Rockgas in 'extended decline' since Origin sale to Contact

BUSINESSDESK: Contact Energy's Rockgas LPG business has been in an "extended period of decline" since Contact bought it for $156 million in a related-party transaction with its majority shareholder, ASX-listed Origin Energy, five years ago.

A case study in the Edison Investment Research inaugural New Zealand Petroleum Sector Yearbook says the LPG unit is now worth far less than Contact paid for it, at somewhere between $45 million and $95 million.

The analysis, led by one of New Zealand's leading energy sector analysts, John Kidd, also criticises the independent expert's report that backed the purchase from Origin at the "full but fair" price of $156 million.

"With the benefit of 20/20 hindsight, in our view the transaction that saw Contact acquire Rockgas from Origin – still Contact's majority shareholder – has unfolded to be substantially more positive for Origin than Contact."

Origin's predecessor, Boral Energy, bought into Rockgas in 2000 and upped its stake to 100% in 2004, the same year as it purchased a 50.4% cornerstone shareholding in Contact.

Being a related-party transaction, the 2007 Rockgas sale required the recommendation of independent directors, led by deputy chairman Phil Pryke.

It followed Origin's failed attempt to merge Contact and Origin to create a dual-listed Australasian energy company, which Contact shareholders rejected.

Edison says time has shown the price paid was a "very full" valuation and that little of up to $33 million of projected synergy gains between the two businesses have been achieved.

The purchase coincided with intensifying competition in the LPG market.

"The trend of market and earnings decline since 2007 contrasts sharply with the half-decade leading into 2007, when solid growth in both macro and micro KPIs [key performance indicators] was the prevailing theme," the Edison case study says.

"From shortly after Contact acquired the business, Rockgas's absolute [sales volumes] and relative [market share] metrics commenced what has materialised into an extended period of decline", during which earnings before interest, tax, depreciation and amortisation fell by two-thirds to $6 million in the 2011 financial year.

Edison says Contact produced the valuation model used by the independent expert, accounting firm PWC, which relied on Origin and Rockgas financial information, meaning "the fairness opinion appears to have used the assumptions and forecasts in the Rockgas/Origin model as the basis for its own discounted cashflow analysis".

Industry peer comparisons were heavily biased towards "very large and diversified utility and investment businesses".

"Very few in our view could be considered a strong comparator to … Rockgas". More appropriate comparators might have yielded a value of around $109 million on a 5.3 times earnings multiple.

"Based on Rockgas's most recent full-year reported earnings, the 7.6 times EBIDTDA multiple that supported the 2007 acquisition would imply an equivalent current value of $54 million," says Edison, which estimates a fair market value for Rockgas today at between $45 million and $95 million.

The range reflects doubts about how valuable potential synergies with an existing business may be.

Rockgas sources around 60% of its LPG from Origin on commercial terms and buys the remainder in the spot market.

Edison's research suggests the LPG market is settling down after a period of intense competition and upheaval, but remains in decline, suggesting Rockgas's somewhat improved recent performance is "more a case of bottoming out rather than marking a turning point towards material upswing".

Contact this week reported a 5% improvement in LPG margins and a 1% improvement in total sales volumes for the year to June 30, although total revenues at $116.5 million were down from $117 million the year before.

Edison says Contact faces an "enormous" challenge "to somehow lead the revival of a domestic market that currently presents as being in structural decline. As the incumbent in a sector that is under pressure at many levels, how Contact will achieve this is not at all clear." 

Disclosure: Pattrick Smellie worked for Contact Energy at the time of the Rockgas acquisition