OUTLOOK: Full steam ahead with some financial engineering

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The Independent Online
When a company that made £45m profit last year, from sales of almost £4bn, bids for one that made £129m from just over £1bn you can be sure there is a hidden agenda. In the case of Trafalgar House's hostile offer for Northern Electric there has be en little attempt to disguise the real logic.

Certainly there is no industrial sense in a property, shipping and construction group owning an electricity distributor. In management terms, too, it appears hard to fathom what a team that has difficulties organising a Caribbean cruise thinks it can offer a business deep in the throes of a severe cost-cutting and reorganisation programme.

Even if the Trafalgar House management believes it can do better, the terms of Northern's licence would restrict it from doing anything too dramatic for fear that all the benefits would be taken away by the regulator. No, this deal is financial engineering pure and simple. Some would describe it as little more than a tax scam, though this might be a trifle unfair. Analysts are uncertain as to the extent of the tax attractions but it seems clear they are substantial.

Having lost £347m before tax in the year to September 1993, Trafalgar House plainly has stacks of trading losses to offset against Northern's profits. It also desperately needs more UK earnings to use up its unrelieved advance corporation tax, £223m at the last count. And when the National Grid is privatised next summer, Trafalgar's capital gains tax losses will wipe out any potential liability.

The other overwhelming attraction of Northern to Trafalgar House is its strong cashflow. Trafalgar has stated its desire to get more involved in infrastructure projects; the trend towards privately financed design, build and own contracts demands more cash than Trafalgar can muster on its own.

So the deal is good news for Trafalgar and 1,077p is a reasonable opening shot in what will be a protracted bid battle. But it is extremely unlikely to be enough for two reasons. This is what the arbitrageurs now piling into the stock believe. First, if there is so much tax benefit in it all for Trafalgar House, how about a share of it for the institutions? The premium as it stands doesn't look enough against what Trafalgar gets out of the deal. Second, the offer almost certainly undervalues the National Grid at £4bn. Swiss Bank has devised an ingenious scheme for passing the value of the Grid through to shareholders via an interest-bearing bond. Those that elect for this offer will eventually get whatever value the market cares to give the Grid. Thatdoes not alter that fact, however, that by assigning a notional value of £2 to these shares, Trafalgar may have undervalued the rest of the Northern Electric business. Moreover, those shareholders that elect for the cash alternative don't get any of theadded benefit.

What the offer does underline is the paltry sum raised by the Government for the taxpayer four years ago. If one of the weakest managements in the sector can more than quadruple the value of its business in four years something was massively wrong with the pricing in the first place. Not that many commentators or analysts were saying that at the time. If there is a silver lining in all this for the Government, it is that once these utilities start getting absorbed into long-standing quoted companies, their long-term future as private-sector enterprises becomes that much more assured.

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