Jeremy Warner's Outlook: Osmond on the hook for Resolution deal

Click to follow
The Independent Online

Reducing the price of a takeover bid already tabled, or indeed abandoning it entirely, is regarded as a crime so heinous among British investors that few dare ever attempt it. Certainly, the Takeover Panel scarcely ever allows it. Could it be that Hugh Osmond's Pearl is about to risk public condemnation by breaching this ancient City taboo?

With shares in Resolution trading at a sizeable 7 per cent discount to Pearl's 720p a share bid, the stock market self-evidently believes there is room for doubt. The discount, if there was certainty that the bid would go through, would be counted in pennies.

The body language scarcely gives reason for encouragement either. Pearl insists that there is nothing fundamentally wrong, but already the deal has been delayed three times and, although the betting still has to be that Mr Osmond will eventually deliver as promised, there is quite clearly a problem here.

Yet precisely what it is remains a matter of some conjecture. This is my understanding. What appears to have happened is that, for whatever reason, there was a modelling error over how quickly cash could be extracted from the Resolution life funds which has in turn undermined the takeover bid's capital assumptions. The bid is cash confirmed by the bankers, but they have syndicated on possibly false assumptions over servicing and repayment.

The upshot is that Mr Osmond and his backers must either provide more equity capital or alternatively persuade the Financial Services Authority that they should be allowed to extract more shareholders' capital from Resolution immediately its life funds are merged with their own.

Mr Osmond has made his offer conditional on FSA approval, yet it is a moot point as to whether the FSA's failure to approve on grounds that the offer as framed would be detrimental to policyholders would count as a breach of this condition. FSA officials meet later this week to decide on Pearl's application for a change of control at Resolution. If they impose their own conditions on this approval, is that a deal breaker for Mr Osmond?

And if the financing is based on false assumptions, who is to blame? Technically, the reason for the delays is that the FSA has asked Pearl to resubmit its application using the same information as is available to the regulator.

Is Resolution, then, in a worse state than it had led everyone to believe? Absolutely not, says Resolution, which points out that directors would not have been able to dispose of £180m of shares earlier this year if they had known of a material adverse change in circumstance and, in any case, any such change would have had to be announced to the markets.

How to make sense of all this? To the extent that the FSA has a problem with this deal, it is not to do with the takeover as such, but with the quite aggressive assumptions that lie behind its financing. Yet this is a matter that could easily be addressed by simply altering the way the bid is financed, and it shouldn't give Mr Osmond scope to wriggle off the hook.

None the less, Mr Osmond must be tempted. The auction room conditions under which he won Resolution have since evaporated, leaving him as the only man standing.

Standard Life is too bruised by the experience to return should Mr Osmond attempt to reduce his price and Friends Provident seems fast to be imploding. What's more, credit conditions show no sign of easing, which must make the deal's bankers jittery.

ABN Amro, Deutsche Bank and Morgan Stanley have already guaranteed that Pearl is good for the money, or to use the jargon, the bid is "cash confirmed". Yet what would already nervous bankers say if the assumptions they are lending against are wrong?

Two things seem clear. One is that the FSA must be robust in its defence of policyholders' interests. If Mr Osmond has made mistakes in his assessments, that's his look out. Policyholders' interests cannot be compromised for his sake. Continued turbulence in the capital markets mean the FSA must be extra-vigilant in ensuring that safe amounts of capital are kept in this business. Mr Osmond's claims that he has somehow found the magic formula for running the funds with less capital are those of someone still living in the boom conditions of the past. They have no place in today's more straitened environment.

Rightly or wrongly, there is a suspicion that crunching together these so-call "zombie" closed life funds was always as much about ripping off the already disadvantaged policyholder as creating value from economies of scale. The FSA must offer policyholders the greatest possible protection.

The second point of clarity is that Mr Osmond must also be held to the letter of his takeover bid promise. There is no force majeure here, or FSA obstruction that Pearl couldn't have foreseen. If Mr Osmond is forced to dip his hand into his pocket for more capital, so be it. He's already taken more out of Pearl than the £800m he paid for the business, so he and his backers can easily afford it.

If they have miscalculated on the likely return from Resolution, that is again their problem. They played tough and rough to win Resolution. Now they must be as good as their word. Are these delays more about procedure than substance, which is the public message given out by all the involved parties? You bet they aren't. The chances of this all ending up in protracted proceedings before m'learned friends grow higher by the day.

Premier wilts under mountain of debt

Stock market speculation that Premier Foods is in financial difficulties refuses to die, not with standing the company's repeated denials.

Already up to its neck in debt as a result of the misjudged takeover of Rank Hovis McDougal, the company now faces very considerable increases in working capital demands, with strongly rising raw material prices and no certainty of being able to hand this price inflation on.

Attempts to force up the price of Hovis by a further 6p a loaf are being strongly resisted by supermarket groups. What's more, last time Premier whacked up the price, the effect was counterproductive, with consumers merely switching to less expensively priced loaves.

Led by Robert Schofield, Premier was a perfectly good business with a reasonably convincing strategy of buying up other companies' unwanted food. Brands included Branston Pickle and Cross & Blackwell. The Sudan 1 foods scandal, where Premier admitted to inadvertently using a cancerous dye in its worcester sauce, was quite a setback, but it seemed to be one that Mr Schofield was recovering from.

Then along came RHM, a business which, on the face of it, seemed to fit well with the Schofield strategy of buying up well-known British food brands. It also provided the opportunity for closing overlapping production facilities, delivering a supposed £85m in cost synergies. Yet there were three problems with the deal. One was that RHM was already heavily indebted, and Premier made it even more so by paying part cash.

The other was that, having been private-equity owned for many years, RHM was stripped down to the last light bulb and was in need of heavy investment. Finally, the deal for the first time linked Premier to the wheat cycle in a major way, making the whole company much more vulnerable to the vagaries of the harvest and strongly rising rival demand for grain.

All these problems have now come home to roost, with no obvious way of addressing them, other than asset sales into a falling market, abandoning the dividend or a rescue rights issue. With the dividend yield now higher than the earnings multiple, the stock market has already made up its mind where things are heading.