Brian Gaynor: Contact trio are too ready to kowtow

Contact Energy's annual meeting should be renamed "The Phil Pryke Show". The former chairman usually dominates proceedings and this week was no exception as his address to shareholders, which lasted 17 minutes, was much longer than that of either chairman Greg King or chief executive David Baldwin.

Pryke was feisty and emotional. He said the media and several fund managers were "uninformed", "arrogant" and had "entrenched views". He refused to accept any blame for the failed merger with Origin Energy.

Pryke's address, with those of fellow independent directors Tim Saunders and John Milne, demonstrated the enormous gap between them and many shareholders. These differences date back a long way and have come to a head since Origin Energy acquired a controlling interest in the New Zealand company in 2004.

In July 2004, Origin Energy said it had agreed to purchase Mission Energy's 51.2 per cent Contact Energy stake for $5.67 a share and, under the Takeovers Code, Origin was required to make the same offer to all shareholders.

The independent directors recommended that minority shareholders should not accept Origin's offer after Grant Samuel determined the group's value was in the $5.74 to $6.34 a share range.

On the day of the notice of offer, the NZ company said three Origin representatives would become directors and chief executive Stephen Barrett and an independent director would resign from the board. Origin also wanted its managing director, Grant King, to replace Pryke as chairman.

A later announcement said the independent director resigned "following Origin's decision to reduce the size of the Contact board from eight to six directors".

Why did the independent directors acquiesce to Origin? The board composition changed from four independent directors, three Edison Mission representatives and the managing director (originally seconded from Edison but remunerated by Origin) to a board comprising three independent directors and three Origin representatives.

As an Origin representative replaced an independent director as chairman, and the chairman has a casting vote where there is a stalemate, then board control was effectively transferred from the independent directors to the new majority shareholder.

The next big issue was the sale of Contact's interests in the energy retailer Red Energy, which was a competitor of Origin, and the Valley Power project, both located in Victoria, Australia. The independent directors later supported the merger with Origin because it would offer better growth prospects in Australia yet the board had sold its Australian activities after Origin gained control.

Another important milestone was the statement made by King at last year's annual meeting on October 12. He said: "The company faces a major challenge in the coming three-four years as its legacy entitlements under Maui gas contracts are progressively used up and an increasing proportion of the company's thermal fuel comes from higher cost sources, such as Pohokura gas contracts.

"While wholesale electricity prices are likely to continue to rise over this period, it is not expected that these prices will keep pace with the increase in Contact's fuel costs and there will be significant pressure on the company's trading margins."

This comment had a huge impact on Contact's share price, which fell from a high of $7.45 on the day before the October meeting to $6.50 on November 25.

On November 26, Origin put the merger proposal to Contact Energy's directors at a meeting in Sydney.

Should King have made negative statements about Contact's long-term gas situation when his Origin management team was likely to be working on the merger proposal and Contact's directors admitted at this week's meeting the gas position was probably not as bad as it appeared 12 months ago?

Meanwhile, Origin's share price rose slightly in the October 11 to November 25 period, a situation that would help boost the Australian group's share of the merged company.

The merger announcement, which was finally made on February 20, was botched for several reasons including:

* Pryke's involvement was a negative factor because he had recommended a 2001 offer from Edison Mission at $4.14 a share (adjusted for an 11c dividend paid by Contact) and there were concerns that he was too willing to appease the Australians.

* The independent directors' support for the merger was far too enthusiastic, particularly when they recommended the earlier $4.14 a share offer and the independent appraisal report on the proposed merger was still a long way away.

* King and Pryke should have had face-to-face meetings with the media and major shareholders in Wellington and Auckland instead of trying to have a phone conference, which was totally unsatisfactory because of technological problems.

David Hunt, who was the group's first truly independent chief executive for five years, resigned on the day of the announcement. David Baldwin, who is on secondment from Origin, has replaced him. During the term of the secondment, Contact will reimburse Origin for the cost of Baldwin's salary and other employment benefits.

The merger proposal never obtained traction and was finally abandoned by Origin on June 28 after it decided there was insufficient support from key shareholders.

The main items at this week's meeting were resolutions 1, 2 and 3, which consumed 1 3/4 hours of the 2 hours and 45 minute meeting. These motions, proposed by the Shareholders' Association, asked for the removal of Pryke, Saunders and Milne from the Contact board. All three defended their position.

Pryke attacked the media, claiming several arrogant institutions were dictating to local shareholders. One of his main arguments was that institutions take a short-term view whereas directors have a long-term focus.

This was a strange approach for Pryke to take as far as the $4.14 a share offer in 2001 was concerned was that it represented "a premium to the Contact share price on the day prior to the announcement of the offer" and "the share price is highly likely to fall from current levels in the event the offer fails".

Saunders also went on the front foot and criticised a "minority of self-interested vocal shareholders". He said he should be judged on his performance as a Contact director and shareholders should forget his Feltex involvement when casting their vote.

The problem with this argument is that Contact's strong share price performance in recent years has been primarily due to shareholders' rejection of the independent directors' recommendation to sell out at $4.14 in 2001.

Milne adopted a more rational approach although he accused journalists of taking a lazy attitude towards the merger. It is bizarre to believe the media had an important influence on the institutions that opposed the deal.

Contact Energy's minority shareholders are unhappy with the performance of their independent directors, particularly Pryke and Saunders, for several reasons including; they are too quick to accept takeover or merger offers; they have allowed Origin to gain control of the board and King to make overly negative comments at last year's meeting; the company has sold its Australian operations and the new chief executive has been seconded from Origin.

This discontent has not been dispelled by the annual meeting poll, which showed the resolutions to remove Pryke and Saunders were only defeated because Origin voted its 51.4 per cent stake in support of them.

How can investors have confidence in independent directors when they appear to acquiesce to the controlling shareholder and only remain on the board through the support of this shareholder?

* Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management. bgaynor@milfordasset.com