THE DISTILLERY: Too much sugar

There are times, make no mistake, when writing this column is a trial every bit as difficult as that undergone by CSR overnight. Today, almost everyone writes on the failed demerger. Rather than repeat the already endlessly repeated details, following is a summary of what the judgement means for the future of the company.

Option one is a legal challenge. Elizabeth Knight of The Sydney Morning Herald reckons CSR's "... most likely initial response will be to appeal against yesterday's judgment.” John Durie of The Australian, however, counters that "...courts have long declined to enforce contracts that breach public policy and commercial morality, and Justice Stone simply applied the same logic. CSR will struggle to find a case to appeal this judgment and will now consider commercial alternatives”. He reaches this conclusion despite describing Justice Stone as "a former law lecturer whose politics seem to lie to the left of Genghis Khan”. Matthew Stevens of The Australian adds that any legal challenge "... would potentially risk lengthy delays on completion and a backlash from a public that might well misinterpret any challenge as an attempt to weasel out of its liabilities. That said, if there is any suggestion that this ruling might limit CSR's options beyond blocking the demerger deal, then it would seem the board would have little choice but to further test the legal waters.”

Option two is to sell the sugar business. As Elizabeth Knight points out, this could either transpire through a simple asset sale or spin-off listing. She reckons "...once the cash is in the door, the proceeds could be distributed via dividend – which, if undertaken over time, would be equally tax effective.” Matthew Stevens of The Australian disagrees, writing "...a straight asset sale will result in tax leakage of some $200m-plus, but can't be blocked, and at least the CSR rump will collect the $1.3bn cash from sale.” However, both are partly wrong. As Malcolm Maiden of The Age points out, "...while there would be no legal opposition to a trade sale to Bright Food or another buyer (because a sale would not downsize CSR's balance sheet, only to replace assets with cash) the same groups that opposed the break-up could legally challenge a return of the sale funds or most of them to CSR's shareholders, for the same reason they successfully opposed the split.” Stephen Bartholomeusz of Business Spectator and Alan Jury (Chanticleer) of The Australian Financial Review agree.

Malcolm Maiden and Alan Jury explore a couple of further options resulting from a sale. From Maiden, "...[CSR] could take up an implicit suggestion in the judgment and accept a NSW government proposal that Sucrogen agree to meet asbestos liabilities if CSR itself cannot, but that would cruel the float and repel trade buyers.” Or, Maiden goes on, the raised funds could be retained "for expansion”. To achieve this, Alan Jury suggests CSR should return to Chinese suitor, Bright Foods, with "appropriate obsequiousness”.

Finally, as all point out, now that CSR has highlighted $2 billion as the demerger target price, it is the defacto valuation for any kind of sale and a stretch from any current bid.

Option three is to keep the sugar business and add value to it, a course favoured by Maiden and Knight. With roughly a billion dollars in debt, this column will add, the extra cash would do CSR no harm.

On a less saturated topic, there is at last some debate filtering through to Australia on Obama's proposed "Volcker rules” (beyond Business Spectator, that is, which has covered them extensively). The Australian today runs an op-ed by Peter L. Swan, professor of finance at the Australian School of Business, University of NSW. Swan swings an axe first at Volcker's proprietary trading ban. "Research on bank proprietary trades I have carried out with colleagues and published in the Journal of Business shows Australian banks providing these facilitating services systematically have lost hundreds of thousands of dollars a month. Why then would banks lose money in this manner? ... Facilitating banks are far from being stupid. They provide facilitation only to their largest clients that normally generate huge fee income for banks that act as their agent. Premium fees are charged and the bank stands by, ready to provide a premium service as a principal when required, even at a loss. Considering all aspects of the client relationship, the bank comes out ahead ... There are swings and roundabouts in trading profits. You scratch my back and I scratch yours. Capitalism is not about making profits on every trade or activity but delivering enough to your clients such that they will stick by you when you need them, and vice-versa for the client.”

Swan takes a second, related swing at the second part of the new rules, commercial banks owning hedge funds and the like. "Bank proprietary desks, hedge funds, mutual funds and pension funds undertaking "swing" round-trip trades to earn positive but generally not exorbitant returns after transaction costs, are not "actively doing nothing" but are in fact implementing the "Wall Street walk". By buying when they expect good performance and selling when then expect poor, they monitor and discipline firm management.”

In other words, banks make markets and markets are efficient. This column will only counter with one point. The Volcker proprietary trading and hedge fund ownership ban is proposed only for deposit-taking banks that enjoy government guarantees on their funding sources (deposits). They are therefore designed to remove implicit government subsidy from the kind of activity Swan describes, which seems very much in line with Swan's underlying belief that markets are the best way to enrich society. If unsupported banks can make markets without implicit government support then jolly good. If they can't, then in Swan's own terms the concept was simply too inefficient. Describing the Volcker rules as "purely socialism” is bizarre to this column. See this video of Volcker to make up your own mind.

This column would also recommend getting up to speed on the new securitisation reforms being proposed by the FDIC in the US, which have the potential to be every bit as important as the Volcker changes.

A second AFR op-ed by John Black, CEO of Australia Development Strategies, rises to the defence of yesterday's RBA pause. According to Black, "Rising regional unemployment figures for high socio-economic status (SES) areas have tended to lead recent economic downturns. This high SES jobless growth is what we started to notice returning in November and December ... It is similar to what Australia experienced in late 2007, when the total unemployment figures looked rosy, but jobs were being shed in richer parts of Australia ... Basically, if the rich areas are losing high SES jobs, then job losses in middle and working class areas follow, in that order ... And, while we trust completely the government and mining industry spin that the mining boom is fantastic for jobs growth ... can someone please explain why central Perth had the highest unemployment growth ... in the twelve months to December 2009?” Black goes onto canvass housing and concludes "...stress faced by first home-buyers confirms the evidence in the profiles: kids have been encouraged by the stimulus to buy homes many say they can't afford, especially when they say they no longer have two jobs.”

All good points, many of which have been made in this column before. After the first round of first home buyer grants in 2001, a rocket was lit under Sydney house prices for two years. By 2003, falling affordability in outer suburbs killed off buyers and, as prices fell, the property move-up ladder stalled, retarding growth in inner suburbs. It seems entirely possible to this column that a similar dynamic could play out nationally this time, albeit under the conflicting influences of high immigration and rising unemployment. This column would see a stalled housing market as a blessing in disguise, offering some risk mitigation against the eventual "popping of the Chinese economic bubble”, as Black describes it.