Brian Gaynor: Investors hungry for risky business

Stephen Tindall wants to privatise The Warehouse because he doesn't believe New Zealand investors have an appetite for his high-risk, high-growth plans for the company.

He couldn't be more wrong, New Zealand investors have a passion for high-risk and high-growth companies. The problem is that we don't have enough of these and one of our icon business leaders now wants to snatch back his company before he revs it into top gear again.

Rakon was floated at $1.60 some months ago and closed yesterday at $3.35. Delegat's Group, which has an aggressive growth strategy, had an IPO at $1.40 a share in April and is now at $2.27.

The strong performance of these companies indicates that investors have a huge appetite for growth-oriented listings.

The New Zealand Exchange's share price has risen from $5.60 to $6.80 since it announced its Australian ECN (Electronic Communications Network) strategy this month and Pumpkin Patch continues to be highly rated as it pursues an aggressive growth strategy.

And what about Brierley Investments, Fletcher Challenge, Equiticorp, Chase Corporation and a host of other listed companies that adopted high-risk policies? It could be argued that New Zealand investors have too much appetite for risk. In the past year the market value of Plus SMS reached nearly $300 million yet the company has not got a single dollar in revenue.

The Warehouse is another company that has been embraced for its successful high-growth strategy.

The discount retailer was floated at $2.50 a share in 1994, had a 1:5 bonus the following year and reached $9.00 before a 1:1 bonus issue in March 2000.

The acquisition of Clint's Crazy Bargains and Silly Solly's in Australia in 2000 was greeted with a great deal of excitement and the group's share price rose to $6.85 eight months after the 1:1 bonus issue. It hit an all-time high of $7.90 in June 2002 but fell steadily over the next few few years as the Australian operations reported losses.

Investors sold out of The Warehouse because it hit a wall in Australia, not because they were risk averse. Greg Muir resigned as chief executive in May 2003, basically over a disagreement regarding Australia, and the firm's share price hit a five-year low of $3.04 in May 2005 before the Australian operations were sold.

Tindall is attempting to privatise The Warehouse because he believes there is unfinished business, he has a point to prove. He said the Australian operations would not have been sold under privatisation and he has an aggressive growth strategy for its food operations.

Tindall had contact with several Australian private equity organisations during the sale of the group's Australian operations and asked Pacific Equity Partners (PEP) to join his consortium because it has much retail expertise and has had many investments in New Zealand.

All we know at this stage is that the consortium will offer $5.75 a share, valuing The Warehouse at nearly $1.8 billion. Tindall will own just over 50 per cent of the consortium (the Tindall Foundation will not join the consortium) and the purchase will be mostly debt funded and secured against the company.

Tindall will not have an executive role, he has confidence in Ian Morrice and his executive team, and senior executives will be able to sell their shares into the offer and then acquire a shareholding in the consortium.

The board will be dissolved and replaced by a smaller and more active one. Tindall believes the new board will play a major role in the privatisation's success.

There has been considerable discussion whether the acquisition will be through the Takeovers Code, requiring 90 per cent acceptance of all shareholders, or a scheme of arrangement, where approval of only 75 per cent at a meeting is required.

But the issue goes beyond whether 90 per cent or 75 per cent acceptance is required. A takeover offer is from an external source and the role of the target company directors is to advise whether the offer is fair or not. In a scheme of arrangement the target company is effectively a sponsor of the transaction and plays an active role in ensuring its success.

The latest Takeovers Panel annual report, which was released this week, is extremely critical of schemes of arrangement. The Panel believes that schemes and amalgamations "do not have the same protections for shareholders that apply to changes under the Code".

It notes that technical devices have been used to ensure that these transactions are not captured by the Code and quoted the INL/Sky TV merger and Transpacific acquisition of Waste Management as examples of this. As soon as Tindall started talking about imputation credits it was clear that the proposed transaction would be under a scheme of arrangement as these credits are owned by the company and can only be distributed through the authority of the board.

These credits will probably be the difference between the success and failure of the offer. In simple terms a takeover offer at $5.75 a share would have little chance of success but a scheme of arrangement, where the company's imputation credits can be used to assist the purchaser, is much more likely to succeed.

Under a takeover everyone has to receive the same offer but under a scheme of arrangement shareholders could either accept a cash offer from the Tindall Consortium or a share buyback from The Warehouse. Share buybacks representing less than 15 per cent of the equity value of a company are classified as dividends and as most shareholders, particularly Tindall, Tindall Foundation, Foodstuffs and the overseas investors, do not use imputation credits these can be distributed more effectively to shareholders that can utilise them.

The next big step is for Tindall to present his scheme of arrangement to The Warehouse board. The board is unlikely to reject any proposal, including the distribution of imputation credits, because a number of key directors have had long-term relationships with the founder. Chairman Keith Smith and non-executive director John Avery have been directors since 1988 and were advisers to the company before that.

The best hope for shareholders is that the independent directors negotiate a higher price.

But the outcome of a scheme of arrangement is not assured because two votes have to be put to shareholders. These are;

* 1. Approval of the scheme of arrangement under the Companies Act requiring a 75 per cent majority of shares voted.

* 2. Approval of the related party transaction under NZX Listing Rules requiring a 50 per cent majority of shares voted.

Tindall and associated parties, who own just over 50 per cent of the company, can vote on the first resolution but not the second, which requires a 50 per cent majority, making it the important one.

This is where Foodstuffs with its 10 per cent holding comes in.

Tindall has had preliminary talks with the retail co-operative but no agreements have been reached. He intends having further discussions and the outcome could have an important bearing on his attempt to privatise The Warehouse.


House moves

November 1982: Stephen Tindall opens first Warehouse store in Takapuna.
October 1994: IPO at $2.50 a share.
November 1994: The Warehouse lists on NZX.
July 1995: 1:5 bonus issue.
March 2000: 1:1 bonus issue.
August 2000: Australian operations acquired for A$118m.
November 2000: The Warehouse lists on the ASX.
February 2001: Greg Muir replaces Tindall as CEO.
June 2002: All-time high of $7.90 a share.
May 2003: Muir resigns as CEO and is replaced by Tindall.
October 2004: Ian Morrice replaces Tindall as CEO.
May 2005: Recent low of $3.05 a share.
December 2005: Australian operations sold for A$92m ($99m).
July 2006: Foodstuffs acquires 10 per cent.
Sept 2006: Tindall announces plans to privatise the company.