OUTLOOK:Regulator's job to close the door behind the horse

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The Independent Online
Regulators of all kinds are past masters at slamming stable doors after the horses have bolted, and the Takeover Panel and the Stock Exchange are no exceptions.The clever use of options contracts, as seen in the deals between Trafalgar House and S wiss Bank Corporation that emerged this week in the offer document for Northern Electric, cannot be ignored by anybody interested in the orderly conduct of takeover bids.

No doubt something will eventually be done by the exchange and the panel to stop a repeat, though SBC must take some comfort from the fact that the panel at least appears to have given the nod to its plans beforehand.

To recap, Trafalgar agreed a number of contracts for differences - basically options - in the shares of its bid target, Northern Electric, and of several other regional electricity companies. These gave Trafalgar the same financial benefit as buying the shares, without actually owning the underlying stock or the votes attached.

The manoeuvre was claimed to be a way of defraying expenses, based of course on inside knowledge of the fact that Trafalgar itself was about to launch a bid that would set shares on fire in the whole electricity sector.

Swiss Bank Corporation would have hedged in the stock through its market-makers to protect itself from losses, and would have profited from fees for doing the deals. The fact that SBC's market-makers, independently of Trafalgar, also built up a substantial stake in Yorkshire Electricity has seriously muddied the waters, but is not relevant to the options.

Now buying shares in your bid target ahead of an announcement is a time-honoured practice, partly to establish a bridgehead but also to defray expenses if the bid fails. Though strictly speaking such purchases profit from inside information on your own intentions, they are exempt under the legislation. For example, the consortium bidders for BAT six years ago departed empty handed but with a tidy profit on the stake they built.

One key argument is whether it is right to allow dealings at the same time in other related stocks. Trafalgar's options might seem modest, but they could be the thin end of a wedge, opening the door to a wide range of manipulative dealings ahead of future bids. Better to keep it simple and insist that these ``legal insider'' purchases are restricted to the target company alone.

While it is hard to blame the panel and the exchange for being one step behind a bunch of innovative financiers intent on pushing out the boundaries of what is acceptable, they are not alone.

For example, it took the Securities and Investments Board and its satellite regulators several years to wake up to mis-selling of pensions. And the Bank of England is famous for the sound of slamming doors after each new scandal.

The entirely self-regulatory takeover panel and the statutorily backed exchange have on the whole been able to react much faster than some other regulators, though they have had their share of disasters - such as the failure to prevent the blatant market-rigging in the mid-1980s takeover boom.

In comparison, the question of how widely bidders and their market-making arms can deal in other shares ahead of a bid is a relatively minor matter on which the panel and the exchange should act quickly.

Bad news over the counter The boom days have long been overfor the drugs industry, as governments and centralised buyers around the world continually erode prices for prescription products. But now the big companies' efforts to find other ways to safeguard the revenue from their money-spinning older drugs are increasingly running into problems.

Wellcome is putting a brave face on its failure to achieve US Food and Drug Administration approval for over-the-counter sales of Zovirax, a well estabslished and successful anti-viral treatment for herpes and shingles. But it is hard to share the company's confidence that it will eventually persuade the increasingly hard-line US regulator to allow a non-prescription version.

Gaining over-the-counter approval for a drug is crucial because in some cases it actually boosts sales as the market for the cheaper version expands. This can protect against declining prescription revenues. The fact that the company and at least half the City's analysts were convinced that approval was likely underlines the unavoidable riskiness of investing in drug companies.

With one-third of sexually active Americans reported to be suffering from genital herpes, the FDA is right to take all steps to ensure that amateur treatment, without the supervision of a doctor, does not allow an infection to build up resistance to the drug.

The rejection is very bad news for a company facing the expiry of its patent in less than three years' time. As the fate of Tagamet, SmithKline Beecham's ulcer treatment, showed, the end of a drug's monopoly rights can be devastating - Tagamet's sales fell 76 per cent in the third quarter of last year. After years of double digit growth, Wellcome's earnings per share might actually fall in 1997.

Apart from Wellcome, shares in all the other pharmaceutical majors closed higher yesterday, which is surprising because the FDA's rejection is bad news for the industry as a whole. Drug shares stand at an unjustified premium to the rest of the equity market.

Hard times for the DIY sector It is only a few years since Britain looked like transforming itself from the fabled nation of shopkeepers into a nation of painters and decorators. The housing boom of the mid to late 1980s inspired large sections of the population to invest heavily in everything from white emulsion to vinyl flooring.

Now things are very different. The housing market is stagnant and analysts expect the DIY market to grow at a rate of only 4 per cent a year over the next few years, a far cry from the 1980s when double-digit growth was the norm. All of which makes Sainsbury's supposed interest in acquiring some or all of the Texas Homecare branches from Ladbroke intriguing.

Sainsbury has had more success than most in DIY. True, its Homebase chain is smaller than B&Q or Texas, but it is profitable.

It also has retail skills which could easily transfer to an expanded chain. Instead of competing on price and short-terms promotion, look for Sainsbury's emphasis on quality and service.

The problem for all the DIY warehouse operators is how to cope with the double threat of overcapacity and new entrants. The number of retail superstores almost doubled between 1985 and 1990 to 1,019, and most of the chains are still adding further stores. Home Depot, the American group, is still considering entering the UK.

With these pressures, something else may have to give, even after Texas is swallowed. It is unlikely to be B&Q, the market leader, which makes substantial profits.

The spotlight then falls on Do It All, the joint venture between Boots and WH Smith, which has contrived to lose more than £50m over the last two years. The question is, would anyone want to buy it?

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