Full picture out of frame

By Karyn Scherer and Chris Barton

On the face of it, it is an unlikely coupling - New Zealand's second-largest internet service provider and a property and cinema business with fingers in pies including Auckland's Planet Hollywood restaurant and the company that makes Shortland Street.

According to the Wood brothers, who are redefining for the 21st century the term nouveau riche, the impending marriage between Force Corporation and Ihug is a New Zealand version of the world's mega-merger between Time Warner and America Online.

Others regard the suggestion as absurd. As some see it, the deal has a whiff of the 1980s about it. It is no coincidence, they note, that Force's chairman and major shareholder, Peter Francis, is a former deputy chairman of failed property developer Chase Corporation.

Mr Francis himself admits he has never surfed the net.

"Personally, I don't. I don't own a PC," he laughs. "I'm not very good at that sort of thing at all, but I'm learning real quick, I tell you."

Fortunately, what Mr Francis lacks in technological knowledge, the Wood brothers make up for in spades.

Nick Wood, aged 32, is not saying how all the pieces in the Ihug-Force jigsaw puzzle fit together. "I'd love to tell you," says Mr Wood, worth about $55 million on paper as we speak, "but if I did it would be giving the game away." To underline the point, he says: "It would be like me pulling my pants down."

Indeed. Brother Tim, aged 31, worth about $30 million, is not concerned that not everyone understands the end game. "We're not worried if people don't get the picture straight away."

The brothers' cocky attitude is typical. Both love to show that when it comes to "the black art of the internet," they know more than anyone else.

The arrogance of youth? No, says the burly and happy Nick, who is the slightly manic brains behind the Ihug phenomenon. He groans a little when he is reminded he once replied "because I'm a very smart businessman" in answer to a question about why he would succeed in the internet service provider game against the might of Telecom.

"It's more like blind stubbornness really. I'm not an arrogant person. When I commit to something I like to see it through. That's how all this got started. I'd come up with some harebrained scheme and John (his father) and Tim would sit here saying 'No, no, no,' until I pounded it through."

The slow striptease is classic Ihug - and not an unfamiliar strategy in the IT industry where it is often referred to as vapourware. Release tantalising snippets about products or services under development - not enough to bare all but enough to keep the competition guessing.

Force began doing due diligence on The Internet Group (Ihug is its trading name) just before Christmas, just three months after pay television operator Sky TV decided against investing in the company.

The Wood brothers were introduced to Sky by Tappenden Holdings, the investment company owned by Alan Gibbs and Trevor Farmer, and run by former trade unionist-cum-capitalist Rob Campbell.

Tappenden had originally eyed Ihug for itself, but saw benefits in it talking to Sky, in which it also has a stake.

It is widely believed the Sky deal fell over because the brothers were being difficult. There were allegations they demanded huge salary increases and generous holidays - allegations they claim were exaggerated. According to them, it was Sky that played hardball, demanding control for a meagre 30 per cent stake.

In the end, the deal came unstuck when the Sky board took the proposal to management. The management team had its own view of where the company was going and that did not match with Ihug, which had international aspirations.

Tappenden, however, remained keen and now owns 10 per cent of the company.

The Woods reject the view that there is no real synergy with Force, claiming while some directors may not understand much about the internet, top management does.



"We're all on the same page," says Tim Wood, who handles the marketing - bringing us the snorkelling cat advertisements which turned the former Internet Home Users Group into a household name.

The brothers also argue that moviegoers and net users share similar demographics, providing opportunities for cross marketing.

Nick Wood says: "We like the idea of being in the movie business. It has been one of my passions for years. I'm a movie freak. We can see ways of making it a better business and improving it more."

Exactly how is hard to guess. Extending Force's phone movie booking service to the net might be one possibility. There is also the somewhat futuristic idea of using high-speed net links for movie distribution, so that movies are delivered via a digital stream to the cinema screen rather than using conventional projector rooms.

A more realistic scenario would be Force opening some doors for Ihug to new content relationships through its partnership with Village Roadshow, and perhaps even through shareholder Shamrock's association with Disney.

Nick Wood points out that the company also has 30 per cent of TV production house South Pacific Pictures - a perfect vehicle for producing New Zealand net content.

But not everyone is convinced, and it is notable that it is not a line Force itself is keen to push.

Bruce Mckay, head of research for broker DF Mainland, laughs at the idea. "I think that's clutching at straws. I saw Nick Wood on TV when he said that and I could see his eyes shifting."

The brothers claim they are talking with other parties to secure television and movie content in preparation for a nationwide rollout of their net-based multicast pay TV service.

The company has spent about $3 million to date getting its Ihug Digital TV service ready for the Auckland market - something it "launched" in September, but which has only 50 or so users. At present it offers 12 broadcast and 12 movie channels with plans for a pornography channel.

"It's still a trial while we get the technology sorted out," says Nick Wood.

He believes the missing link is the next generation set-top box complete with its own storage drive which would hold e-mail and browser software and allow movies to be downloaded overnight for viewing later.

But that is still several months away, as is the completion of BCL's digital trunking network which will not be ready until April.

So, the new company will be "clicks, bricks and flicks." But just how long the bricks and flicks remain part of the equation remains to be seen.

Provided Force shareholders approve the transformation into Ihug Limited, Force will ditch its property investments. Once it offloads its entertainment centre in central Auckland and its Mt Wellington retail centre, it expects to have about $15 million in the bank, with no debt. As Mr Francis says, it will be in a strong position to borrow.

Which leaves the flicks. Mr Francis says the company is determined to stick with the cinema business in the short term. But he is more equivocal about the long term.

"There's certainly no intention [to sell the cinemas] at this stage, but I suppose as time goes on you've got to look to where your money is best invested, and if there are other areas to have it better invested in, you would look at that."

The deal, then, is essentially a backdoor listing for Ihug, which is somewhat ironic given that in April 1995 Force did a deal with cashbox company Ascot Management that ensured its own backdoor listing on the stock exchange.

The Wood brothers say the company is keen to boost its subscriber numbers by buying other internet companies here and in Australia.

Information provided to Force shareholders shows that last month, it billed about 99,000 dial-up customers an average of $32 each, including GST. It claims phenomenal growth of 32,000 new customers in New Zealand and 24,000 in Australia last year. Taking churn into account, net growth was 40,000 subscribers.

In the year ending March 1999, it produced earnings before interest, tax and amortisation of $3.5 million. This slipped to just $120,000 in the nine months to the end of December, due to higher operating costs.

Staff number 300 up from 150 a year ago. Not bad for a company that started in August 1994 with a Commodore 386 PC, and a loan of $8000 which bought a terminal server and 20 Motorola 14.4Kbps modems.

It is now up to Force shareholders to decide whether they want to take the risks involved.

Some might be tempted to argue that the new company could not be any worse than the old one. After hitting a high of around 88c two years ago, Force's share price has steadily declined. It spent most of last year hovering around 60c.

The company is tightly held, and until recently, was largely the personal plaything of Mr Francis and several of his mates. Because it is such a small company (its market capitalisation has generally hovered around $100 million), few analysts have bothered paying much attention to it.

But most agree it faces a bleak future if it continues on its current path, given that the cinema business in New Zealand appears to have matured. Enthusiasm for property as an investment is also waning, and the company's foray into Argentina has caused some concern.

Not that this has deterred one Wellington analyst. In his latest report to clients, Salomon Smith Barney's Clyde D'Souza was bullish on the stock, recommending it as a good buy.

Interestingly, Mr D'Souza is listed as Force's ninth biggest shareholder in its latest annual report. Between September 1998 and August last year, he doubled his personal holding in the company from 125,000 to 300,000 shares.

Several broking firms are being questioned by the Securities Commission about the heavy trading of Force shares just before the company issued a "don't sell" notice last week.

Others remain sceptical about the Ihug deal. David Wallace, an analyst for Ord Minnett Securities in Wellington, blames American-driven hype about the internet for the spectacular rise in Force's share price over the past week.

Mr Wallace blames a market desperate for potential growth stories for the jump, and believes many Force shareholders may decide to bail out. "Watch the insiders," he warns.

At DF Mainland Mr Mckay is slightly more generous. The deal, as he sees it, is a marriage of convenience. Ihug, he argues, has done well to get this far.

"The Wood brothers started off with a PC in a small room and now it's a $65 million a year company with operations in two countries, and possibly going into a third.

"What Force can bring is their own disciplines and controls to that entity to stop it from getting too big and blowing itself up."

The Woods' 60-year-old father, John, would heartily agree. Wood snr, who gave his sons their initial $8000 and is himself worth about $30 million on paper, sits quietly in the corner of Nick's modest third floor office overlooking Newton Gully. If the deal goes through, he'll probably sell some of his shares and travel a bit. An avid gardener, he wants to visit gardens in Britain.

The fate of his retirement is in Force shareholders' hands.