Adam Bennett

The Warehouse Extra lacks the economies of scale required to be a viable and effective competitor in grocery markets and would not achieve them in the foreseeable future, David Goddard QC told the Wellington High Court yesterday.  Goddard is acting for Woolworths in its appeal against the Commerce Commission's blocking of a prospective takeover of the company by Woolworths or Foodstuffs.

Goddard also said the Warehouse Extra "experiment" depended on the "halo effect" where selling groceries resulted in much higher sales of general merchandise in that store than in outlets devoted to general merchandise alone.  It was not clear that was being achieved.

Like much of the information which the court will hear over the nine-day hearing, Goddard's third key point was deemed to be commercially sensitive and will not be made public.  The hearing should not be "a clearing house for commercially sensitive information", Goddard told Justice Jill Mallon and lay member, Professor Stephen King of the Australian Competition and Consumer Commission.

Woolworths, Foodstuffs and The Warehouse are all involved in appeals against the commissions' June decision disallowing a takeover of The Warehouse by either of the other two.  Woolworths and Foodstuffs each have a 10 per cent stake in The Warehouse which is 51 per cent owned by founder Stephen Tindall. A successful appeal against the commission's ruling would likely be followed by a full takeover bid worth about $2.5 billion.

In July, commission chairwoman Paula Rebstock said that without the "competitive threat" offered by The Warehouse's fledgling move into grocery retailing via its Warehouse Extra stores "Foodstuffs and Woolworths would not face the same incentives to reduce prices, and increase quality, service and innovation".

Foodstuff's share of New Zealand supermarket sales is about 56 per cent against Woolworth's 44 per cent.

The commission was not satisfied a Warehouse takeover by either of the duopoly members would not lessen competition.  However, since the commission's initial decision, The Warehouse has said its three Extra stores, at Sylvia Park in Auckland, Te Rapa in Hamilton, and Whangarei , were underperforming and it had put plans for further Extra stores on hold for the current financial year.

Much of Friday's court session will be dedicated to an update of relevant information, which Goddard confirmed would deal with The Warehouse's postponement of a further rollout of Warehouse Extra stores.  "The game has moved on," he said.  That additional information, also to be heard in a closed session, would be central to Woolworth's appeal.

The court will hear opening submissions from Foodstuffs and the Commerce Commission today. Testimony from expert witnesses, principally economists, will be heard early next week.

The booming private equity industry poses a threat to global financial stability by exposing banks to credit risks and by leaving debt-saddled target companies vulnerable to economic shocks, the International Monetary Fund says.

In its latest six-monthly Global Financial Stability Report, the IMF says the current wave of leveraged buyouts differs from those during the 1980s and late 1990s in that both the size of the deals and the level of debt involvedhad increased.

However, the IMF said unlike previous LBO activity, the current wave was largely being funded through loans that were sold through a process of syndication to highly professional investors rather than through high-yield, or "junk", bonds.

While that resulted in less concentration of risk, banks faced particular issues during the syndication process, which could take several months.

"During this time, adverse market events could render the deal unattractive. The bank that has provided bridge finance or has underwritten the provision of the leveraged loans would be at risk during that period and could suffer large losses as a result of adverse market developments.

"A collapse in one or more high-profile deals could leave banks with exposure during the syndications stage and could trigger a wider reappraisal of risks across a broader range of credit products."

The IMF also said higher debt levels potentially increased the vulnerability of acquired firms to economic shocks.  "This is reflected in the downgrade in credit ratings of several targeted companies," the fund said.

The private equity industry raised $US430 billion ($592 billion) last year and is forecast to raise $US500 billion ($688 billion) this year, as significant investors, including Asian central banks, institutions and wealth managers, and Middle Eastern countries flush with petrodollars.

Given the amount of money continuing to pour into the sector, competition for viable deals would intensify.  "Already, ratings agencies have warned that the number of viable targets has diminished.  "The strong demand for all elements of the capital structure of these deals means that prices are often bid up to levels that represent high multiples of earnings."

The IMF said current takeover activity was taking place against a benign backdrop of continued global growth, low real interest rates, high corporate profitability and low volatility.  If one of those factors changed, it said, it was likely that some private equity deals would fail to live up to expectations.

Mergers & Acquisitions Industry
* Last year global merger and acquisition activity totalled a record US$3.6 trillion with the size of the average deal rising from about $US400 million during the late 1990s to about US$1.3 billion.
* Deals are getting bigger as few companies are too large to be considered potential targets.
* The IMF says the current wave of M&A activity is driven by a number of factors including target companies' strong balance sheets, their less-than-optimal capital structures, and a wish to avoid regulatory costs associated with being publicly listed.
* The sheer weight of private equity money looking for a home is also driving deals.

Infratil's move to increase its stake in Trustpower and the sale of its holding in Port of Tauranga helped power a more than 200 per cent increase in the investment company's net profit during the nine months to December.

Infratil's net profit of $55.98 million for that period was 215 per cent ahead of the same period a year ago.

Though the company's operating surplus before tax was little changed at $17.76 million, it received a substantial boost from investment realisations and revaluations of $38.45 million against $239,000 a year ago.

The company said its financial and operational results for the third quarter were in line with expectations but were "upstaged" by a series of transactions concluded toward the end of the period.

They included its acquisition of Alliant Energy's shares in Trustpower at a bargain price and a subsequent sell down on market, and to the Tauranga Energy Consumer Trust leaving it a 50.5 per cent controlling stake. Its sale of 5 per cent of Port of Tauranga also netted a gain of $38 million.

Over the third quarter Infratil secured its 48.5 million additional shares in Trustpower for $286 million - a net cost $5.90 a share.

Trustpower shares were trading at about $7 each at the time.  Meanwhile, Trustpower contributed $29 million to Infratil's earnings over the nine months against $24.2 million a year ago.  "The 20 per cent increase reflected higher than average generation output and excellent management of electricity price risk," the company said.

Chief executive Lloyd Morrison said Trustpower's "excellent result" surprised a few people "considering the difficult conditions" where a dry hydro year meant high prices on the wholesale electricity market.

Wellington Airport, in which Infratil holds a 66 per cent stake, lifted operating earnings by $2.2 million to $37.2 million despite relatively flat passenger numbers.  Infratil Airports Europe contributed a loss of $800,000 as against a $5.6 million profit a year ago.  Infratil Energy Australia contributed earnings of $7.3 million compared to a loss of $2.1 million last year.

During the third quarter its Victoria Electricity retail division had 147,200 customers against 77,000 at the end of March.

NZ Bus which Infratil purchased from Scottish company Stagecoach almost two years ago contributed $11.5 million to group earnings, a result Morrison described as "adequate".  Potential changes to the public transport sector by policy makers meant there was "uncertainty as to the future of that business".

Morrison said the recent disruption to Wellington bus services caused by a new computerised rostering service and driver shortages would cost the company hundreds of thousands of dollars, he said.  The "embarrassing" disruption last week saw rush hour services cut and drivers unfamiliar with routes literally lose their way.

Infratil shares closed a cent lower at $5.79 yesterday.

Private equity's ongoing raid on publicly listed companies continued yesterday with a consortium led by Australian giant Pacific Equity Partners (PEP) getting a foot in the door at transtasman credit services firm Veda Advantage.

Veda, formerly Baycorp Advantage, yesterday said it had received a proposal to privatise the dual-listed company from a consortium comprising PEP and Merrill Lynch Global Private Equity.

In the past 18 months PEP and its partners have acquired New Zealand companies Tegel, Griffins, and Independent Liquor. It also owns A&R Whitcoulls and is believed to be working on a bid for The Warehouse with supermarket co-operative Foodstuffs.

The consortium proposes to pay A$3.61 a share for 100 per cent of Veda Advantage, less any dividends paid to shareholders before the deal is completed. The price is at a 20 per cent premium to the company's Monday close of A$3. Should it proceed, the offer values the company at approximately A$814 million.

Veda's shares rose 53c to A$3.53 on the ASX and climbed 58c to $3.90 on the NZX.

Veda said the proposal followed a period of "preliminary interaction" between its board and the consortium. The board had agreed the proposal had sufficient merit to provide the consortium with due diligence access and a definitive proposal was expected within six weeks.

However Veda emphasised: "There is currently no proposal capable of the board considering recommending or putting to shareholders for consideration, nor is there any certainty that any binding proposal will be received from the consortium or any other party at any future time. "Despite the ongoing nature of discussions with the consortium, shareholders should be cautious about whether any proposal will eventuate, including potential pricing."

PEP managing director Anthony Kerwick said the "significant work" on the proposal suggested "this is an interesting opportunity and the right kind of company for us to invest in".

Allco, which holds 17.3 per cent of Veda and a seat on its board, yesterday said it had noted the proposal, and would keep the market informed about its own position "as any material developments occur".

Allco made a A$3.52 a share offer for 50 per cent of the company in 2005 after acquiring a cornerstone stake from a New Zealand institutional investor. The bid lapsed in October 2005 after gaining little traction.

A source close to the current PEP proposal noted that it was at "a significant premium to the Allco bid on an adjusted basis". It was also at "a very comfortable premium" to the valuation provided by independent experts Lonergan Edwards at the time of Allco's offer. The valuation was one of the grounds on which the Baycorp board rejected Allco's bid.

Baycorp's management defended the company against Allco's offer by promising hefty capital returns to shareholders.

Since Allco's failed bid, the company has returned about A$280 million to shareholders through capital returns and share buybacks. The latest capital return, a special dividend, followed the A$97 million sale of the BayCorp Collection Services business to a consortium comprising Allco and Deutsche Bank Capital Partner last May.

After the sale, the company changed its name to Veda Advantage but will continue operating under the Baycorp Advantage brand until the end of next month.

Consortium bid
* Pacific Equity Partners has teamed up with Merrill Lynch to bid A$814 million for Veda Advantage, the company formerly known as Baycorp Advantage.
* Veda Advantage's board has given the consortium the green light to perform due diligence.
* The proposed offer at A$3.61 ($4) a share is at a significant premium to Allco Equity Partners' failed A$3.52 bid for the company just over a year ago.