Contact Energy’s share price was slam dunked on Monday after the company announced it was investigating overseas geothermal opportunities.

The unexpected statement, which was included in the electricity generator’s interim result statement, read as follows; “Contact believes that in the current environment, material growth opportunities in New Zealand that leverage Contact’s long history in geothermal and hydro development and operations are unlikely. Therefore, Contact is investigating options to leverage its skills and experience to grow in international markets”.

The group’s share price plunged 9 per cent, from $6.92 to $6.30, immediately following the announcement. This was because investors believed that Contact’s major capital expenditure programme was complete, it was now in a strong cash flow position and this would enable it to raise its dividend rather than look for new investment opportunities.

The company’s dividend announcement was also disappointing because directors decided to pay an 11 cent per share interim dividend, the same as last year.

By contrast, two days later Meridian Energy announced it was raising its interim dividend and was planning to return $625 million to shareholders over the next five years, contingent on the Tiwai Point aluminium smelter remaining open.

Meridian CEO Mark Binns told Radio New Zealand that New Zealand companies had to have a competitive advantage to be successful offshore because good local companies will always beat good foreign companies. He went on to say that Meridian had assessed its offshore opportunities and had decided it would not be appropriate to spend shareholders money on overseas projects.

Meridian’s shares leaped 4 per cent, from $1.90 to $1.98, following this announcement.

Why did Contact Energy announce offshore expansion plans that inevitably led to a sharp decline in its share price while Meridian Energy issued an investor friendly statement that it prefers capital returns over overseas investment?

One of the reasons is that the two electricity generators have totally different majority controllers; Contact is 52.3 per cent owned by the ASX listed Origin Energy while Meridian Energy is 51.0 per cent owned by the New Zealand Government.

One of the long-standing issues with Contact Energy is that the company has made a number of decisions and recommendations that have not been in the best interests of minority shareholders.

Origin Energy first became involved in Contact Energy in mid-2004 when it purchased Mission Energy’s 51.2 per cent holding for $5.67 a share.

The Australian company was required to make a full offer under the Takeover Code but Contact’s independent directors recommended rejection after Grant Samuel valued the electricity generator between $5.74 and $6.34 a share.

Origin immediately changed the board composition from four independent directors and three Edison Mission Energy representatives to three independents and three Origin appointments. In addition, Grant King, an Origin representative, was appointed chairman whereas under the Edison Mission Energy regime Phil Pryke, an independent director, was in the chair.

This meant that the Contact board was now clearly under Origin control as the chairman has a casting vote in any stalemate situation.

Contact was back in the headlines again on October 12, 2005 when King told the annual meeting in Auckland that there will be “significant pressure on the company’s trading margins” because of rising costs.

The company’s share price declined from $7.45 just prior to the annual meeting to $6.50 on November 25, the day before Origin put a proposal to the Contact board that the two companies should merge.

The proposed merger, which was announced to Australasian stock exchanges on February 20, 2006, was greeted with dismay in New Zealand.

Contact shareholders were concerned that the proposed merger was made just after their Origin dominated board had warned about declining profit margins and were particularly irked because the New Zealand company’s independent directors enthusiastically recommended the merger before the independent report was published.

The merger proposal was abandoned because of strong opposition from Contact’s minority shareholders.

A year later Contact’s purchase of Rockgas from Origin also raised concerns about the relationship between the two ASX and NZX listed companies.     

Rockgas was originally established in the 1930s as an importer of LPG into New Zealand.

In 1990 Boral and Caltex, two Australian companies, each acquired 50 per cent of Rockgas. Origin acquired Boral’s 50 per cent stake in 2000 and Caltex’s 50 per cent holding in 2004. The latter cost $17.6 million, which valued Rockgas at $35.2 million.

In March 2007 Contact announced it would purchase Rockgas from Origin for $156 million compared with the $35.2 million valuation just three years earlier.

NZX rules require material transactions between an issuer (in this case Contact) and a related party (Origin as the parent company) to be approved by an ordinary resolution of the issuer. However this approval is only required if the purchase price is in excess of 5 per cent of the average sharemarket value of the issuer.

The Rockgas purchase did not need this approval because the $156 million purchase price represented only 3.1 per cent of Contact’s sharemarket value.

Contact commissioned a report by PricewaterhouseCoopers which concluded that the purchase price was fair as far as Contact’s minority shareholders were concerned.

An analysis of the Rockgas purchase by John Kidd in the 2012 New Zealand Petroleum Sector Yearbook concluded that Rockgas sales had fallen 28 per cent since the acquisition, its costs had continued to rise and its “operating margins have deteriorated sharply”.

Kidd wrote that “the transaction that saw Contact acquire Rockgas from Origin has unfolded to be substantially more positive for Origin than Contact. Origin sold at what will probably be reflected upon as the peak of the mergers & acquisition market, shortly before the GFC hit, and even then at full value”.

Kidd valued Rockgas between $45 million and $95 million compared with Contact’s $156 million purchase price five years earlier.

The market’s initial response to Contact Energy’s announcement on Monday was that Origin could be planning to either sell its geothermal assets to the New Zealand company or propose another merger. The lower the Contact share price the more favourable any merger agreement would be to Origin.

There is absolutely no suggestion that Origin is planning to sell assets to Contact or that it is preparing another merger proposal but a number of schemes and transactions in the 2000s have made Contact shareholders nervous.

This nervousness is heightened because Origin is under pressure due to falling energy prices and high debt levels. The ASX listed company’s share price has fallen 21 per cent since early September 2014 while the benchmark ASX index appreciated 4 per cent over the same period.

Origin has a number of geothermal interests including a 40 per cent stake in Energia Andina S.A., Chile’s leading geothermal exploration company, and a geothermal concession in Indonesia.

The concern is that Contact could purchase one or both of these assets from Origin for $225 million or lower without requiring shareholder approval because this would be below 5 per cent of Contact’s sharemarket value. Contact would then have to contribute substantial capital to the development of these offshore geothermal assets with CEO Dennis Barnes indicating that the total could be up to $1 billion.

The clear difference between Contact Energy and Meridian Energy is that investors are concerned that the former often makes decisions that are in the best interests of Origin Energy, rather than minority interests, whereas the Crown has no influence on the latter.

In other words, Meridian has a better governance structure for minority shareholders than Contact.

Contact shares fell 10.4 per cent during the week, from $6.92, to $6.20, while Meridian’s appreciated 7.6 per cent, from $1.90 to $2.045.


Brian Gaynor

Portfolio Manager

Disclosure of interests; Milford Asset Management holds shares in Contact Energy and Meridian Energy, along with Origin Energy debt, on behalf of clients.