Australia's largest domestic food manufacturer, Goodman Fielder, has been besieged by an unlikely suitor, the yeast company Burns Philp, in what is turning into an ugly takeover battle. David Robertson reports from down under.

Australia's largest domestic food manufacturer, Goodman Fielder (GMF), has been besieged by an unlikely suitor, the yeast company Burns Philp (BPC), in what is turning into an ugly takeover battle. David Robertson reports from down under.

GMF, which owns the Uncle Toby and Meadow Lea brands, is bitterly fighting the A$1.85 (US$1.01) a share offer from Burns Philp, a company many times smaller than itself; although GMF is having difficulty convincing Sydney analysts that it is worth more.

Tom Park, chief executive of GMF, is repositioning the company to focus on its retail brands - a strategy implemented in mid-2001. For a number of years GMF had been considered an obvious takeover target given its relatively weak performance but now the company's board wants to give the new strategy time to reinvigorate the company. Last week the board made an aggressive statement to shareholders asking them to reject the $2.4bn offer.

"After careful consideration of the offer, as well as the potential issues and risks that could affect Goodman Fielder shareholders, the Board of Goodman Fielder recommends that shareholders reject the offer," said chairman Dr Keith Barton.

Fair price?

But it is hard to see why shareholders should reject $1.85. For the last three years the share price has pumped along between $1.40 and $1.60 and while it is fair to say that most of the upside has come since the new strategy was implemented the company has hardly set the stock exchange on fire with its heady growth.

While the share price has risen from $1.37 last November to $1.78 today as a result of the bid, most analysts value the company between $1.60 and $1.80. There is also a potential headache on the way for Australia's largest baker as domestic wheat prices are likely to rise further because of drought conditions across the country. A 20% drop in wheat supply this year could push up prices by $10 a tonne. GMF has hedged its wheat prices until December this year but after that the wheat crisis could dent its bottom line.

Shareholders must also be aware that if they reject the Burns Philp offer, the share price is likely to collapse.

"The largest risk in the near term is the potential for BPC to withdraw its takeover for GMF," said the investment house Salomon Smith Barney. "If this were to occur then the current takeover premium built into the stock would likely erode and we may see the share price reapproach its pre-bid levels closer to $1.40."

Unexpected bid from Burns Philp - and it comes with strings

Although GMF has been a target for some time, nobody expected Burns Philp to be the one to bite. The yeast and spices group is 57%-owned by the New Zealand billionaire Graeme Hart, who bought NZ$300m (US$164.7m) of the company's stock only to see the share price shrink from A$2.50 to A4c each. But Mr Hart, who is deputy chairman but de facto head honcho of the group, has rebuilt the fortunes of Burns Philp and is now looking to make his own push into retail brands courtesy of GMF.

Burns Philp made a lightning raid at the end of last year for $325m of GMF shares through Credit Suisse First Boston giving it a 14.9% stake. But the deal comes with many conditions, which the management of GMF has objected to.

Among the controversial conditions is a provision that requires GMF directors to confirm previous and future earnings and liabilities statements. This might seem an obvious precaution in the post-Worldcom business environment but GMF is not happy about it. The unusual request was given more validity last week when GMF admitted that it was in talks with the taxation office over $101.6m in unpaid tax, on top of an existing provision of $37m. (This tax bungle may give Burns Philp an opportunity to reduce its bid price and still keep investors on side.

GMF touting for a rival bid

The Australian Takeovers Panel has rejected a claim by GMF that the conditions are unacceptable so the company is now relying on shareholders to dismiss the offer. The board is also trying to drum up interest from rival bidders.

Sources close to the deal admit that GMF is seeking other buyers and is even offering to split the company to make the spreads, margarine and oils business attractive to companies like ConAgra, Nestlé and General Mills. Private equity groups have been approached about the bread business. So far, however, nobody appears to be willing to open their cheque books - partly because they would have to overpay substantially to beat Burns Philp's premium price.

In reality the most likely threat to the completion of a deal does not come from GMF but from Burns Philp. Buying GMF will push Burns Philp's debt to a weighty $2.7bn in a market that is very wary of big debt deals - at last bankers are learning from the mistakes of Vivendi et al.

Hart not scared by debt

The debt provision does not seem to bother Hart; he bought the Whitcoulls book chain for $73m in the early 1990s mostly with debt and sources close to Burns Philp say he believes that GMF's ability to generate large cash flows will limit the effect of the debt burden.

"It is a misunderstanding of debt," said the executive. "People see it as a risk but he [Hart] refers to the intelligent use of debt where it is not a problem being highly geared. He is used to debt and confident with it."

Of course, most students are used to, and confident with, debt but that does not mean bankers will keep lending. The conditions that wrap this deal seem to be bankers' jitters and if there are further revelations from GMF they may well walk away from the show.

"The key unknown from today at this stage is the certainty of BPC's financing arrangements," notes UBS Warburg.

The real deal killer may turn out to be the strength of the Aussie dollar. It has been in the doldrums for several years, much to the pleasure of exporters. Burns Philp gets 60% of its earnings in US$ and only 6% Australian dollars; this could be enough to shake the confidence of the bankers.

Given the lessons of 2002 they might decide $2.7bn debt for a company with a market capitalisation of just $357m (or $2.5bn post takeover) is just too dangerous.