Aquila the Hun lines up Kiwi conquests

Friday 12th July 2002

Sharemarket punters may have got all excited over the impending exit of US giant Aquila from United Networks (UNL) but a lot of water has yet to pass under the bridge.

The sale may look straight up enough. Although Aquila is selling all of its investment - often a signal for potential buyers to look extremely carefully at the asset and the asking price - it's well known this is just another example of an embattled US corporation pulling in its global horns.

But lurking in the background is a poisonous cocktail of regulatory and grassroots political issues. Buyers will have to ensure they have their heads thoroughly around these if they are to avoid getting burned.

UNL is New Zealand's 11th largest listed company by market capitalisation with assets of over $2.3 billion.

It's the country's largest electricity and gas distributor with networks in Auckland, Wellington and the Bay of Plenty and owns and operates broadband communications networks in Auckland and Wellington.

Aquila is inviting buyers either to make a Takeovers Code offer for the whole company or to bid for specific assets. If Aquila/UNL accept a breakup sale then Aquila will make a code offer to the minorities and then dole out the assets to the successful bidders.

As these sorts of assets come up for sale once a decade, if that, other lines companies are positively salivating over the opportunity.

UNL says "more than 20" overseas and local buyers have lined up to take a look.

The share price has shot up from $8 to $9 in anticipation the successful buyers will pay top dollar.

And they probably will. "Never, ever underestimate," says one long-time industry observer, "the stupidity of our lines companies."

The fly in the ointment is that any firm bid is essentially an expensive bet against the regulator, Commerce Commission chairman John Belgrave.

Energy Minister Pete Hodgson last October charged the commission with investigating allegations the lines companies were monopoly price-gouging their customers. If the commission finds any or all are doing so they face being clobbered with price controls.

The commission circulated a discussion paper in March, triggering a veritable tsunami of industry submissions.

As the power industry is a soft target for populist centre-left governments most companies seem to see some form of regulatory constraint as inevitable but are arguing for a cuddly new-age compromise such as a "price/service equilibrium."

The commission will hold a conference later this month to hear submissions face-to-face. It will then prepare its final report to the minister, so any regulatory action is some months off.

In the meantime Belgrave and his henchpersons are poring over the lines companies' statutory disclosures, particularly their return on investment (ROI).

ROI - the after-tax return on average total funds employed in the business - is the most significant profitability measure for network industry regulators.

The other key figure is a company's weighted average cost of capital or WACC. The Ministry of Economic Development regards ROIs consistently above WACC as an indicator monopoly profits are being extracted.

UNL looks particularly vulnerable.

According to PricewaterhouseCoopers its WACC is 6.5% but industry analysts say that figure is way too low - industry WACCs are in the range of 7.5-9%.

Whatever, that's a long way below UNL's disclosed ROI of 12.87%.

The company, of course, has an answer for this. It argues, for instance, that its prices are lower than those of Buller Electricity, whose ROI is just 6.38%.

Potential buyers face the highly risky task of pricing an asset that could be whacked with price controls before they've got their feet squarely on the pedals.

In any case it's highly unlikely UNL's assets will be priced according to sensible benchmarks.

In Australia lines businesses change hands at around 1.3 times their optimised deprival value or ODV. Here the multiple has been 1.5 to 1.6 times.

But a share price of $9 implies a value for UNL of more than twice goodwill-adjusted ODV. If the market is right and this is the sort of price bidders will pay, somebody's going to get a very expensive asset even without regulatory action.

The joker in the pack, if any is needed, is the United Networks Shareholders Society, the successor of the Power New Zealand Shareholders Society.

With a 10.7% UNL stake the society is in a position to block any sale.

Its chairman, Bob Stanic, is also a UNL director but at present there's no apparent conflict of interest - what's good for UNL shareholders generally has also to be good for the society.

But the society holds the shares in trust for the North Shore, Rodney, and Waitakere District Councils. They, and around 4000 "shareholder" members, have the power to hire and fire trustees, although only two at a time when they stand annually for re-election.

Talk councils and you're talking politics, not just value maximisation.

How comfortable, for example, will the North Shore council be with a sale that will inevitably see UNL's Takapuna head office closed down and its staff paid out?

The society can't sell shares that belong to the councils, even though the shares don't vest with the councils for another couple of years, unless the trust deed is amended by a ruling of the High Court.

Those who remember the labyrinthine twists and turns and Machiavellian manoeuvrings of the control battle between Mercury Energy and Power New Zealand might happily anticipate a bit of fun to come.

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