Edison's Contact cash-grab - fact or fantasy?

Friday 1st March 2002

Those who've been around the block a few times know there can be smoke without fire. A great deal of the stuff has been generated lately from the friction between US energy conglomerate Edison and the minority shareholders in Contact Energy, of which Edison now owns 48.9%.

The question is, where's the fire?

According to Arcus Investment Management, a smallish funds management outfit that boxes well above its weight by ignoring the industry code of omerta and speaking out on shareholder issues, the rest of Contact's shareholders need to be on their guard against Edison's passion for Contact's prodigious cashflows.

Edison was certainly the company's earliest and most ardent suitor. When the National-led government sold the company in 1999 Edison paid $5 a share for a 40% shareholding and must have felt itself a little hard done by when the rest of the shares were hocked off to Joe Blow public and institutional investors at $3.10.

It must now be feeling positively battered, having unsuccessfully offered $3.85, and then $4.14, for the holdings of the minorities, of which Shoeshine is a modest but happy member.

Somewhere along the line, Edison's passion for Contact's cashflows has assumed, in the eyes of the minority shareholders, the proportions of Prince Charles' ardour for Camilla.

So Contact's shareholders will assemble for their annual meeting on March 11 to consider Shareholder Proposal #2 - Transactions with Edison Mission Energy and related parties.

The proposal - it doesn't have the force of a resolution and doesn't have to be implemented by the board even if passed - has been generated out of the belief that Edison, scorned in its attempts to make Contact completely its own, is now determined to use the majority of its directors on Contact's board to milk Contact of its cashflows by underhand means.

It proposes, in essence, that Contact be barred from buying or selling any assets jointly with Edison unless the transaction has been approved by a special shareholders' resolution, requiring 75% of votes after an independent appraisal report has been commissioned and delivered.

The proposal is intended mainly to prevent Edison from signing joint-venture energy project deals with Contact that will shift the burden of finance costs and project risk from its own balance sheet to Contact's.

The underlying suspicion, prompted perhaps by Edison's well-reported difficulties over the past couple of years, is that the US company is long on debt and short of cash. With 100% of Contact it would be able to devote all the company's cashflows, which last year amounted to $256 million, to service its debts or take on new debt. With any less than 100% it's reliant on the good graces of Contact's board, including the directors it hasn't nominated, to furnish it with cash by paying dividends.

Quite why Edison should be suspected of resorting to underhand means, such as joint ventures of "dubious" value to Contact, isn't clear.

Edison's Asia-Pacific point man, Bob Driscoll, points out his company doesn't need Contact's cash that much. Stories of group member Southern California Edison's troubles stemming from the Californian power crisis and of parent Edison International's "cash crisis" are at least six months out of date, Driscoll says.

That's all fixed up now - both companies have had credit-rating upgrades - and Driscoll expects both to regain their investment grade ratings by the middle of next year.

Arcus' suspicions were aroused by last year's joint-venture deal between Contact and Edison to build a co-generation plant in Victoria.

Contact will contribute $A66 million during the construction phase. That equates to 4.9% of Contact's shareholders' funds at the time of the announcement, just below the 5% threshold at which shareholders would have had to vote to approve the deal.

Arcus suspects 4.9% is no accident. It also wonders why, if the project is so attractive, Contact, or Edison, couldn't have done it on their own.

Driscoll says Contact has always aimed to expand into Australia - two other projects were looked at two years ago but dumped when they didn't look likely to meet Contact's "hurdle rate" of return.

He's a little surprised, he says, that Arcus should be "opposed to investments that meet Contact's hurdle rate and provide additional revenue to its shareholders."

Which is somewhat missing the point - Arcus isn't opposed to Contact making good investments but to Contact co-investing with Edison for Edison's nefarious benefit.

Nor would Arcus' proposal make it impossible to run the company, as Contact's board has suggested in its reply. The proposal refers only to "assets" and so would not, as Contact claims, have the effect of forcing the company to hold a shareholders' meeting to approve the secondment of a chief executive from Edison or a technical assistance deal.

But it's unclear why Arcus and its confederates don't trust Contact's independent directors to do their statutorily decreed duty.

Nothing Shoeshine knows of would suggest the trio - chairman Phil Pryke, Tim Saunders and John Milne - can be bought, bullied or coerced into doing the will of the majority shareholder to the detriment of the minorities.

Nobody has ever suggested the independent directors of Carter Holt Harvey (majority shareholder International Paper), Independent Newspapers (majority shareholder Rupert Murdoch's News Corporation) or Sky Network TV (majority shareholder Independent Newspapers) have acted in a way that's unfair to small shareholders.

Then again, Arcus knows its proposal has no hope of succeeding. The aim, it says, is to keep 'em honest. It should at least provide some entertainment at the annual meeting.

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