Jeremy Warner's Outlook: Sir Gerry's Rentokil proposal doesn't add up, but Franklin buys the story none the less

The drawback of flat rate taxes is...; Much explaining to be done at MFI
Click to follow
The Independent Online

Last night it emerged that Sir Gerry has the support of Rentokil's largest shareholder, the US value investor Franklin Templeton. Franklin's Tucker Scott reckons Sir Gerry is the man for the job, and he doesn't seem to be in the least bit concerned about the cost of bringing him in.

On the face of it, Sir Gerry's proposal is quite breathtakingly arrogant, and it is hard to believe it would command the support of anyone. There's no takeover bid, there's no strategic vision, there's nothing in the way of financial innovation, and beyond Sir Gerry himself, there is no management team.

Instead, Sir Gerry proposes merely to parachute himself in as executive chairman, take a long hard look at the business, establish what has to be done and bring in the people to do it. Isn't that precisely what Mr McGowan and his new chief executive, Doug Flynn, have been doing? Still, no matter; for his trouble, Sir Gerry would personally get free shares in the business worth £53m.

Add in the free shares that his advisers and partners get under the proposal, and that's a cool £70m, or 2.55 per cent of the company. Admittedly, this is a lot less than the originally floated 10 per cent, or even the subsequently canvassed 5 per cent, but for many conservatively thinking fund managers, it will still seem unpalatable.

Sir Gerry would also be entitled to the proposed cash payout of 35p a share on the first tranche of stock, worth a further £2.8m. These sums, mind, are just his golden hello. There's no performance criteria attached to them whatsoever, unless you count the promise to do the job for at least three years and not to take up any other executive position in the meantime. Well thanks for that, Gerry. Much obliged to you, I'm sure.

The press release cutely refers to these payments as consideration for Raphoe, Sir Gerry's management vehicle, releasing him from his contract. As it happens, Sir Gerry owns more than 70 per cent of Raphoe, so he's hardly going to sue himself for breach of contract if he chooses to walk.

On top of all this, Sir Gerry would also get whatever the remuneration committee decide to pay him by way of salary, complete, presumably, with performance-related long-term bonus plan worth squillions more. As for the 35p a share cashback, anyone could do that, for it amounts only to paying shareholders with their own money.

Sir Gerry says he will approach shareholders to convene an extraordinary meeting if the board reject him. Yet even with Franklin's support he might find the vote hard to win. Alternatively, he might make a hostile bid in Raphoe shares or in a mixture of Raphoe shares and cash. This would amount only to swapping shares in Rentokil for stock in a more highly leveraged New Rentokil, so it's hard to see why shareholders would back that either.

The City has plenty to thank Sir Gerry for. With Compass, Granada and Allied Domecq, he succeeded in creating outstanding value for shareholders, though with the first two there was always a suspicion of smoke and mirrors; the trick for investors was to get out at the same time as Sir Gerry, for what came after wasn't nearly so lucrative.

All the same, what was suggested yesterday scarcely amounts to a serious proposal, and in any case breaches just about every corporate governance code in the book. So why is Franklin so keen to back it?

The Franklin shareholding of 14.75 per cent has been built up through aggressive buying over an 18-month period in the hope Rentokil might eventually attract a private equity bid. None has materialised, and the fund manager is today showing a quite considerable loss on its average purchase price. Franklin reckons Sir Gerry would reinvigorate the company and bring back a sense of optimism.

Dilution of just 2.55 per cent might seem a small price to pay if Sir Gerry can achieve such a result. But where are the penalties if he can't, and what sort of a precedent does it set? Before long, every chief executive of reputation would be demanding similar signing-on fees. Even so, Franklin's intervention has given the game a whole new lease of life. Sir Gerry won't be lightly dismissed and at the very least Mr McGowan will be forced to match his cashback proposal.

The drawback of flat rate taxes is...

The point that has been largely missed in the furore about flat rate taxes is that there is no politically feasible way of introducing such a regime that wouldn't result in an immediate and very considerable loss of tax revenue to the Government.

It takes a leap of faith to believe that the supposed economic benefits of flat rate taxes, in terms of superior economic growth, would eventually make up the difference. How long would it take, and how would public spending be paid for in the meantime?

Yet the Tories seem close to backing the idea, the LibDems are flirting with it, and even Tony Blair is said to be interested. It's the latest thing, and if there's any merit in it all, the politicians want to stamp their mark on it. So how might it work in practice?

The best analysis of how flat rate taxes might be applied to Britain is by the Adam Smith Institute (ASI). This is broadly supportive but even the ASI concedes that there would be an overall loss of tax take unless the rate of tax is established at the current average, in which case many taxpayers would pay more under the reforms than they do at present. Not exactly a vote winner.

To benefit low to average income earners most, and therefore be seen as progressive in nature, the tax would need to be set at the existing standard rate of 22 per cent, with a much higher personal allowance of say £12,000 so that lower earners could be taken out of the tax system altogether. Even then the arrangements wouldn't compensate for the present system of tax credits for very low-income earners. But the biggest drawback is that, set at such a low level, there would be a veritable collapse in the tax take.

This would have to be addressed either through hefty increases in sales taxes or steep cuts in public spending. Either way, average and lower income earners could be expected to lose out disproportionately, as they tend to be the biggest consumers of public services and sales taxes make no distinction between rich and poor.

Flat taxes may be appropriate for emerging economies, or those like Russia where the tax system had collapsed, but they are much more problematic in developed countries with an already mature tax system. What the politicians need to be looking at is a simplified and flatter tax structure, not the full monty.

Much explaining to be done at MFI

John Hancock has long been living on borrowed time as chief executive of MFI. Might yesterday's trading update be the thing that finally brings his reign to an ignominious end?

Many thought him lucky to survive the botched introduction of a new IT system, which resulted in a profits warning and a collapse in the share price. He fired those directly responsible, but he should perhaps have gone himself. Instead he hung on like a limpet, the buck stopping some way short of the top.

MFI would like us to believe that the 15 per cent decline in orders seen since the second half in its core, UK retail business is all down to a general deterioration in the market place, but can it really be that bad? Nearly all retailers and builders merchants are struggling. The becalmed housing market plainly isn't helping either. But 15 per cent is a mighty fall that would seem to point to continued company-specific failings.

In baseball, it's three strikes and you're out. Mr Hancock has had at least two.

j.warner@independent.co.uk

Comments