Power of difference between big bids

By Mark Reynolds

Between the lines

The chasm between the price Edison Mission Energy paid for its key stake in Contact Energy and the price TransAlta was willing to pay for the same stake has raised a few eyebrows.

Edison paid $1.2 billion for the 40 per cent shareholding. That was a quarter above the most optimistic of forecasts, and nearly 31/2 times book value.

The price TransAlta offered has not been made public, but it was certainly less than $1 billion and indications trickling from the company's offices in Wellington are that it was closer to $800 million.

Based on Contact Energy's earnings for the past financial year, Edison paid about 17 times the value of Contact's earnings before interest, tax, depreciation and amortisation (ebitda) for the holding. That compares with the 11-12 times ebitda believed to have been offered by TransAlta.

Internationally, a company could be expected to pay 12-13 times ebitda for a company such as Contact Energy - but that would usually be to secure full control, not just a 40 per cent holding.

Having full ownership would allow consolidation with parent company assets, bringing taxation benefits and operating efficiencies.

TransAlta, with existing electricity retailing and generating operations in New Zealand, had been expected to be able to outbid allcomers for the Contact stake, on the basis that it would be able to bring some economies of scale to its operations if, over time, it could get that full control of Contact.

But it is apparent from TransAlta's bid that the company saw potential problems in securing ultimate control, and therefore had to temper its bid with the reality of maybe being stuck with a minority holding in Contact.

Unlike Edison Mission, which has no existing operations in New Zealand, TransAlta already has a strong position in what is widely regarded as the most open and dynamic energy market in the world, so had no need to bid aggressively just to secure experience here.

Edison Mission, on the other hand, was willing to pay a premium to buy a management team that would give it some expert knowledge and experience of deregulated markets, which ultimately could be applied to extract more value from the $US47 billion worth of assets that its parent company, Edison International, owns and operates around the world.

All of this begs the question: What is in this for people considering investing in the remainder of Contact that will be sold by the Government next month?

The short-term answer is that Edison has vast resources that, when applied to Contact's existing operations, should lead to a more efficient company.

The longer-term answer is that, like TransAlta, Edison will also want full control of Contact at some time. A patient investor should be able to reap a reward when that time comes.