Brian Gaynor: Peddling family silver at cut-price rates

The proposed re-listing of Progressive Enterprises brings back a host of memories. The supermarket group has had a particularly colourful history that includes numerous ownership changes.

But more importantly, the Progressive Enterprise story is a perfect example of our tendency to sell assets to foreign interests at well below their full and fair value.

This unfortunate characteristic has to be eliminated, particularly as foreign predators are hovering over the NZX at present.

Progressive opened its first Foodtown supermarket in Auckland in 1958. The company listed in 1971 and was one of the best-performing stocks in the late 70s and early 80s under the astute leadership of managing director Tom Ah Chee and chairman Brian Picot.

At the end of 1984 it was the 12th-largest listed company. In the following 24 months Craig Heatley's Rainbow Corporation purchased a controlling stake.

In March 1987 Heatley proposed a merger between Progressive and Rainbow, which also owned 20 per cent of Woolworths Australia. Brierley Investments chief executive Paul Collins went on the offensive because he was also interested in the supermarket operator.

Collins publicly rubbished Rainbow's earnings quality, financial stability and management ability. His constant criticism drove Rainbow's share price from $10 at the end of 1986 to $2.10. Heatley issued a $10 million defamation claim against Collins and his company, which was later withdrawn.

In a totally unexpected move BIL made a successful takeover offer for Rainbow, Heatley was appointed to the acquirer's board and Progressive's controlling stake was transferred from Rainbow to BIL.

Two weeks after the October 1987 sharemarket crash Magnum made a share and cash offer for Progressive, which BIL accepted in respect of its 65 per cent holding. But Coles Myer of Australia, which had accumulated an 11 per cent holding, refused to accept.

In March 1987 Magnum sold its 87 per cent stake to Coles Myer for $477 million valuing the supermarket operator at $548 million. Thus the company had four controlling shareholders in less than 12 months.

Progressive came back to the New Zealand sharemarket in April 1992 through the sell down of a 60 per cent holding by Coles Myer at $2 a share.

Sharebrokers were excited about the issue and predicted that Progressive would substantially outperform Port of Tauranga, which had its public share issue at the same time.

They were totally wrong.

Coles Myer extracted $130 million of cash from Progressive just before the IPO and purchased a number of assets from the New Zealand company below book value.

The new listed entity had serious management problems and its share price fell to $1.66 at the end of 1992 and was at $1.14 in December 1995.

The supermarket operator made a gradual recovery, particularly after Barry Alty of Foodland replaced Graeme Kelly as managing director in March 1998 (Foodland had acquired Coles Myer's 38.6 per cent stake in July 1993).

In mid-1999 the West Australia-based company made a takeover offer for Progressive at $2.95 a share.

PricewaterhouseCoopers valued the company at between $3 and $3.44 a share and concluded the offer was not fair. Foodland raised its offer to $3 a share and the bid was successful.

But the important point is that New Zealand investors sold Progressive on an 6.5 EBITDA multiple (the company's value divided by earnings before interest, tax, depreciation and amortisation) yet in Australia Foodland was trading on an EBITDA multiple of 8.1, Woolworths on 8.5 and Coles Myer 9.1.

In mid-2002 Foodland purchased Woolworths (New Zealand) from Dairy Farm International for $690 million. Woolworths operated 85 stores in New Zealand with 63 under the Woolworths brand, eight Big Fresh and 14 Price Chopper.

The combined EBITDA forecast for the 2003 fiscal year was $135.5 million with Progressive contributing 63 per cent and Woolworths 37 per cent. Woolworths had more stores (85 versus 68 operated by Progressive) but Progressive's outlets were bigger and had a higher EBITDA margin.

On December 6, 2004, Metcash announced its intention to make a takeover offer for Foodland.

In a complicated deal Metcash would acquire Foodland Australia but shares in Foodland New Zealand, which comprises Progressive and Woolworths, would be distributed to existing Foodland shareholders, and Foodland New Zealand would be a separate listed company.

The target company rejected the offer as inadequate and was highly critical of the arrangement to split off the New Zealand operations. Foodland argued the proposed Foodland New Zealand deal was complicated, there was no guarantee it would be implemented and Foodland shareholder interests might not be protected.

The independent expert's report, which was prepared by Grant Samuel, contained important points including:

* Progressive has about 44 per cent of the New Zealand retail grocery market through its Foodtown, Woolworths and Countdown supermarket chains. Foodstuffs has the remaining 56 per cent, mainly through New World and Pak'N Save.

* New Zealand represents 65.5 per cent of Foodland's operating earnings.

* The New Zealand activities are far more profitable as they have an EBITDA margin of 6.1 per cent compared with 4 per cent for the Australian operations.

* Foodland's earnings in New Zealand are substantially higher than predicted at the time of the Woolworths acquisition.

But the most important point is that Grant Samuel values the New Zealand operation at between $2.06 billion to $2.26 billion gross, which is 8 to 8.8 times forecast EBITDA of $257 million for the 2005 fiscal year.

Grant Samuel concludes that Foodland's New Zealand operations are worth more than Woolworths Australia and Coles Myer based on the share price of the two Australian companies.

It is clear from the Grant Samuel valuation that Australians believe that our companies are worth far more than we do.

Australians are attracted to New Zealand because they can buy our companies cheaply, we have light-handed regulatory regimes and the marketplace is less competitive (the duopoly in the supermarket sector is a good example of this).

The latest development in the Metcash/Foodland takeover offer is that Foodland is now proposing to split the company in two and list the New Zealand operation on the Australian Stock Exchange.

The obvious conclusion from this is that Foodland believes Australian investors will put a higher value on the New Zealand operations through the ASX than New Zealand investors through the NZX.

Grant Samuel believes Woolworths Australia and Coles Myer will be interested in the New Zealand activities and "a demerger of Foodland's New Zealand retail business would facilitate the ultimate acquisition of the business by Woolworths or Coles".

The Metcash/Foodland battle may have a few more twists and turns but the Progressive story is yet another example of our willingness to sell great New Zealand companies at a big discount to international values.

After the sale the wealth created by these organisations goes offshore while the NZX and New Zealand investors miss out.

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