Ombudsman's decision sheds light on EIL about-face in OtagoNet deal
Tuesday, 10 July 2018
An Ombudsman's decision has thrown light onto Electricity Invercargill Limited's about-face on plans to massively increase its stake in OtagoNet and has made plain that the public should not have been denied this information.
The parent company of Electricity Invercargill Limited [EIL] - the Invercargill City Council owned Holdco - spent more than three years resisting the release of any information to Invercargill resident Nicola Fallow.
Fallow complained to the Ombudsman's office and in June the Ombudsman Leo Donnelly asked Holdco to release the material to her, but with some redactions.
Redacted KPMG Report.compressed by yogesh on Scribd
Despite the redactions, the information the Ombudsman cleared for release explains a lot.
**READ MORE:
*OtagoNet goes south for top price**
Fallow said she hoped the release would help clarify to all parties the level of detail to which the public was entitled.
The Ombudsman told Fallow that Holdco had been entitled to refuse parts of her request for the report, but he confirmed he had asked Holdco to release the balance of the report.
There was a 'relatively high' public interest in the release of the material in the report, the Ombudsman said.
'Successive Ombudsmen, as well as the courts, have recognised an interest in the public being adequately informed on matters of public expenditure and governance.'
The proposed acquisition represented a large expenditure for Holdco and the venture could have impacted on the rate burden on Invercargill residents, and the ability of the council to pursue future investment opportunities or deliver frontline services.
'Although public consultation was undertaken prior to a decision being made about whether to exercise the option, the public do not appear to have been made aware of the actual costs, forecasted benefits or associated risks involved in any depth,' the Ombudsman said.
The released report, an assessment by KPMG of the 2014 deal, makes clear why EIL reversed its course from pursuing an option to increase its stake in OtagoNet from 27.5 per cent to 50 per cent.
On Tuesday, Tom Campbell, chairman of EIL declined to comment on the report, as it was a Holdco report, not an EIL report, and referred questions to Holdco chairman Cam McCulloch.
McCulloch said Holdco did not release the report to Fallow, until the Ombudsman intervened, for two reasons.
The first was some of its contents were commercially sensitive, and it took 'a while' for the Ombudsman to work out what was commercially sensitive.
The second reason was that it 'was a report about something that didn't happen'.
In the end, EIL had made its own decision not to proceed with the 50 per cent share of OtagoNet, McCulloch said.
'We [Holdco] were of the view we might have to make the decision … that's why we commissioned the [KPMG] report.'
EIL and The Power Company had paid not only market value, but a 55 per cent premium, which was well above comparable transactions in the electricity sector.
Initially both The Power Company and EIL had each owned 24.5 per cent of the OtagoNet Joint Venture and Marlborough Lines Limited owned 51 per cent.
In 2014 all three companies engaged in a shootout for their respective stakes.
A shootout is an exit mechanism which requires parties to submit hidden bids to an independent party, outlining what they are willing to pay for the others stakes.
The Power Company and EIL, working together, won the shootout, and bought Marlborough Lines 51 per cent stake.
Of this, The Power Company paid the majority, with EIL contributing only $9.5m for its extra 3 per cent.
However, EIL had an option under the deal to buy a further 22.5 per cent from The Power Company, for $65.3m, and thereby become equal partners.
In order to raise the required credit to allow EIL to exercise the option, the city council was asked to take up extra uncalled shares in Holdco which would then be used to secure funding from Holdco's bank.
In October 2014, EIL chairman Neil Boniface said it had decided against increasing its shareholding in OtagoNet to 50 per cent.
The board decided it didn't match up with their business objectives, he said.
Boniface said it made better sense for The Power Company to remain as the major shareholder in OtagoNet as it was more in line with their business strategy.
The KPMG report which took Fallow more than three years to obtain says the vast majority of the 55 per cent premium paid by The Power Company and EIL related to benefits they figured would arise from future events with an unspecified timeline, that may not occur.
The management had calculated $30.9m of 'synergy benefits' would occur - but then paid all of this to Marlborough Lines.
'In general, acquirers do not pay the vendor for the synergies,' KPMG says.
KPMG re-calculated the internal rate of return for the deal, and said it was very low, given the risk profile.
It was also lower than Holdco had been told it would be, and lower than the after-tax returns on five and 10-year Government Bonds which were notoriously low because they were so safe.
In fact, the return on the incremental investment by EIL in the joint venture would contravene its own statement of intent, the KPMG report says.
In some years the incremental dividend flow wouldn't just be minimal, it would be negative, meaning a deferral of dividends.
It may have even jeopardised Holdco's ability to meet the hurdle rates outlined in its own statement of intent.
The original model had under-estimated the tax payable.
'The strategic rationale for the ultimate bid price is not well supported,' the KPMG report says.
The report was prepared for the city council and Holdco and EIL decided not to take up the 50 per cent option, leaving its neighbour and partner in the buyout, The Power Company Limited, holding it.
The Power Company, for its part, insisted it was still happy with the deal though it subsequently wrote off $51.3m of 'goodwill' on it.