Ihug and Force: why?

Friday 7th April 2000

"Better than a salmon farm or a gold mine."

Touché.

Wood says Ihug was happy to avoid the administrative headaches of a solo listing - it would have taken longer and meant a lot of time away from the business. But after the talks with Sky TV fell over, he and brother Tim had more or less resigned themselves to an initial public offering - until Force stepped in.

"Force was an accident that popped up. We didn't expect it to be part of the equation. We were expecting [a merger partner] to be more a media player. It's not a marriage made in heaven, it's not an AOL-Time Warner, but it's a good enough match. Even a deal with Sky wasn't going to give instant access to content - Sky doesn't have those rights."

Good for the Woods

The logic is there. The Force deal does provide money. Force company secretary Peter Holdaway says once the sale of certain properties - including its Entertainment Centre on Auckland's Queen Street and the Mt Wellington retail development - is

complete, and debt repaid, there should be between $5 million and $10 million available for Ihug's e-commerce activities. Plus, Force is profitable - it made a $7.826 million after-tax profit in the year to June 30, 1999. It also provides management, and potentially, some benefits like online booking, delivery of movies by satellite and possibly, a bundled leisure dollar package for customers.

But some key questions remain. Would it not have been cheaper to get these benefits another way? Quality management and board talent can be brought in, marketing and delivery synergies can be achieved through relationship building as well as asset purchase.

Ord Minnett analyst David Wallace doesn't believe the Ihug-Force merger is harmful for either company, but nor is he convinced about any benefits.

"If you come to the basic premise of why companies merge it's to create some sort of advantage through lower costs, market strengths or complementary products. There's not much of that here, except movie tickets online."

It could also be a way out for the Woods - or so some analysts are saying. Unlike similar deals, the contract with Force doesn't require the brothers to stick around. Instead, Wood says there's a gentleman's agreement that they will stay on board, though some of the smaller holders, like father John Wood, can sell out.

"The understanding is that no one has any intention of selling their shares. We've agreed dumping shares would not be good for the company. We are here to finish the business."

On the other hand, if the stock price hit $3.00 (the price at the end of February was $0.85), Wood says he wouldn't be averse to selling down a bit.

And for investors?

That would be nice for him, but what's in it for investors right here, right now? Force valued each Ihug subscriber at approximately $1000 on the day the deal was struck. That cost Force $120 million - $0.5714 a share for the 210 million new Force shares to be issued to Ihug shareholders. But since then Force's share price has gone up from around $0.55 to more than $0.90 and then back to between $0.70 and $0.85. At these prices each subscriber is worth up to $1900. This is at the top end of the $1600 to $1900 range paid for Australasian Internet service providers over the past few months.

"At $1885 per Ihug subscriber, [Force] is looking fully priced, compared with Australasian peer group multiples," JB Were - one of the brokers involved in the merger deal - said in a recent investors' report released when Force was near the top of the $0.70 to $0.85 range. (It was nearer the bottom as Unlimited went to press.) Whether JB Were is recommending the stock is hard to tell. At best, says Were, it's an "interesting opportunity for investors seeking exposure to the higher risk/reward environment of the Australasian Internet sector".

Force shareholders were due to vote on the Ihug bid in late March. Wood sees any future synergies that emerge as an added bonus, but believes there's some benefit in bringing an outside perspective to both the Internet and the cinema businesses.

He has a few ideas, for example, on how to get cinema utilisation - about 30% average during the day - up nearer the 65% usage rate Ihug achieves on its network. And he sees self-confessed techno-illiterate and Force head-honcho Peter "I-have-never-surfed-the-Web" Francis serving much the same role as Wood's father, John (and joint Ihug founder) - that of critical observer. And then there's the stuffy old business of behaving like a public listed corporate - something the Woods have no experience in, though Francis has been doing it for years. Through the Tappenden deal - completed the day before the Force takeover - veteran corporate heavies Alan Gibbs and Trevor Farmer are also added to the Ihug equation, along with an estimated $12 million of their money.

So what does it all mean? Well, it's a bit like Hollywood marriage: let's just wait and see.

Warburg Dillon Read technology analyst David Lane sees Force as Ihug's Internet-disaster insurance policy. He says Ihug has already hedged its bets through expansion from pure

Internet service provider into telephony, e-commerce and digital TV. Now it also has reliable cash flows, capital and solid board members.

"I believe Force is a very safe option for them," Lane says. "If [the Woods] had floated on their own, perhaps the stock price would have performed very well, but there were many risks associated with this strategy ... We can't know whether the market would have been mature enough to have understood them as a stand-alone listing and provided them with the currency needed for expansion."

Off-screen chemistry

There may be some synergy benefits from the merger - getting content through Force subsidiary South Pacific Pictures or other Force contacts, for example, or leveraging the fact that cinema audiences and Internet users have similar demographic profiles.

Most important, though, is the behind-the-scenes chemistry. Force does it better, apparently, than Sky. "In other negotiations there was one-upmanship and leverage for control," says Nick Wood. "We were arm-wrestling with each other. This has been a very friendly merger. I've not met anyone in the whole group I can say I wouldn't get on with. None of the [Force] guys want to put the brakes on or will expect 10 committee meetings to get a decision."

Well, that's a start.

Nikki Mandow

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