Brian Gaynor: Pulling the cork on wine takeover issues

The dispute over the Oyster Bay Marlborough Vineyards' takeover raises a number of concerns regarding disclosure and valuations.

It also raises the role of directors, particularly Bill Falconer, in relation to these issues. Falconer is chairman of Oyster Bay as well as Restaurant Brands, which has yet to release the independent appraisal report for the June takeover offer by CVC Asia Pacific.

Falconer was chairman of Southern Petroleum when it was acquired by Fletcher Energy. There have been ongoing legal disputes about the inadequacy of information provided to shareholders during that offer.

He also chaired St Lukes Group when it was acquired by Westfield under a controversial merger proposal after a flimsy independent report issued by PricewaterhouseCoopers (there was no requirement to have an independent report under a merger arrangement).

The Oyster Bay story began on April 30, 1999, when the company was incorporated.

Two weeks later it issued a prospectus for the sale of 9 million shares at $2 each. The other directors were Ruth Richardson, John Maasland, Jim Delegat, Robert Wilton and alternative director Rosemari Delegat.

In his letter to investors Falconer wrote: "Delegat's Wine Estate Ltd has made a significant financial commitment to the future of Oyster Bay by agreeing to subscribe for a minimum of 20 per cent of Oyster Bay's share capital".

According to the offer document the $18 million raised would be used as follows:

* $5.9 million to purchase the Gifford's Creek vineyard from Delegat's.
* $4.2 million to buy the Airfields vineyard from Delegat's.
* An additional $4.2 million to develop the Airfields vineyard.
* Further capital expenditure of $2.2 million.
* Working capital provision and offer expenses of $1.5 million.

Also, there were a number of agreements between Oyster Bay and Delegat's. These included:

* Delegat's was contracted to manage the Gifford's Creek and Airfields facilities on behalf of Oyster Bay.
* Delegat's agreed to purchase and Oyster Bay agreed to sell to Delegat's all of the grapes produced at the two vineyards for an initial term of 20 years. Delegat's can extend the agreement for two further periods of 10 years each but not beyond June 30, 2049, without the consent of all parties. The price paid by Delegat's for the harvest is determined by annual negotiations between the seller and the buyer.
* Oyster Bay may not sell its vineyards within 5 years of purchasing them. After that Delegat's has the right of first refusal if Oyster Bay wishes to sell. If Delegat's doesn't take up this option the vineyards may only be sold to a party that agrees to uphold the grape sale agreement with Delegat's and is approved by Delegat's.

The Oyster Bay share issue was an incredibly sweet deal for Delegat's. The promoter committed to outlay only $3.6 million for its minimum 20 per cent stake yet it was selling two vineyards for $10.1 million and transferring significant development costs to the new company.

In addition, Delegat's retained the management contract over the two vineyards and has veto powers over the sale of the properties to an outside party until June 2049.

In February 2002 Oyster Bay purchased the Fault Lake vineyard for $2.2 million and entered an agreement to lease the Wairau River vineyard from the Marlborough District Council.

As part of the purchase agreement Oyster Bay made a commitment to pay Delegat's $4.5 million to develop the Fault Lake vineyard and $4.1 million for Wairau River.

Oyster Bay also has long-term management and supply contracts with Delegat's over both of these vineyards.

Oyster Bay joined the NZAX, the alternative market sharemarket, when it opened in November 2003. At that stage the vineyard owner had completed five full years and had only exceeded its prospectus net surplus forecast in two of the five years.

The company should probably not have been allowed to list on the NZX because its relationship with Delegat's was far too close and requires waivers from the exchange's important related party transaction rules.

On NZAX listing Delegat's Wine Estate owned 32.6 per cent of Oyster Bay compared with 29.8 per cent a year earlier. It is unclear why Delegat's was not subject to the requirements of the Takeovers Code when it raised its shareholding from 29.8 per cent to 32.6 per cent.

The real excitement began on May 10 this year when Marlborough businessman Peter Yealands made a bid for 50.1 per cent of the company at $3.10 a share. At the time Yealands owned 6.7 per cent of the vineyard company.

The bid initiated a protracted and acrimonious bidding war between Yealands and Delegat's, which ended on August 9 after Delegat's reached the threshold 50.1 per cent. This was achieved after Delegat's raised its offer to $4 a share.

Shortly after August 9 the Takeovers Panel received complaints that Oyster Bay's land, including its vineyard developments, were undervalued in the target company statement and Ferrier Hodgson's independent adviser's report.

Essentially this issue comes down to an argument about land valuation. In this instance Oyster Bay's valuer is Logan Stone.

Vineyard values have risen dramatically in recent years but Stone's valuations are based on the income derived from the grapes sold to Delegat's rather than the market value of the land. The income basis valuation method had been adopted because of Oyster Bay's sale restrictions.

But Yealands claims that Falconer and his board have been selling grapes to Delegat's below market value and because of this the income-based valuation is also understated.

He argues that if a new Oyster Bay board adopted a tougher attitude towards Delegat's and obtained a higher price then the land valuations would be higher.

Another side of the argument is that if Delegat's gains control of Oyster Bay it could agree to pay a higher price for the grapes, remove the land sale restrictions and revalue the land by a substantial amount.

At this point Christine Pears, the CFO of both Oyster Bay and Delegat's, enters the story.

The Logan Stone valuer usually prepares a market as well as an income-based valuation but only the latter is published.

According to the Takeovers Panel, Pears told the Logan Stone valuer to prepare an income-based only valuation for 2005. No market-based valuation was supplied to Ferrier Hodgson nor was there any dialogue between Ferrier Hodgson and Logan Stone.

The Logan Stone valuer told the panel that his market-based valuation would be in the region of $90 million compared with the income-based $45 million figure
in the takeover documents.

It seems extraordinary that a senior executive of Oyster Bay, who also held a similar position at Delegat's, should tell a valuer how to do his job. The panel found in favour of the complainants and shareholders who accepted the Delegat's $4-a-share offer have the ability to withdraw their offer.

Delegat's will undoubtedly win this battle and retain over 50 per cent of Oyster Bay, but it will be much more difficult for it to win the war.

The winemaker is reported to be looking at an IPO but this will be scrutinised by analysts, investors and the media. The Oyster Bay structure and takeover battle has dented Delegat's image in the investment community and the company will have to come up with a far more investor-friendly structure if it is to get a successful IPO off the ground.

* Disclosure of interest; Brian Gaynor is an executive director of Milford Asset Management.