Sky City spoils takeover ship for ha'penny worth of tar

Shoeshine

Friday 23rd April 2004

Being stingy with your shareholders' money is normally an admirable trait. But Sky City Entertainment's penurious attitude toward the minorities of Sky Leisure imperils its cleanup bid's chance of succeeding.

After all, the value of the bid is only $14 million, hardly a big stretch for a company with a market capitalisation of $1.8 billion.

The 82c a share offer for the 3.1 million shares Sky Entertainment doesn't own is at a 22% discount to the $1.05 pre-bid close.

This virtually assures the minority ordinary shareholders will ignore it, leaving the bid's success dependent on acceptances from the convertible noteholders.

These instruments convert into voting shares, at the election of the noteholder, at a ratio of two shares for each note.

The bid is conditional on Sky Entertainment reaching the 90% holding it needs to go to compulsory acquisition of the holdings of any standouts.

The bidder already has 3.1 million ordinary shares and 23.8 million notes which it will, presumably, convert forthwith, giving it 50.7 million votes, or 74.4% of the diluted total.

As Sky Leisure's fully diluted voting capital is 68.15 million shares (that is, if all the notes are converted), the bidder needs a further 10.7 million votes to get to 90.1%.

Assuming no existing ordinary shareholder accepts, that means Sky Entertainment will have to pick up 76% of the outstanding notes.

It may well get there, but it nonetheless seems an unreasonably high hurdle for a bidder who already has 74.4%.

Its meanness is hard to fathom. The numbers involved are so small it's positively embarrassing.

The company is arguing the shares have been overpriced and the notes underpriced.

Maybe so. But the value of the premium on the notes, less the discount on the shares, is $514,000, or about what it costs to keep the Entertainment boardroom stocked with claret each year.

The 22% discount on the ordinary shares saves Sky Entertainment just $709,550.

First New Zealand Capital estimates Leisure's corporate overheads, most of which will be eliminated if Entertainment's bid succeeds, at $1.3 million a year.

Capitalise that by applying a suitable multiple First NZ reckons five times and the value to Entertainment in those savings alone is $6.5 million, or enough to offer a further 37c a share on a fully diluted basis.

And if the bid succeeds there will be many other cost rationalisations, although they will probably be fairly limited in dollar terms.

All this is not to say the bid taken overall is unfair, a question Grant Samuel will determine.

First NZ Capital puts a fair value on the shares of $0.79-0.86, and on the notes of $1.58-1.72.

It gets there by splitting out the property assets SkyCity Metro and Symonds St which it values at $55-60 million.

It capitalises forecast cinema ebitda of $8.3 million at $62 million and subtracts capitalised overheads and the company's December 31 net debt of $56 million to get an equity value of $54-59 million.

The real question for Entertainment is why it got into Leisure, the former Force Corporation, at all.

The company has promised much and delivered little and has never returned its cost of capital.

Last year it made a $3.3 million profit which, while an improvement on 2002's Argentina-driven $20.1 million loss, wasn't much of a return on an enterprise value of $110 million.

Chairman David Gascoigne promised "a further strong year of earnings growth" but at the half year this didn't seem to be happening.

The December first-half gain was just $205,000, down from $1.02 million in the same period the year before.

It blamed the fall on the costs of closing down the failed Planet Hollywood restaurant, "a restatement of the prior year Fiji surplus" and the timing of cinema fitout contributions.

Taking these out, it said, the result would have been a $700,000 profit, against $900,000 the year before.

The company pointed out the second half of the previous financial year had benefited from a particularly strong line-up of films, including the second Harry Potter and Lord of the Rings movies, Chicago, the latest James Bond, and Whale Rider.

It noted the product schedule for the June second-half this year looked less attractive.

In an unusually compliant initial response to Entertainment's bid, independent directors David Henry and Mike Daniel confirmed audiences were down in the second half so far due to less-attractive films apologies, presumably, to Peter Jackson.

It followed, they said, that a larger premium than Entertainment was offering wasn't realistic.

So there's a lesson for would-be cinema chain buyers. Get in when Hollywood's having a bad year. Of course, there is no guarantee Hollywood won't have a bad year next year too and the year after that.

In the meantime Entertainment, if its bid succeeds, will have a further $56 million of debt to service.

The flat line its share price path has assumed should be delivering a message to the boardroom growth for growth's sake is not what the market is looking for.

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