KEY POINTS:
The potential takeover of Tourism Holdings is a loss, loss, loss situation as far as New Zealand is concerned.
If MFS Living and Leisure's $2.80 a share bid is successful, the NZX will lose a major tourism company that is poised to expand overseas.
A successful offer will also cut the earnings of the domestic tourism sector and reduce the tax take.
Shareholders only have to focus on the offer price, but there are much wider issues at stake in this takeover bid.
The latest stage in the Tourism Holdings development began when Trevor Hall replaced Denis Pickup as chief executive on July 3 last year.
Hall had an impressive career in the tourism sector before a stint as executive director of a listed Australian software company between 2000 and 2002.
He was chief executive of the New Zealand Lotteries Commission in the three years before his latest position.
Hall immediately did a strategic review and split the company into four divisions:
* Rentals. The New Zealand and Australian campervan activities operating under the Maui, Britz and Backpacker brands.
* CI Munro. The Otorohanga manufacturer of campervans, caravans and other special-purpose vehicles for the Australasian market.
* KX Group. Kiwi Experience, Tourism Transport Fiji and Airbus, Auckland Airport's transfer service.
* Leisure Group. A wide range of activities including Kelly Tarlton's, Milford Sound Red Boats, Fullers Bay of Islands, Johnston's Coachlines and Waitomo Glow-worm Caves.
The Rentals division is the most profitable in terms of earnings and margins.
In the June 2006 year it had ebita (earnings before interest, tax and amortisation) of $24.7 million and a margin of 22.7 per cent, whereas the rest of the company had ebita of only $7.1 million and a 9.3 per cent margin.
Hall believed the leisure activities would continue to underperform because the company had limited distribution capacity.
These leisure facilities are highly dependent on group tourists and the big international tour operators drive a hard bargain as far as pricing is concerned.
Tourism Holdings is forced to accept low margins from group visitors as the intermediary, usually a large overseas tour operator, captures the higher margin.
Tourism industry sources are critical of recent developments in the Asian inbound trade.
They report that many Chinese visitors pay only for their Shanghai to Auckland airfare before they leave home. When they arrive in New Zealand they are picked up by a tour operator and a Chinese student driving an old bus.
They are driven around the North Island from souvenir shop to souvenir shop and their accommodation and internal travel is funded mainly from the commissions the tour operator receives from the souvenir shops.
These group tours have little value as far as the traditional tourismsector is concerned.
Hall, with his board's agreement, began to talk to a number of other New Zealand tourism operators about the prospect of a joint venture deal with his Leisure Group.
The main purpose of this strategy was to try to create an organisation with critical mass that would have more bargaining power with the powerful international distributors and tour operators.
When Hall could not generate any joint-venture interest he engaged an investment bank to sell the leisure activities. During this process MFS made a non-binding offer to acquire these assets for $140 million. This compared with broker valuations of just over $60 million for the Leisure Group late last year.
MFS made a bid for the whole company when it received legal advice that the sale of the Leisure Group would require 75 per cent approval of Tourism Holdings' shareholders and US- based Sterling, Grace had raised its shareholding from 15.9 per cent to 17 per cent.
Sterling, Grace, which is known for its erratic behaviour, could easily vote down the proposed sale by Tourism Holdings.
The independent adviser's report, prepared by Ferrier Hodgson, poses more questions than answers. A number of points in this report, which values Tourism Holdings between $2.67 and $3.07 a share, are worth noting, including:
* Ferrier Hodgson uses a discounted cash flow analysis whereas most independent reports use the multiple-based valuation method.
* The Leisure Group is valued at only $128 million yet MFS offered $140 million for these activities.
* Over the past four years the Rental Group reported 2.5 times more ebita than leisure and over the next three years is forecast to achieve 2.1 times more. Nevertheless, the rental assets are valued at only $243 million, just 1.7 times the $140 million offered for the Leisure Group.
* Ferrier Hodgson uses a discount rate of 11.1 per cent, which is well above the rate used by the Australians when they do their analysis. Thus MFS will have a higher Tourism Holdings valuation than Ferrier Hodgson and other New Zealand analysis.
The target company directors support the bid because the $2.80 offer price is a substantial premium to the pre-offer price and the offer "is the most value-creating option available to shareholders".
The bid was at a large premium to the market price because the directors did not announce the $140 million Leisure Group offer to the NZX. The failure to reveal the earlier MFS/Leisure assets bid appears to be inconsistent with continuous disclosure requirements and has severelyrestricted the options of TourismHoldings' shareholders.
A preferred outcome would have been to sell the Leisure Group and keep the rental assets in the listed entity.
Hall believes the Rental Group has better long-term prospects because this area attracts independent travellers who do not go through tour operators or distributors.
A high percentage of campervan rentals are sold directly to the traveller, mainly through the internet, which cuts out the middleman and gives a much higher margin to the New Zealand operator.
Tourism Holdings is the world's second-largest campervan rental company after Cruise America, a family-owned Arizona business, and has well developed plans to expand into the United States.
Hall believes there is good potential for the rental brands in North America because the independent traveller, particularly Germans who make use of Maui in Australasia, will alsodo so in the United States.
A successful takeover of Tourism Holdings will also have a negative impact on the Government's tax revenue because MFS Living and Leisure is a stapled security that doesn't pay tax. Under this structure a company distributes its earnings to a trust and investors pay tax on the distributions from the trust.
A successful takeover of Tourism Holdings at $2.80 a share is not the best option for New Zealand, particularly as MFS had already offered $140 million for the leisure activities. The preferred outcome would be the original MFS/Leisure Group deal or a higher price.
A higher price is warranted, particularly in light of the $140 million offer for the Leisure Group.
* Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management.
