Brian Gaynor: Capital storm over profit announcement

The Capital Properties' profit announcement will have angered a large number of former shareholders.

The results showed the company's net tangible assets a share (NTA) rose from $1.48 to $1.66 at the end of March, well above the takeover price of $1.48 a share.

An accompanying Capital Properties' analysis indicated the company's NTA would rise by at least a Ministry of Defence building in Wellington.

This would give Capital Properties an NTA of about $1.74, 18 per cent above the takeover price. The outcome of the takeover was a surprise because listed property entities in other countries, particularly Australia, usually trade at substantial premiums to NTA and Capital Properties' independent directors did not recommend acceptance.

The unexpected outcome raises several questions about the role of directors, independent advisers, shareholders and the Takeovers Code in a disputed takeover.

The Capital Properties takeover saga began on September 15 last year when AMP Property Portfolio announced its intention to make a full takeover offer at $1.42 a share.

The target company's major shareholders were Kiwi Income Property Trust with 19.2 per cent and the bidder with 15.6 per cent.

Deloitte valued Capital Properties between $1.48 and $1.73 a share and said the $1.42 a share offer was not fair.

The target company's independent directors unanimously supported this opinion and recommended that shareholders should not accept the bid.

Deloitte's valuation was based on a discounted cashflows (DCF) analysis. The Independent Adviser's Report also contained an extra valuation of $1.44 a share based on the value of assets and liabilities of Capital Properties.

Deloitte noted that this $1.44 valuation did not incorporate aspects of value captured by the DCF valuation, particularly the potential for growth or a premium for control.

It is reasonable to assume that the addition of these two considerations would have raised the assets and liabilities valuation towards the upper end of the $1.48 to $1.73 a share Deloitte assessment.

A particularly aggressive letter sent by Stephen Costley, general manager of AMP Property Portfolio, to the Capital Properties' independent directors on October 21 set the tone for the takeover. Costley released this letter to the stock exchange.

He criticised media comments by Capital Properties' chairman Tony Frankham and the disclosure of future prospects in the target company statement and the Capital Properties' cashflow modelling.

Most importantly, Costley wrote: "While we do not consider dividend yield to be the sole definitive valuation factor, it is plainly material and significant for shareholders and investors."

Costley took a high-profile stance through the takeover offer and won the public relations battle by a clear margin. Although Capital Properties' independent directors never recommended the offer, they were reserved and low-key compared with the aggressive AMP executive.

By mid-November, AMP had reached 70 per cent of the target company but acceptances had slowed and Costley became increasingly aggressive.

He went too far at times and was slapped over the knuckles by the NZX for claiming that Capital Markets would be delisted once AMP reached 65 per cent or 70 per cent.

On November 21, when AMP had reached 71 per cent, Capital Properties announced the resignation of Frankham and fellow directors Peter Coote and Richard Didsbury.

They were replaced by Murray Gribben of AMP, Costley and another AMP representative (Stewart McRobie of AMP was appointed on December 12). This meant the new board consisted of three AMP representatives and two independent directors, Michael Cashin and James Ogden.

It is normal for a 70 per cent shareholder to have a majority of directors but unacceptable that this should occur in the early stages of a hotly contested takeover battle.

On November 25, Capital Properties said it was undertaking a major review of its business.

It was obvious the company's dividend policy was the major purpose of the review as the only direct quote from Gribben, the new chairman, was as follows: "No dividend will be paid pending the announcement of the outcome of the review. The outcome of the review, including future dividend policy, will be announced before the end of January 2006."

On January 5, when AMP Property Portfolio had reached 84.8 per cent, Capital Properties released its "rigorous review of the existing assets, operations, policies (including distribution policies) and capital structure".

The two-page letter contained no review of the existing assets, operations or capital structure. The only specific information related to dividends with the payout ratio to be reduced from 100 per cent of net earnings to a range of 40 per cent to 60 per cent.

In his October 21 letter, Costley criticised the target company's board for its poor disclosure, yet the new AMP-dominated board was far worse.

Costley also noted in his October letter that dividends had a material and significant impact on shareholders and investors, yet the only disclosed outcome of the "rigorous review" was a reduction in the dividend payout ratio from 100 per cent to 40 per cent to 60 per cent.

From this point onwards, Costley and AMP placed a great deal of emphasis on the dividend reduction.

He wrote to the target company shareholders: "The board of Capital Properties has recently informed the market that there will be significant changes to the company's future dividend policy and payout ratio.

"The change to the payout ratio represents a possible halving of forecast yield for remaining Capital Properties shareholders."

How could an AMP-dominated board introduce a new dividend policy that was supposed to create greater shareholder wealth while, at the same time, AMP Property Portfolio was arguing that this policy change was the main reason why existing shareholders should sell their shares?

The answer is that Capital Properties' shareholders were in a hopeless position once AMP obtained control of the target company board after just 42 days of the 149-day offer period.

The independent directors were effectively neutered because AMP controlled the target company's financial resources and an effective defence can only be mounted if the independent directors have the financial resources to do so.

Deloitte should have been asked to undertake a supplementary assessment after the "rigorous review" was completed in January.

In the absence of this supplementary assessment, Costley and AMP were able to dominate the argument with the ridiculous assessment that the new board's wealth-creating policy initiatives were the main reason why remaining holders should sell their shares.

Capital Properties' March 2006 year result showed that the company has plenty of scope to maintain its high dividend payout strategy and still have sufficient funds to invest and grow.

The Takeovers Code has worked well but changes need to be made to the composition of target companies' boards during offer periods to ensure that minority shareholders are fairly represented throughout the full offer period.

Calendar of events

2005

Sept 15: AMP to make an offer for CNZ at $1.42 a share.
Sept 30: Offer opens.
Oct 3: CNZ's NTA rises from $1.29 to $1.48 a share.
Oct 10: Deloitte values CNZ between $1.48 and $1.73 a share.
Oct 10: CNZ recommends rejection of $1.42 a share offer.
Oct 28: AMP raises its offer from $1.42 to $1.48.
Oct 28: Kiwi Income Property accepts in respect of its 19.2 per cent.
Nov 3: CNZ will not recommend bid until it is raised to $1.55.
Nov 21: AMP takes effective control of the CNZ board.
Nov 25: CNZ is to undertake a major review of its business.

2006

Jan 5: CNZ releases its "rigorous review".
Feb 26: AMP reaches 90.1 per cent.
Apr 12: CNZ is delisted.
May 30: CNZ announces a new NTA of $1.66 a share.

Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management.