C2
THE DOMINION POST
WEDNESDAY, FEBRUARY 22, 2012
BUSINESSDAY
dompost.co.nz
Kerr’s Epic show of disdain for small investors
The Epic fund fee-fest is a big fat raspberry
for small investors.
T
HE SMOKE of
burning bridges
is drifting over
the battle for
Pyne Gould
Corporation as
takeover bidder George
Kerr mounts his final
assault.
To Chalkie’s eye, it appears
Kerr no longer cares what small
investors think of him and isn’t
afraid to show it. How else to view
the extraordinary fees extracted
from disastrous investment fund
Epic and disclosed to the market
last week.
Not only does the eye-popping
sum add insult to injury for Epic’s
suffering investors, it also casts
serious doubts on the quality of
PGC’s independent valuation
report, produced to advise PGC
shareholders on the takeover.
Indeed, there are other reasons
for PGC shareholders to doubt the
fullness of the information they
are getting, but we’ll come back to
that shortly.
The Epic fund was created by
Kerr in 2007 and there have been
many twists and turns in its
downward spiral since then. The
fund’s manager, Equity Partners
Infrastructure Management, was
sold by Kerr to PGC in 2009.
That transaction has already
consumed many column inches of
comment, as have subsequent
deals, so we’ll fast-forward to the
current situation in which Kerr’s
takeover of PGC – his consortium
has reached 66 per cent ownership
– allowed Epic to terminate its
management contract.
This is what it decided to do
and on Valentines Day PGC
announced the parties would go
their separate ways. Epic,
however, had to hand over a
whacking great termination fee of
$5.6 million, plus a ‘‘performance
fee’’ of $3.3m relating to its
remaining significant
asset, a 17.5 per cent
interest in British
motorway service
station operator Moto.
The recipient of the
cash is a PGC
subsidiary, now
majority-owned by Kerr’s
consortium.
The $8.9m amounts to about 15
per cent of Epic’s net equity at last
balance date – a big chunk of
investors’ funds.
Given the horrible
performance of Epic – since
issuing shares at $1 its net assets
per share have fallen every year to
stand at just 42c – shareholders
would be forgiven for thinking the
manager deserves tarring and
feathering instead of a golden
handshake.
However, the management
contract said Epic had to fork out
five times the fee paid over the
previous 12 months. Given that
Epic was paying about $1.5m a
year in management fees for the
privilege of having its value
destroyed, the termination fee
therefore technically amounted to
more than $7m.
With the actual fee negotiated
down to a mere $5.6m, payable in
shares rather than cash, Epic
chairwoman Margaret Devlin has
written to shareholders suggesting
they got a bargain.
Maybe – a bad contract is still a
contract – but what about the
performance fee?
The deal was that the manager
would get a performance fee if
certain things happened, such as if
Moto was sold or if Epic
terminated the management
contract. The fee was to be a
portion of any upside on the Moto
investment if it exceeded an
internal rate of return of 9 per cent
a year.
Moto, as Epic investors may be
General Manager
Strategic and Development Focus
Business and Operational Role
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Knowledge is power: George Kerr, left, and Bryan Mogridge may know what other
Photo: FAIRFAX NZ
Epic shareholders don’t.
aware, has been a disaster. It was
so laden with debt it had to stop
dividends and beg shareholders
for more equity after it found
lenders were no longer prepared
to indulge its excesses.
At the last balance date,
according to Epic, Moto’s assets
exceeded its debts by just $690,000
and it recorded a net loss of $7.7m.
How could its returns to Epic
generate an IRR of more than 9 per
cent?
Devlin refused to talk to
Chalkie, but through a PR-man
justified the $3.3m fee by referring
to its consistency with Epic’s
balance sheet, which in 2010 and
2011 included a fee liability
provision of $3.5m – effectively a
guess of what the fee might be if
Moto hit performance targets
years in the future.
She also said Moto’s earnings
before interest, tax, depreciation
and amortisation had grown at a
compound rate of 16 per cent a
year, and the company had
therefore not been a disastrous
investment. Since ebitda excludes
one of Moto’s biggest costs –
interest – this seems an odd
definition of success. It’s also an
odd definition of IRR.
Given that the fee was to be set
at ‘‘realisation date’’ – now –
therefore returns from Moto were
to be assessed now and not years
in the future, the insistence on
accounting for future performance
seems odd too.
After all, it appears the Epic
board’s negotiation skills turned a
potential fee payment of over $7m
into an actual payment of $8.9m.
Great job.
The size of the fee would
presumably also be a surprise to
consultancy firm Grant Samuel,
which valued PGC last November
when Kerr’s consortium,
Australasian Equity Partners,
made its takeover bid.
‘‘Grant Samuel has assumed no
performance fee would be paid
based on the structure of the
performance fee and the
performance of Moto,’’ it said.
As for the management
contract, ‘‘the lower end of the
valuation range has been set at
zero given the strong likelihood
the management contract will be
terminated on AEP securing
control of PGC’’.
Grant Samuel said the Epic
management contract was worth
$2.4m tops.
Clearly, Grant Samuel was not
just wrong but not even close to
being right. Could it also be wrong
in its assessment of PGC’s other
assets?
Let’s recall that Kerr is offering
37c a share for PGC, well below
Grant Samuel’s valuation of 49-to57c a share. In effect the deal
offered shareholders a bird in the
hand or two in the bush, a tricky
decision. But what if there were
more, or bigger birds in the bush?
For example, a dissident
shareholder group has produced a
valuation suggesting PGC is worth
69c a share.
PGC’s assets are difficult to
assess, but of concern to Chalkie is
the information gap between what
shareholders know and what Kerr
knows. Kerr has been a PGC
director since 2008 and in that
capacity is extremely wellinformed about PGC’s business, as
is independent chairman Bryan
Mogridge. However, Kerr is also a
director of companies in the
Torchlight asset management
group and is closely involved in
the management of Torchlight
private equity funds – collectively
a big and hard-to-value part of
PGC’s business.
Mogridge, the only independent
director left on PGC’s board, says
he has nothing to do with
Torchlight and quit the boards of
Torchlight companies in October
last year, the same month Kerr
revealed his takeover intentions.
Chalkie is not suggesting there
has been any deliberate nondisclosure, but since the formal
takeover began Torchlight has
been extremely active,
particularly in respect of an
Australian listed company named
RCL.
Previously part of the Babcock
Susan Watson and
Chye-Ching Huang
COMMENT
S
TATE-OWNED enterprises
at first glance look like
ordinary companies
incorporated under the
Companies Act 1993. But lurking
in the SOE Act are provisions
that make them different animals
altogether, ones that need to be
treated with utter care, respect
and caution.
Section 9, dealing with the
Treaty of Waitangi, is perhaps the
most well-known provision
dealing with SOEs, but there are
two others as important but far
less visible.
Section 4 refers to social
responsibility requirements, and
Section 7 relates to contracting
with the Crown. The Government
has not stated whether it will be
keeping these provisions, or some
version of them, for the partially
privatised entities.
If you’re a member of the
investing public interested in
buying SOE shares when they are
floated, or a voter or policymaker, you should look carefully
at Sections 4 and 7 in order to
understand what sort of beast
you’ll be selling, buying and, in
the process, perhaps modifying.
While requiring SOEs to be
profitable, Section 4 of the SOE
Act also charges each entity with
being a ‘‘good employer’’ and an
organisation that ‘‘exhibits a
sense of social responsibility’’.
Is it possible that a litigant
could use this section to require
an SOE to change contracts with
Cautious: Susan
Watson, above,
and Chye-Ching
Huang, left, urge
investors to read
the fine print.
its employees or its
environmental practices, for
example, even at the expense of
shareholder value – and even
when the SOE’s actions satisfy
other laws and regulations?
One possible view is that
Section 4 doesn’t make SOEs that
much different from companies
that have adopted ‘‘corporate
social responsibility’’ provisions
of their own. It could be said such
social responsibility
requirements, whether voluntary
or statutory, are so vague that
they are little more than window
dressing anyway. In the 1990s,
cases on Section 4 read the
provision down to require
essentially no more of SOEs than
to be as profitable as possible.
But judges might take a
different approach to Section 4
today, influenced by the trend of
‘‘social responsibility’’
commitments in private
companies and international
developments such as the
introduction of a provision
broadly similar to Section 4 into
the UK Companies Act.
Policymakers, voters and
investors should therefore be
slow to conclude that Section 4 is
essentially meaningless. The
effect, if any, of keeping or
removing it must be carefully
examined. Options include
clarifying what is meant by
‘‘social responsibility’’, and
considering whether the purposes
of the section might be better met
though existing or changing
regulation, if required.
S
ECTION 7 is another
provision that ordinary
companies don’t have to
deal with. When the
Government wants an SOE to
provide goods or services, the two
enter into an agreement under
which the SOE will do so,
but the Crown is in return to
pay ‘‘the whole or part of the
price’’.
Its purpose is to prevent
the Crown from using SOEs
ad hoc to subsidise goods
and services. If the Crown
wants to use SOEs to
provide social benefits, it
has to pay the entity
transparently. SOEs then
can’t use non-commercial
obligations as an excuse for
The Electricity Authority, established in 2010 as an independent Crown entity, is responsible for the overall
operation and regulation of New Zealand’s electricity markets.
Permanent/Full Time National Office - Wellington
This role is responsible for the effective management of the Ministry’s review and
appeal processes, complaints and corporate claims, and provides a senior point of
engagement with advocacy groups.
For further information, a position description or to submit your application
please visit our website www.msd.govt.nz/careers and follow our online process.
Applications close 5pm Monday, 5 March 2012.
October 2011:
➤Pyne Gould Corporation
shareholders advised of pending
takeover offer from Australasian
Equity Partners, a fund led by
PGC director George Kerr in
association with US investor
Baker Street Capital. Between
them they already control 37.5
per cent of PGC.
November 2011:
➤AEP formally offers 33c a share,
6c more than the shares were
trading prior to the offer.
➤An independent report from
Grant Samuel values PGC at
49-to-57c a share.
➤AEP raises offer to 37c and
extends closing date from
December 2 to December 9.
➤AEP extends offer to Dec 16.
December 2011:
➤AEP extends offer to Dec 23.
➤AEP extends offer to January 6.
➤AEP discloses 47 per cent stake,
extends offer to January 31.
January 2012:
➤AEP passes 50 per cent
ownership, waives 90 per cent
ownership condition.
➤AEP extends offer to Feb 15.
February 2012:
➤AEP declares offer
unconditional, extends offer for
final time to March 30.
➤AEP stake reaches 66 per cent.
& Brown stable, RCL is now an
independent entity in the real
estate business, owning thousands
of sections on various
development plots in Australia
and New Zealand. The New
Zealand ones are at Jack’s Point
and Henley Downs, adjacent sites
on the shores of Lake Wakatipu
near Queenstown, acquired from
interests associated with Kerr in
2007.
Last November a PGC
subsidiary took over loans to RCL
(apparently holding them in trust
for the Torchlight fund)
Chalkie is written
by Fairfax
business bureau
deputy editor
Tim Hunter.
Investors should look closely at the SOE Act
General Manager Corporate Services
General Manager
Client Advocacy and Review
PGC TAKEOVER
comprising senior and project
debt totalling about A$200m. The
lending had previously been
provided by Bank of Scotland
International, and BOSI appears
to have retained an interest
according to a security agreement
dated December between it and
Torchlight.
Judging by RCL’s statements to
the ASX, Torchlight now has RCL
by the short and curlies and is
trying to get its hands on the real
estate.
Chalkie reckons this deal is
potentially significant for PGC –
just as the Epic deal was – yet not
a peep has emerged from PGC
about it.
In similar vein, a Torchlight
subsidiary last November took on
the management of Australian
listed IEF Real Estate Group, a
hospitality property fund with net
assets of about A$100m. PGC has
said nothing about it, even though
Mogridge is chairman of the new
manager, Bodiam RE. Part of the
deal appears to involve Torchlight
providing new equity capital for
IEF. Interests associated with
Kerr sold property to IEF in 2007.
What all this suggests to
Chalkie is that PGC shareholders
accepting Kerr’s takeover offer are
probably leaving even more value
on the table than the independent
report implies. Furthermore,
there are deals going on that could
affect the value of PGC, but
shareholders have not been told
about them, even if only that they
are not material.
The experience may leave
small investors reluctant to
become involved with Kerr in
future – once bitten, twice shy. But
Chalkie reckons Kerr would
rather not be involved in public
markets either, so he doesn’t mind
burning
bridges.
In performing this function, the Authority’s vision is to be recognised as a world-class electricity regulator.
The General Manager Corporate Services (GMCS) plays a lead role in the attainment of this aspiration,
with responsibility for enhancing organisational performance in a fast-paced professional environment.
In addition, the GMCS is the Authority’s chief financial officer, and is responsible for managing the
Authority’s public sector accountability responsibilities, strategic-level financial analysis and advising
on board governance matters.
Features which make this position different include the rapidly evolving nature of New Zealand’s relatively
young electricity market, the intellectual demands of a complex subject matter in an essential industry,
and the opportunity to drive best-practice organisational development and innovation.
In addition to chartered accountant qualifications, the attributes being sought for this role are experience
in corporate services management at senior executive level, with demonstrable knowledge across a range
of functions including IT, strategic planning, programme management, and communications. A strong
collaborative working style is essential in this role.
poor commercial performance.
The Government used Section
7 when it paid New Zealand Post
$25 million a year to keep 432
uneconomic post offices open
until 1988, when it stopped.
Section 7 doesn’t seem to be in
common use now, possibly
because when the Crown
contracts with an SOE (such as
MetService’s six-year contract to
provide weather and road
monitoring information to the
Transport Ministry), it is not
clear whether that contract is
made pursuant to Section 7 or is
just an ‘‘ordinary’’ contract that
any company could make with
the Government.
Don’t be fooled into thinking
that Section 7 is meaningless,
though. In fact, it has never been
tested by the courts, so we don’t
currently know for sure whether
the Crown could force an SOE to
contract with it under Section 7.
There are good arguments on
each side. Why would Section 7
exist if it simply restates existing
contract law but wouldn’t the
Crown forcing a contract
undermine the point of requiring
transparent contracting?
Sections 4 and 7, along with
Section 9, deserve careful
attention. They are part of what
make SOEs unique. What is done
about them during partial
privatisation could have a big
impact on things like the sale
price, public attitudes and even
how the SOEs continue to operate
in the future.
Historically, one criticism of
SOEs has always been that they
are neither fish nor fowl, merely
hybrid forms of the corporation
that cannot be held truly
accountable for their
performance. Partial
privatisation and stock exchange
listings will address, to some
extent, that criticism.
But as SOEs become more like
other companies – albeit state
controlled – the issues around the
extra requirements imposed on
SOEs by the SOE Act become
acute.
Professor Susan Watson and Dr ChyeChing Huang lecture at the Auckland
University Business School’s
Department of Commercial Law.
CALLING FOR
SEASONED CA’s
DIRECTOR
Ref: WEL153886
A newly created position that will see you interact with some of the
big players in the country, you will most likely have had experience in
a large public practice, and be ready to get out of the technical weeds.
Your outstanding relationship and stakeholder management skills will be
highly valued. You will also be able to demonstrate intellectual smarts
and the ability to spot great opportunities to influence and represent your
organisation in a wide range of contexts.
DIRECTOR
Ref: WEL153885
Another newly created role, but more suited to a wise head, with a wide
range of experiences under your belt. You will represent your organisation
in a wide range of contexts and you must be comfortable and capable
of public speaking. You will be instrumental in maintaining levels of
professional conduct amongst your peers and will use your experience to
assist and support a wide range of stakeholders.
For both roles you will need to be a Chartered Accountant or equivalent
qualification, experienced in leading and developing teams of
professionals and have a passion for your profession.
To discuss these roles in more detail please contact Penny Stonyer
04 978 1001 or Sarah Morris 04 978 1055. To apply please visit
www.talent2.com and enter the relevant job reference number.
For further information, or to apply, contact Cargill McKenzie on (04) 499 5211
or email [email protected] no later than Wednesday, 7 March 2012.
www.msd.govt.nz/careers
talent2.com