Richard Inder: Feltex may spot tactical gain in dragging its feet

The glacial progress of merger talks between carpet-makers Godfrey Hirst and Feltex is beginning to look like a tactical move by the beleaguered New Zealand company.

But that is not a reason for shareholders to breathe easy.

Australian Godfrey Hirst made its approach in late June, just after Feltex had warned, for the second time in three months, that a housing slowdown would knock profits below market expectations.

Taking a 5.8 per cent stake, Godfrey Hirst said a merger would benefit both companies.

A week later, the two met.

Feltex then reported "constructive discussions" and its directors resolved to discuss the matter at their July board meeting three weeks later.

They emerged from that meeting and asked Godfrey Hirst to disclose financial information comparable to that available on Feltex. Just why it took three weeks and a meeting to make such a simple request was never explained.

What has happened between now and then is unclear. Feltex released its annual results this week, declaring the merger discussions had barely moved beyond where they were in July.

It said: "Discussions with Godfrey Hirst remain at the stage of seeking reciprocal information and agreeing the terms on which it is to be shared."

As it made the statement, the two were in talks about the merger. But the meeting broke up with little or no resolution and Feltex offered no more comment on the outcome of the discussions.

It is not clear where the blame for the lack of progress lies.

The pessimistic, and by no means outlandish, explanation is that Feltex is dithering.

This conclusion would be in keeping with its past failures - two profit warnings and one profit upgrade, the latter a revision of a forecast made just 10 days before Feltex closed its books on the 2005 year.

Such dithering would also be in keeping with its behaviour this week:

* The shift from quarterly to half-yearly reporting, a move that is in opposition to overseas trends and at odds with the need to keep the market informed at a time of such uncertainty.

* The disclosure of its annual results, the early departure of chief executive Sam Magill and the tortuous progress of merger talks without meeting or holding a conference call with its stakeholders. (Management were interviewing candidates for the position of chief executive and holding the increasingly bizarre merger talks.)

However, the odds that Feltex is dragging its feet on the talks for tactical gain are high.

Godfrey Hirst has every incentive to move quickly. Feltex's shares are languishing at around 58c, well below their $1.70 float price, and shareholders are vulnerable to any offer that would allow them to put the sorry saga behind them.

(There has been a considerable amount of churn on the share register since the company first came clean on its difficulties in April. Large shareholders, including a former 9 per cent stakeholder, Australia's Hunter Hall, have sold out. However, a large number of retail investors who bought in at the float remain.)

Feltex is also leaderless.

Meanwhile, the sale of Feltex at a price close to the present share value would be an admission of defeat and a stain on the otherwise distinguished careers of many of the carpet-maker's directors.

Chairman Tim Saunders has a lot at stake. He sits on the boards of some of New Zealand's most high-profile companies, including electricity generator Contact Energy and coal company Solid Energy.

The new acting chief executive, Peter Thomas, is closely linked with the CSFB private equity fund that bought Feltex for $19.5 million in 1996 and then sold out last year in the $254 million initial public offering. Thomas, a Melbourne-based consultant and Feltex director, received a fee for a successful completion of the offer and was entitled to part of the proceeds from the sale of the CSFB shares.

Neither has emerged from the saga looking flash. So, quite apart from their duties to shareholders, both men will have a strong desire to shore up their reputations.

It is, therefore, not a large leap to suggest the duo believe their review of Feltex's operations, due to be presented to shareholders in the spring, will lift the share price and put them in a better bargaining position.

It is a risky strategy and, if it were fuelled by ego, Feltex's shareholders should be nervous.

Under the board's leadership, Feltex failed to recognise the extent and the effect of the slowdown, so it is fair to ask whether it is capable of coming up with the correct prescription to fix the troubles.

It is also not clear whether the prescription will dovetail with the plans of the potential merger partner, Godfrey Hirst.

The two firms are subject to the same challenge - a surge of cheap imports from China. They will also be aware of how management has configured the other's operations.

But these factors are not sufficient to ensure the creation of two complementary businesses. Indeed, the incentive may well be for each to pursue different market niches. As a result, it is more than possible Feltex could destroy value that might be released from a merger.

Finally, Feltex's shares have fallen as low as 43c. Most observers believe its present showing is largely a product of Godfrey Hirst's presence on the share register.

Should Godfrey Hirst walk away, Saunders and Thomas will face a truly Herculean task.

Feltex shares are not for the faint-hearted.