The true Spotless test

The Spotless response to the pressure being exerted by private equity group, Pacific Equity Partners, is both clever and principled.

Ever since PEP emerged last month with a highly conditional proposal for a scheme of arrangement takeover around the $2.63 a share mark, Spotless has known that it couldn't just reject the approach – which it did – and hope that PEP would simply disappear.

Not only does PEP have options over about 19 per cent of Spotless' capital but the board and management of the company are acutely aware that at least twice that proportion of its capital base would like to see an offer tabled.

That puts the board in a rather delicate position. It isn't enough for them to believe that the company is worth considerably more than PEP has indicated it might offer, but it needs to convince its shareholders – or PEP – that the latent value exists.

Having dismissed the original approach almost instantly, Spotless didn't slam the door on PEP. It "engaged" with its suitor. Today it said that after discussions with PEP, it had received a revised proposal at an indicative price of up to $2.68 a share.

That's not much of an increase from PEP – essentially all it has done is to say that Spotless shareholders will be able to keep their interim dividend of up to five cents a share – but it is something that Spotless had to respond to.

Significantly, the modest change to the value of the proposal hasn't won PEP access to due diligence, which was a key condition of the proposal, along with a unanimous recommendation from the board.

Spotless has retained its negotiating leverage and, without saying so explicitly, the continuing denial of access to due diligence and the absence of an endorsement says that PEP isn't going to get anywhere without another bump in its proposed offer price.

What PEP has extracted is an offer from Spotless to provide it with a management presentation ‘'to ensure PEP has a full understanding of the Spotless directors' view on each of Spotless' businesses.''

Presumably the board believes that the presentations will convince PEP that there is more value in the group than $2.68 a share and lead to an indicative offer more in keeping with the board's view of value. That would enable the board to allow PEP access to a formal due diligence program.

The board plans, however, to do something unusual. It is going to make that management presentation available to the market-at-large. PEP isn't going to have any exclusive privileged information.

That is a very principled approach. The possibility that a private equity group might make an offer shouldn't be sufficient justification for giving it access to sensitive information that the market doesn't have.

By providing it with the presentation, however, Spotless may give PEP the confidence to put a price on the table that convinces the board that it should be given access to the company's books to verify the detail behind the presentation.

It also demonstrates Spotless is prepared to engage with PEP – it is prepared to contemplate a change of control if the price is right and its willingness to do so suggests that PEP isn't completely out of the ballpark of the board's view of value.

Alternatively, if the presentation is sufficiently convincing and compelling, Spotless may be able to convince its shareholders, and the market, that they have misunderstood the latent value in the group as it transitions from being a collection of siloed service businesses into a properly integrated services business.

If it were successful in doing that, it would be able to continue to stonewall PEP without the pressure of knowing a large proportion of its register is anxious to sell at the current indicative price.

There will be considerable pressure on Spotless' management to make that presentation, scheduled to occur before Christmas, credible and convincing. The market's response to it will determine Spotless' fate, and value.