring church and nails his list of demands to the door: "Independent expert reports have been a running joke for three decades, given they always endorse the actions of whoever hired them ... Seven hired an independent expert – Deloitte – to formulate an opinion on the transaction. To no one's dismay, Deloitte decided the merger was fair and reasonable; an opinion that was taken with a huge grain of salt by Seven's larger shareholders. Unfortunately for Deloitte ... RiskMetrics and CGI Class, both opined that the deal was a stinker ... Surely, the time has come to end this farce? Either restore the credibility of independent experts by breaking the nexus between them and those commissioning them, or save everyone the time and money and do away with them altogether. Courts regularly appoint receivers and liquidators after being petitioned by creditors. It would be no great leap for a similar system to be instituted for independent experts.”

This column can't help wondering why the two large minority shareholders have agreed so lightly. Guaranteeing one year of earnings in the WesTrac business is a paltry return for their leverage, especially given the awful long-term structure of combined media and earth moving assets. It either reflects poorly upon their judgement, or, whispers at some wildly bullish truth in the prospects of the new Stokes' entity available to insiders. Not knowing, anyway, makes the new entity highly speculative in this column's book. 

Elsewhere, governance issues are also emerging at Harvey Norman where newly proposed executive options packages have fallen under the eye of Alan Jury of The Australian Financial Review. "These options, if approved, will have much easier earnings growth performance criterion than their predecessors. This isn't, contrary to what some think, a proposal to reprice existing options – it's a whole new, much more generous proposition designed, in the words of chairman Gerry, to compensate the group for income forgone relative to their peers in previous years ... It's not just the directors that are suffering, however. Since July 1, 2007, Harvey Norman's investors have had a negative return of 23.5 per cent – 13.5 percentage points worse that the S&P/ASX200 Index, 39.5 percentage points behind retailing industry leader Woolworths and 122.5 percentage points behind the best-of-category-killer-breed JB HiFi. Some might look at such comparisons for the reason Gerry's crew are earning less that their peers.” Bravo Chanticleer.

Reading between the lines, this column wonders if chairman Gerry isn't also sensing the 'new normal' that this column has been banging on about. Higher rates, lower housing, credit growth and standards of living, and suffering retailers as far as the eye can see.