Envestra Traders Bet on Sweetened Takeover Bid: Real M&A

Traders in Envestra Ltd. are betting it’ll take a sweeter takeover bid to get a hold of Australian gas pipelines long enough to stretch from Sydney to New York.

Envestra ended last week 11 percent above the value of APA Group’s A$1.3 billion ($1.2 billion) all-stock proposal, higher than any other large pending deal in developed Asia, according to data compiled by Bloomberg. APA, already the owner of a third of the company, this month offered a premium that was less than half the average for gas-distribution deals in the past five years, the data show.

APA delivers about half of Australia’s natural gas and wants to buy the rest of Envestra to gain control of profits that are estimated to jump 66 percent by 2014. Sydney-based APA may need to raise its bid 14 percent to win support from the company, according to Commonwealth Bank of Australia.

“APA will have to pay a further premium,” Will Allott, a Sydney-based analyst at Commonwealth Bank, said in a phone interview. “This transaction provides a pretty attractive and steady cash flow stream over the next four years.”

Envestra’s 23,000 kilometers (14,000 miles) of pipelines supply gas to about 1.2 million customers, most of them in the states of Victoria and South Australia. The Adelaide-based company’s networks are regulated by a watchdog that determines revenues over five-year periods. Envestra has just 15 employees.

Lower Premium

APA, which operates and manages Envestra’s pipelines, on July 16 offered 0.1678 of one new APA share for each Envestra share. The bid equated to A$1.07 a share, based on APA’s close the previous day. That price excludes a final dividend of as much as 3 cents a share by Envestra to its shareholders, which include Li Ka-Shing, Asia’s richest man.

The offer was only 6.3 percent more than Envestra’s 20-day stock average, lower than the average premium of 16 percent for gas-distribution deals since July 2008, data compiled by Bloomberg show.

APA ended last week at A$5.95, valuing the offer at A$1 a share. After Envestra closed at A$1.11, no target in developed Asia valued at more than than $500 million is trading further above its offer, the data show.

Envestra today rose 0.5 percent to A$1.115 in Sydney, while APA fell 0.8 percent to A$5.90, leaving the target trading 13 percent above the value of the offer.

APA Chief Executive Officer Mick McCormack has said that the offer reflects Envestra’s cashflows and that the all-stock deal allows investors who accept the bid to still benefit from any growth at Envestra. APA declined to comment further.

Des Petherick, Envestra’s company secretary, declined to comment on how the company will respond to APA’s offer. Managing Director Ian Little told the Australian Financial Review July 17 the deal’s benefits were “hard to see.”

Bid Expectations

“It’s not going to be accepted,” Simon Chan, an analyst at Bank of America Corp. in Sydney, said in a phone interview. “There is headroom for APA to pay a higher price.”

APA could pay the equivalent of A$1.20 a share and reap a 6 percent boost to free cash flow, he said.

A bid of A$1.25, including a 3-cent dividend from Envestra, may be required to win over shareholders, said Allott, the analyst at Commonwealth Bank. A proposal valued at A$1.22 a share, excluding the dividend, may be enough, Sandra McCullagh, a Sydney-based analyst at Credit Suisse Group AG, wrote in a July 17 note.

According to APA, the takeover proposal must be backed by Li’s Cheung Kong Infrastructure Holdings Ltd., Envestra’s second-largest shareholder with a 17 percent stake.

Cheung Kong’s corporate communications unit in Hong Kong didn’t immediately respond to a phone message seeking comment.

Growing Demand

Australia’s domestic gas consumption will more than double between 2010 and 2035, according to a July 2012 report by Australia’s Bureau of Resources and Energy Economics. Gas is replacing coal as a fuel to generate electricity, and liquefied natural gas projects are consuming more gas during production, the bureau said.

With demand set to rise, APA has spent $3.8 billion completing 18 deals in the past decade, data compiled by Bloomberg show. The company bought the rest of natural-gas pipeline owner Hastings Diversified Utilities Fund last year for A$1.2 billion after increasing its bid twice. APA’s pipelines now span every state and territory on mainland Australia.

A takeover of Envestra would create a larger company with broader and cheaper access to capital markets, APA CEO McCormack said in a filing on the day of the bid. As well as buying Envestra, APA is considering investing in new pipelines in Queensland -- home to more than $60 billion of LNG projects -- and a connection between APA’s east-coast grid and the Northern Territory, McCormack said in a statement on July 19.

No Benefit

All the same, buying Envestra offers little strategic benefit to APA, said Ian Myles, a Sydney-based analyst at Macquarie Group Ltd. There’s no immediate opportunity to accelerate Envestra’s growth because capital expenditures are governed by the regulator, according to Myles. He values Envestra at A$1.16 a share.

“Doing it just for financial metrics is not as compelling as doing it with strategic reasons,” he said in a phone interview. “There will always be a number where it won’t make economic sense.”

It’s also not clear how much APA might be charged under change-of-control clauses tied to Envestra borrowings, APA said in its takeover proposal. Envestra’s net debt was A$2.19 billion at the end of 2012, it said in an April presentation.

Profit at Envestra will jump to A$123 million in 2014 from A$73.9 million last year, according to estimates compiled by Bloomberg.

While APA receives a fee for operating Envestra’s grid -- 3 percent of regulated revenue -- APA says almost all the value is locked in the target.

“They can see an extraordinary growth profile,” Paul Johnston, an analyst at Royal Bank of Canada in Melbourne, said in a phone interview. “It’s likely they will sweeten the current deal.”

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