Patrick paints itself into corner with advice to holdersAugust...

Patrick paints itself into corner with advice to holders

August 26, 2005
PROFIT forecasts are normally optional for a target company but it's arguable that in the case of Chris Corrigan's Patrick Corp they will be mandatory.

In fact, it's arguable that Patrick will also be required to have a go at providing forecasts for Toll. That's because of the advice which Patrick has given to its shareholders to date in response to the $4.9 billion bid from Paul Little's Toll Holdings.

Toll unveiled its scrip-cash bid - 0.4 of a Toll share, 0.3 of a Virgin Blue share and 75c cash for each Patrick share - on Monday. On the same day, Patrick directors said they intended to reject the offer and believed that "Patrick shareholders will be better off over the next two to three years retaining their Patrick shares, rather than exchanging them for Toll shares".

Next day, they repeated the opinion but dropped references to the two to three-year time frame. Such statements are intended to influence the way shareholders treat their investment.

The Patrick board must have had a reasonable basis for its claim that holders would be better off to retain their shares. Logic suggests that for the board to reach that conclusion it must have forecasts, which it regards as reasonably reliable, as to how Patrick will perform over the next two or three years, relative to Toll.









That has to be the case; a gut feeling wouldn't justify the advice for holders to retain their shares.

The target's statement must include all information which is known to the directors and which the target holders and their professional advisers would reasonably require to enable them to make an informed decision on whether or not to accept.

If Patrick maintains that target holders would be better off to retain their shares than to accept the bid, then target holders arguably require the information on which they base that claim including, presumably, forecasts as to how Patrick will perform relative to Toll, to enable them to determine whether to retain their shares or switch to a stake in a combined Toll-Patrick.

Profit forecasts could also have relevance for Toll. Because its offer includes scrip, the bidder's statement must comply with the prospectus requirements of the Corporations Act.

That requires all the information which investors and their professional advisers would reasonably expect in order to make an informed assessment of the "assets and liabilities, financial position, profits and losses and prospects of the company".

Clearly, the reference to prospects would require at least some look into the future. Moreover, a bidder is required to include any material information which it knows and which has not previously been disclosed to target holders.

There has long been a debate that if target holders are being offered scrip then they need to know the future likely profitability of the combined entity in order to assess whether or not to accept the offer.

The courts, and more recently the Takeovers Panel, have given support for the general proposition that earnings forecasts should be made, provided the bidder is in a position to do so -- that is, it has a reasonable basis for making the forecasts.

The least that scrip bidders should do is include a pro-forma balance sheet and profit and loss account for the combined entity for the previous full year, to give target holders some basis for assessment. Whether Toll goes further and includes earnings forecasts for Toll and Patrick would depend on how confident it is in the assumptions and, presumably, whether the forecasts suggest that holders would be better off to accept.

Patrick, arguably, doesn't have the option. It has already made claims that holders would be better off not to accept and, arguably, now has to back that up with its reasons for doing so.

IF the Toll bid for Patrick succeeds, it would result in an effective market relaunch of the Virgin Blue airline.

Virgin Blue is 88 per cent owned by two parties. Patrick has 62.4 per cent and Richard Branson's Virgin Group owns 25.1 per cent, so the free float is only 12 per cent. If the holdings of management are taken into account, the real free float is probably only around 8 per cent.

As a result, Virgin Blue is not in any of the S&P ASX indices and there is little institutional support; in fact, it's thought there is only one institutional holding of significance, and it's below 5 per cent.

That would all change if the Toll bid succeeds. Toll proposes to reduce the combined entity stake in Virgin Blue to at least 27 per cent, and probably to around 10 per cent to 12 per cent.

Part of the bid component includes an in-specie distribution of 20 per cent of Virgin Blue to Patrick shareholders, by way of a fully franked dividend.

A further 15 per cent will be disposed of through a share offer to institutions, and perhaps retail investors, with the sale price determined by a bookbuild, fully underwritten by Virgin Group at $1.40 a share.

Toll would also cause Patrick to grant call options to Virgin Group for up to 15 per cent of Virgin, exercisable to the extent of any shortfall, at prices from $1.40 a share up to the bookbuild price. On that scenario Toll's stake would be 27 per cent.

If there are no subscriptions to the share offer, then Virgin Blue will take up the entire shortfall at $1.40 a share. If the issue is fully subscribed, or over-subscribed, the issue price is likely to be higher than $1.40 a share, and Virgin Blue will exercise for 15 per cent of Virgin Blue at the bookbuild price. On that scenario, Toll's stake will drop to 12 per cent.

Toll has undertaken to retain at least 10 per cent of Virgin Blue for at least 30 months.

Such sell-downs would put Virgin Blue in the ASX 200 and create significant buying demand from index funds. S&P won't include stocks unless they have a minimum free float of 30 per cent.

The 20 per cent in-specie distribution would lift the airline's free float to 335 million shares, or 32 per cent. It would come in at number 153 and to achieve full weighting would create an implied institutional demand of $195 million at the current market price, or 122 million shares at $1.60 a share.

The sale of 15 per cent through the share offer would increase the free float to 493 million shares, or 47 per cent. That would rank the airline as number 129 and create an implied demand for $285 million of stock, or 178 million shares.

Any shares taken up by Virgin Group via options would not increase the free float, but if Toll was to sell down to 10 per cent, the free float would increase to 518 million shares or 49.4 per cent. That would rank the airline as number 114 and create implied demand for $300 million of stock, or 187 million shares.

It's probable that some Patrick holders wouldn't want to retain a stake in Virgin Blue and would sell once they received their in-specie distribution. It's also probable that some index funds would start buying at that stage so that they are not completely underweight.