New code gives all investors a say

By BRIAN GAYNOR

A number of commentators are still fighting a rearguard action against the proposed takeovers code.

In the midst of the Montana Wines takeover battle, one claimed that support for the code's equal pricing provisions was based on envy.

Another based his entire opposition to the code on its equal treatment of all shareholders.

He believes the new system is not in New Zealand's best interests because it will protect "the weaker, slower, dimmer bulbs among us."

These arguments are narrow and simplistic. The takeover debate is much wider than the equal treatment of shareholders.

Takeovers are an important economic issue because inadequate legislation in this area is one of the main reasons for the poor performance of New Zealand companies over the past 20 years.

Our takeover environment has been almost totally unregulated for the past twenty years. Under this light-handed regime, one of the best ways to gain control of a listed company is to make a partial offer to a small number of shareholders on a first-come, first-served basis.

The selling shareholders capture the higher price, called the premium for control, and effective control is usually obtained when the acquirer has 35 per cent or more.

(Although 35 per cent is not always effective control, it is much easier for that shareholder to acquire 51 per cent ahead of someone starting with 20 per cent or less.)

One of the main characteristics of a first-come, first-served offer is the speed of execution. Shareholders are given limited time to consider the bid and have little opportunity to assess the management expertise of the bidder.

The main argument in favour of the unregulated regime is that it encourages takeovers and holds management to account.

Advocates of the present system also claim that large shareholders should capture the control premium because they are the main monitors of a company's performance.

These arguments have two basic flaws:

The unregulated environment encourages bids but reduces the prospects of alternative offers once a control position has been acquired. If new controlling shareholders are poor managers, minority shareholders can do nothing to remove them. The entrenched position of ineffective controlling shareholders is a major reason for the poor performance of the New Zealand economy.

In a partial offer - initiated because of poor management and a low share price - institutional shareholders usually receive the premium for control. They receive the higher price even though their ineffective monitoring is one of the main reasons for the poor performance of the target company.

The principal outcome of the unregulated environment is that a large majority of our listed companies have a controlling shareholder and minority shareholders are disenfranchised. Many of these controlling parties have little specific industry expertise.

Ego and the quest for power, instead of economic rationale, have often motivated offers for controlling interests.

Brierley Investments has controlled a large number of the country's businesses yet it has had limited expertise to expand and develop these companies. It has focused on asset stripping - in the legal sense - and the reorganisation and repacking of these companies for resale.

Air New Zealand's dismal interim result is another indication that BIL can be completely out of its depth, yet our takeover rules have favoured the company at the expense of industry experts.

In the 1980s BIL, Equiticorp, Chase, Rada and others acquired a large number of controlling interests and in the past decade Fay, Richwhite, GPG, Eric Watson, Jihong Lu, Richard Yan and a number of overseas interests have come to the fore.

There is some scope for this entrepreneurial activity, but if non-experts control a large percentage of a country's businesses it is difficult for the economy to grow and prosper.

A recent example was the joint acquisition of nearly 40 per cent of Enza - the former Apple and Pear Marketing Board - by GPG and FR Partners. Tony Gibbs and Bill Birnie effectively control our largest apple exporter yet they have no apparent expertise in this area.

Our economy would rest on a much sounder footing if individuals with significant industry or international expertise controlled our leading export-oriented industries.

The main objective of a code, and the tender offer scheme in the United States, is to establish a competitive bidding process for a company. It also gives shareholders the opportunity to make a considered decision that is in the best interest of themselves and the target company.

The proposed code introduces a democratic process to the change of control of a listed company.

This is similar to our political process, where voters have plenty of opportunity to study party policies before an election.

Under existing takeover rules, changes in control are often achieved in pre-dawn coups d'etat normally associated with Central African politics. It is easy to get rid of the incumbent rulers but their replacements can be just as ineffective.

Many political insiders in those countries have large Swiss bank accounts. Their declining years are spent in lavish exile while the population at home struggle to keep their heads above water.

The proposed code establishes a pause period, during which shareholders cannot be coerced into making a hasty decision. The bidder is also required to make a written proposal and shareholders have plenty of time to consider the offer.

Under the proposed code, Lion Nathan would have had to make a pro rata offer to all Montana's shareholders. As part of this offer it would have had to make a strong case why shareholders were better off selling a small number of shares at $4.65 instead of 100 per cent to Allied Domecq at $4.40.

Montana's shareholders would be forced to consider whether Lion Nathan would be a better controlling shareholder than Allied Domecq.

Under the first-come, first-served offer, institutional investors can grab their money and run without having much regard for the continuing management and success of the enterprise. Under the proposed code, the GPG/FR Partners joint venture would have to make a pro-rata offer for at least 51 per cent of Enza. In doing so they would have to convince Enza's shareholders that they had the appropriate skills to run the company.

If the joint venture partners could not convince shareholders of this, and they were unable to buy 51 per cent, then the maximum amount they could hold is 20 per cent.

This would be a much better outcome than the present situation, where Mr Gibbs and Mr Birnie cannot be removed even if they make a mess of running the company.

Long experience indicated that the first-come, first-served partial offer is a poor way to select the most effective controlling shareholder. The flawed process is one of the main reasons our companies and sharemarket have performed badly.

Supporters of the present regime argue that small shareholders can sell their holdings if they don't like the way new controlling shareholders are running their company.

That is precisely what New Zealand investors have been doing over the past decade. They have been unwilling to support the large number of companies with entrenched and ineffective controlling shareholders.

The belated introduction of a takeovers code is not an instant solution to the sharemarket's woes. But it will ensure a more rational and democratic process is applied to the selection of controlling shareholders.

This should have a positive impact on the economy and sharemarket over the longer term.

* bgaynor@xtra.co.nz