(The New Zealand Herald posted the following column by Brian Gaynor on its website on May 24.)
AUCKLAND, N.Z. — RailAmerica’s decision to withdraw its takeover bid for Tranz Rail is not surprising. The official message from the Florida-based company is that “the proposed acquisition does not represent the opportunity for enhanced shareholder value that we had originally contemplated”.
But the real reason is that RailAmerica’s tactics were naive, it was outfoxed by Toll Holdings and Tranz Rail’s share price rose above the 75c-a-share offer.
The Americans don’t have the financial resources to enter a bidding war with Toll and to make additional capital investments in the New Zealand railway if they were successful.
The aborted offer also highlights the fact that broker analysts are continuing to do a disservice to investors by insisting Tranz Rail shares are worth in excess of $2. This may have encouraged some investors to buy shares well above yesterday’s closing price.
RailAmerica’s first mistake was to notify its intention to make an offer before buying any shares. This placed it on the back foot because it was bound by the Takeovers Code and could no longer purchase shares above or below 75c or on market.
An alternative bidder could enter the market at any stage and buy up to 20 per cent without making an offer (it could buy up to 5 per cent without disclosing this to the market).
Its second error was to make the offer conditional on 90 per cent acceptance. This gave the impression that RailAmerica was not in a strong financial position and its bank facilities were dependent on gaining 100 per cent control and full access to Tranz Rail’s cash flow.
The last big mistake was to make the offer conditional on Tranz Rail not selling, or agreeing to sell, any businesses or assets outside the ordinary course of business. As Tranz Rail had assets on the sale block, this condition could upset potential purchasers and they were in a position to stifle RailAmerica’s bid, mainly because of the 90 per cent acceptance condition.
Immediately after the RailAmerica bid was announced on May 15, Toll Holdings began to buy Tranz Rail shares. On that day and the following two trading days, the Melbourne-based group acquired 12.9 million Tranz Rail shares, or 6.1 per cent of the company, at an average price of 77.8c a share.
This put Toll, which is interested in buying Tranz Rail’s road transport operation, in the driver’s seat because it was not bound by the Takeovers Code and could raise its holding to a level that would stymie the 90 per cent acceptance condition.
The Australian company is also in a much stronger financial position than the Americans.
RailAmerica operates 38 short line railroads in the US and eight in Canada. It also owns Freight Australia and has a 55 per cent interest in a 2250km railroad serving the mining region in northern Chile and western Argentina.
The company is relatively small and represents only 0.4 per cent of the total sharemarket capitalisation of North American railways. Its market value of US$215 million ($370 million) pales into insignificance when compared with Union Pacific (US$15.2 billion), Burlington Northern Santa Fe (US$10.5 billion), Canadian National Railway (US$9.4 billion) and several other companies.
It ranks 16th out of seventeen North American railways in terms of gearing with an interest bearing debt to equity ratio of 1.76, compared with an industry average of 0.86. Following the announcement of the Tranz Rail offer, Standard & Poor’s placed RailAmerica on BB- (negative watch).
In 1999, RailAmerica bought a Melbourne-based freight railroad operation from the Victorian Government for A$163 million ($184 million). This included 4000km of track under a 45-year lease agreement. Analysts estimate that this operation, which is called Freight Australia, has about a 1 per cent share of the Australian market in terms of net tonne kilometres carried.
Freight Australia reported operating earnings (earnings before finance costs, other expenses and tax) of US$22 million for the December 2001 year but this fell to US$5 million last year because of drought and a weaker economy. The situation has deteriorated further this year: Freight Australia reported a loss of US$1 million in the March quarter compared with a profit of US$5 million in the same period last year.
Toll Holdings is a Melbourne-based integrated transport and logistics provider that formed a 50/50 joint venture with Patrick Corporation in 2001 to bid for privatised rail assets.
In January 2002 the joint venture won the tender to purchase FreightCorp and National Rail Corporation for A$936 million (the acquired companies had net debt of A$118 million and further project commitments of A$118 million).
The joint venture was renamed Pacific National and is now the largest private rail operator in Australia, with an estimated 24 per cent market share in terms of net tonne kilometres carried.
Pacific National reported net earnings after tax of A$16 million for the February-to-June 2002 period and A$41 million for the first nine months of the June 2003 year.
Toll is rated highly by investors. It is the 65th largest ASX company, by market capitalisation, and, as the accompanying table shows, it is trading at 3.7 times its book equity value, whereas RailAmerica and Tranz Rail are both trading well below their book values.
It also has a relatively stronger balance sheet, with interest-bearing debt to sharemarket capitalisation of only 0.14, compared with 1.71 for Tranz Rail and 2.46 for RailAmerica.
These figures suggest that RailAmerica is not in a strong financial position and it would not have been able to invest significant new capital into Tranz Rail unless it sold assets.
There are several reasons Toll may not be interested in the railway operation and a full Tranz Rail bid:
* Toll, rather than Pacific National, the Australian rail joint venture, acquired the interest in Tranz Rail.
* Toll may have been interested only in spoiling RailAmerica to ensure that the current asset sale process remains on course.
* Pacific National does not own or maintain any track because this is the responsibility of the Australian Rail Track Corporation. It is unlikely that Toll or Pacific National would be keen to take control of New Zealand’s track infrastructure, particularly as it requires large capital expenditure.
Toll can now have a long, hard look at Tranz Rail and there is no need for it to make a full offer unless it perceives that another bidder is preparing to make a move. As the current asset-sale programme proceeds, it may gradually raise its holding to just under 20 per cent. This would place it in a strong strategic position.
Meanwhile, speed restrictions on the West Coast to Lyttelton line are a stark reminder of the problems facing Tranz Rail. Up to 20 restrictions have been placed on the line, limiting speeds to 10km an hour on some sections.
This route, called the Midland Line, operates over bridges and track built over a century ago and now under enormous pressure from the large coast-to-coast coal trains.
Many of the bridges will have to be rebuilt, a time-consuming and costly exercise exacerbated by the requirement to obtain Resource Management Act consent.
* Disclosure of interest: none.