Gaynor: Takeovers code should restore faith

By BRIAN GAYNOR

The sharemarket enters a new era on Monday when the Stock Exchange takeover provisions are tossed into the wastebasket and replaced by a takeovers code. (The old Stock Exchange rules will still apply to listed trusts.)

On-market partial offers to a select number of shareholders will be consigned to the history books. From now on, all shareholders will participate in a takeover bid either through a written offer or by voting to exempt a transaction from the code.

The new regime will bring New Zealand into line with most countries sharing a similar common law structure, including Australia, Canada, Hong Kong, Singapore and the United Kingdom.

Unfortunately, the code will not be the panacea the sharemarket has long awaited. There will be a lengthy and painful hangover from the light-handed regime of the past 20 years, particularly in terms of individual participation in the market and ownership of our listed companies.

Partial offers to selected shareholders have turned a large number of New Zealanders against the sharemarket. According to brokers' calculations, local investors, both private and institutional, own just 40 per cent of the market compared with 54 per cent 10 years ago.

Reserve Bank statistics tell a similar story. Only $6.6 billion or 15 per cent of funds under management are allocated to NZ equities and unit trusts. By comparison, $A214 billion or 35 per cent of Australian managed funds are allocated to Australian equities and unit trusts.

The lack of confidence in the New Zealand sharemarket has serious implications for our economy. Private investors usually accept a higher degree of risk and are more willing to invest in small companies with a low level of sharemarket liquidity and an unproven track record.

As private investors are the main supporters of small and medium-sized floats, the dearth of new issues in recent years is not surprising. Small companies need equity funds to expand, but without a large body of individuals willing to provide risk capital, this is hard to achieve.

A lack of confidence in the sharemarket and a strong preference for bricks and mortar are two reasons our non-agricultural productive sector has failed to fire.

Under the old regime, individuals who invested in the New Zealand sharemarket through managed funds were generally able to take part in a partial bid because their fund managers were part of the inner circle.

As individuals acting alone did not normally participate in a partial bid, one would have expected a large flow of funds from private investors to fund managers. This has not been the case, as the total amount of managed funds allocated to New Zealand equities has grown from $6.5 billion to just $6.6 billion since March 1996. This suggests that individuals are more influenced by their own experiences. If so, the takeovers code should start the slow process of restoring individual faith in the market.

One of the big arguments in favour of the light-handed regime was that takeovers were less costly, easier and gave less protection to inefficient managers. This is true, but the old process did not ensure that efficient managers replaced the inefficient ones, and new controlling shareholders have been almost impossible to remove once entrenched.

The New Zealand regime also made it easier and cheaper for foreign companies to gain control of our companies. For example, Kirin was able to buy 45 per cent of Lion Nathan, whereas it could not have made the same on-market, partial offer for Foster's under Australian takeover rules.

Is Kirin the best controlling shareholder for Lion? What positive contribution has it made to the company? How can Kirin be replaced if it proves to be ineffective?

Lion Nathan has moved across the Tasman but has failed to attract strong Australian institutional support, partly because of its shareholding structure.

The light-handed takeover regime has discouraged local individuals from participating in the market and encouraged overseas investors to take controlling interests. Among NZSE40 companies, with the possible exception of UnitedNetworks, it is difficult to identify positive contributions by overseas controlling shareholders.

The best-performing NZSE40 companies in recent years have been Baycorp, Fisher & Paykel, Sky City and The Warehouse, four companies with no overseas controlling shareholders and substantial institutional support.

An open share registry encourages institutions to actively monitor a company's performance, whereas there is little point in spending too much time over Air NZ, Natural Gas or Trans Tasman Properties while they are under the iron grip of a controlling shareholder or related group of shareholders.

The code cannot unwind these controlling shareholdings, many of which were consolidated in recent weeks. But from now on the open competitive process will involve all shareholders and should ensure that the best bidder wins out.

The code's fundamental rules are:

* When a shareholder wants to go above 20 per cent, it has to make a written pro rata offer to all shareholders and achieve a minimum holding of 50 per cent. If the bidder fails to reach 50 per cent, it has to return all the shares received under the offer to the original shareholders.

* The shareholders of the target company can vote to exempt a controlling transaction from the code. For example, Edison Mission could sell its 47.9 per cent shareholding in Contact Energy to another party without that party making a pro rata bid if Contact Energy shareholders, excluding Edison Mission, approve the transaction at a general meeting. (The initial 20 per cent can always be purchased without having to make an offer to all shareholders.)

* Between 50 and 90 per cent, the controlling shareholder can acquire shares (the creep provision) up to a maximum of 5 per cent a year or make a full takeover offer.

* Once a party reaches 90 per cent, it may go to 100 per cent by whatever means it wishes.

The code is lighthanded compared with regulations in other countries. For example, the cost of an acquisition can be relatively cheap because partial offers are allowed (as long as 50 per cent is achieved).

If a partial bid is successful, the big institutional shareholders will remain on the share registry and will be forced to play a role in monitoring the performance of the new controlling shareholder.

The code is relatively flexible and has several exemptions, including an increase in a controlling shareholding as a result of a share buyback. The high-quality takeovers panel will be called upon to make several important rulings. These include:

* Allied Domecq's apparent attempt to avoid the Code by announcing it has irrevocably promised to buy a further 23.1 per cent of Montana.

* Any major change in Air New Zealand's shareholding that does not include a pro rata offer to all shareholders.

* The exercise of an option by PPCS to buy 51 per cent of Active Meat, a company with a 35.8 per cent shareholding in Richmond. The exercise of this option, without making a pro rata offer to all shareholders, would appear to be in breach of the code because it will give PPCS a 52.5 per cent holding in the Hawkes Bay meat company.

One thing is certain, the sharemarket will go deathly quiet in the next few weeks because many corporate deals were brought forward and completed before the July 1 deadline.

Brokers' incomes will suffer because on-market partial bids are a thing of the past. This is not a negative development as brokers have had it relatively easy, with little incentive to develop new investment products because of the lucrative returns from on-market bids.

They will now have to look for other sources of revenue. Bringing more new companies to the market is an obvious alternative. The code should facilitate this because individual investors, who are the main supporters of new small and medium-sized floats, should gradually return to the market as the code's positive features become evident.

* bgaynor@xtra.co.nz