BEFORE THE TAKEOVERS PANEL

IN THE MATTER OF

 

the Takeovers Act 1993 and
the Takeovers Code

AND

 

IN THE MATTER OF a meeting held under section 32 of the Takeovers Act 1993 to determine:

(1)  Whether Horizon Energy Distribution Limited ("Horizon") and/or the directors of Horizon acted in compliance with rule 64 of the Takeovers Code ("Code") when issuing a revised profit outlook on 28 September 2009;

(2)  Whether Horizon and/or the directors of Horizon acted in compliance with rule 64 of the Code, by omitting to disclose the change in accounting treatment and its impact on Horizon's profitability in the revised profit outlook issued on 28 September 2009;

(3)  Whether the directors of Horizon acted in compliance with rule 64 of the Code in making the statement in the target company statement that "The Directors assess that the Independent Adviser's valuation range does not adequately reflect the Board's view of the full value of [Horizon]".

MEETINGS:

 

12 March 2010 and 22 March 2010

 

MEMBERS:

 

D O Jones (Chairman) 
K J O'Connor 
R A Coupe 
D J Quigg

COUNSEL ASSISTING

 

B W F BrownQC

EXPERT ASSISTING

 

STENOGRAPHER

 

S Gale

 

H Hoffman

APPEARANCES:

 

J S Kós and J Orpin appearing for Marlborough Lines 
D J Cooper, A Nunns and S V East appearing for Horizon 
B Scott and A Kraak appearing for Cameron Partners

IN ATTENDANCE:

 

D W R Dew, K J Forrest, C D Milne and E Hudson representing Marlborough Lines 
R Tait, J McDonald and A Anand representing Horizon 
T King representing Cameron Partners 
K G Morrell, M R Bearsley, M R Tolan and T S Barnes (from the Panel executive)

DETERMINATION and STATEMENT OF REASONS:

 

10 May 2010

Background

[1]  Horizon is a code company under the Takeovers Code ("the Code") because it is a party to a listing agreement with NZX Limited and has its ordinary shares quoted on that exchange's NZSX market.

[2]  Horizon is the owner and operator of the electricity distribution infrastructure in the Eastern Bay of Plenty region and has its headquarters in Whakatane. This part of Horizon's business is regulated under the current regime for electricity lines businesses. Horizon also has a contracting division, Horizon Energy Contracting ("HEC"), which performs maintenance and capital works for the lines business, as well as undertaking contract work for outside parties.

[3]  Marlborough Lines Limited ("Marlborough Lines") is also an electricity lines business. It owns the electricity distribution infrastructure in the Marlborough region. Marlborough Lines also owns 50% of Nelson Electricity Limited and 51% of the OtagoNet joint venture.

[4]  On 14 September 2009, Marlborough Lines issued a takeover notice announcing its intention to make a partial offer under the Code for 51% of the ordinary shares in Horizon at $3.96 per share. Marlborough Lines did not own any shares in Horizon at the time it made the announcement.

[5]  EasternBay Energy Trust ("EBET") is an electricity consumer trust whose beneficiaries are electricity consumers in the Eastern Bay of Plenty region. EBET holds 77.29% of the shares in Horizon. The size of EBET's shareholding meant that Marlborough Lines' offer could not succeed without EBET's accepting into the offer for at least some of its shares.

[6]  On 16 September 2009, a division of the Takeovers Panel ("the Panel") was constituted to exercise the powers of the Panel in relation to Marlborough Lines' offer, for example, for the approval of the independent adviser, reviewing of documents, etc.

[7]  Marlborough Lines' takeover notice indicated that the offer would be made on 29 September 2009. The day before, on 28 September 2009, Horizon announced a "revised profit outlook" to the market. That announcement said that Horizon's forecast after tax profit for the 2009/2010 financial year had increased from $4.5 million to around $6 million. The Chairman's address to the Horizon annual meeting of shareholders on 6 August 2009 included a forecast profit of $4.5 million for the year ending 31 March 2010. Accordingly, the revised profit outlook showed uplift in forecast profit of approximately $1.5 million.

[8]  Marlborough Lines' offer opened on 29 September 2009. On 6 October 2009, the Panel received a letter from Radich Law, representing Marlborough Lines, complaining that the revised profit outlook potentially breached rules 38 and 64 of the Code, which prohibit defensive tactics and misleading conduct, respectively. In the letter, Marlborough Lines noted the timing of the revised profit outlook and described the stated reasons for the upward revision in profit over such a short period as being "unconvincing".

[9]  On 12 October 2009, on receiving Marlborough Lines' consent to do so, the Panel put Marlborough Lines' letter to Horizon for comment. On 15 October 2009 Horizon responded by advising the Panel that it had prepared updated and more detailed financial forecasts as required by the independent adviser, Simmons Corporate Finance Limited ("SCF"). Horizon, as a target company in receipt of a takeover notice, was required by the Code to obtain an independent adviser report. Horizon advised the Panel that because those updated forecasts were materially different to the forecast figures announced on 6 August 2009 the Horizon Board had an obligation to announce the updated forecast to the market under the NZX Listing Rules and the Securities Markets Act 1988.

[10]  In a letter dated 16 October 2009, the Panel executive advised Marlborough Lines that it had received a response from Horizon to the concerns expressed in its 6 October complaint and that, on the basis of that response, the Panel executive did not propose to take the matter further.

[11]  Horizon issued its target company statement on 13 October 2009. Accompanying the target company statement was the independent adviser report prepared by SCF. That report valued Horizon at between $3.96 and $4.68 per share. At paragraph 15.2(b) of Horizon's target company statement, the directors of Horizon stated that they believed the valuation range of $3.96 to 4.68 per share "does not adequately reflect the Board's view of the full value of [Horizon]". A number of reasons were given for this view.

[12]  As part of the normal compliance activities of the Panel executive in monitoring the takeover documents, the Panel executive had received and reviewed a draft version of the target company statement. Arising from the review, the Panel executive in a letter of 9 October 2009 enquired of Horizon's legal advisers, Bell Gully, what the basis was for this view expressed by the Horizon directors. Bell Gully advised the Panel, on 12 October 2009, that Horizon had engaged Cameron Partners Limited ("Cameron Partners") to provide assistance to the Horizon directors during the takeover process, including by providing an "indicative" valuation of Horizon. Bell Gully also advised that Horizon's board had had regard to this valuation, its own views on valuation and other matters, including the historic multiples applied to sales of other network assets in making its recommendation. The Panel executive decided, on the basis of Horizon's response, that its enquiry had been adequately answered, and that no further action by the Panel seemed justified.

[13]  On 19 October 2009, it was announced that EBET had decided not to accept Marlborough Lines' offer. EBET's decision meant that the offer would inevitably fail and it lapsed on 30 October 2009.

Marlborough Lines' request for a section 32 meeting

[14]  On Monday, 22 February 2010 the Panel received a request from Marlborough Lines through its legal advisers, Radich Law, that the Panel convene a meeting under section 32 of the Takeovers Act ("section 32 meeting") to determine five broad complaints alleging breaches of the Code by Horizon, its directors and SCF. These broad complaints were particularised into some 27 alleged breaches of the Code or Takeovers Act, relating to Marlborough Lines' unsuccessful offer for Horizon. The request was accompanied by affidavits in support of the complaints, from:

(a) David William Dew, Chairman of Marlborough Lines;
(b) Kenneth John Forrest, Managing Director of Marlborough Lines;
(c) Edward Allan Hudson, Economist and Financial Consultant;
(d) Christopher David Milne, Company Director and Financial Analyst; and
(e) Samford Lee Maier, Business Consultant.

[15]  Marlborough Lines copied Horizon and Horizon's legal advisers, Bell Gully, into its request that the Panel hold a section 32 meeting. On 24 February 2009, the Panel received preliminary submissions from Bell Gully in response to Marlborough Lines' request to the Panel.

Statutory provisions for meeting of Panel

[16]  The relevant provisions of the Takeovers Act for a meeting of the Panel in respect of its enforcement powers are sections 32 and 35.

[17]  Section 32 provides:

"32 Panel's powers in respect of compliance with takeovers code

(1) The Panel may at any time, if it considers that a person may not have acted or may not be acting or may intend not to act in compliance with the takeovers code, after giving that person such written notice of the meeting as the Panel considers appropriate in the circumstances, but in no case exceeding 7 days, hold a meeting for the purpose of determining whether to exercise its powers under this section.

.... 
(3) Following the meeting specified in subsection (1) of this section, the Panel may make a determination-

(a) that it is satisfied that the person has acted or is acting or intends to act in compliance with the takeovers code; or

(b) that it is not satisfied that the person has acted or is acting or intends to act in compliance with the takeovers code.

..."

[18]  Section 35 of the Act provides: 

"35 Persons who may apply

(1) Where the Panel makes a determination under section 32(3)(b) of this Act (a determination that the Panel is not satisfied that a person has acted or is acting or intends to act in compliance with the takeovers code) the following persons may, subject to subsection (2) of this section, make an application to the Court under section 33F, 33I, or 33K: 

(a) ... the Panel:

(f) a person who, at any time within the period of 6 months before the making of the application, has made an offer or offers to acquire securities in the specified company in accordance with the takeovers code:

...
(g) with the leave of the Court, any other person.

(2) A person referred to in any of paragraphs (b) to (f) of subsection (1) of this section is not entitled to make an application to the Court unless- 

(a) the Panel has consented to the making of the application; or

(b) that person has requested the Panel in writing to make an application to the Court itself and the Panel has not made such an application before the expiration of 10 days after receiving the request.

(3) Where a request is made to the Panel to hold a meeting under section 32(1) of this Act and the Panel does not, within 14 days after receiving the request, make a determination under section 32(3) of this Act, the following persons may make an application to the Court under section 33F, 33I, or 33K-

...
(e) a person who, at any time within the period of 6 months before the making of the application, has made an offer or offers to acquire securities in the specified company in accordance with the takeovers code:"

...
(f) with the leave of the Court, any other person.

..."

The Panel decides to hold meeting under section 32

[19]  The Panel met on 7 and 8 March 2010 to consider Marlborough Lines' allegations. Under section 32(1) of the Act, the Panel must consider that "a person may not have acted, or may not be acting or may intend not to act in compliance with the [Code]" in order to decide to hold a section 32 meeting. The Panel refers to this as the "threshold test" for holding a section 32 meeting. The Panel decided that the threshold test was met in respect of two of Marlborough Lines' particularised allegations. The Panel decided to exercise its discretion to hold a section 32 meeting to determine those two matters. The Panel's 8 March 2010 resolution records:

"On 22 February 2010 the Panel received a formal request from Radich Law, lawyers for Marlborough, to convene a section 32 meeting to inquire into a large number of allegations against various parties involved in the unsuccessful partial offer by Marlborough for Horizon.

 

On the basis of the information available to the Panel, including the information included in Marlborough's request and the preliminary response by Horizon to that request, the Panel considers that:

 

(a) Horizon and/or the directors of Horizon may not have acted in compliance with rule 64 of the Code by issuing a revised profit outlook on 28 September 2009, if there was no reasonable basis for issuing that revised profit outlook; and
(b) The directors of Horizon may not have acted in compliance with rule 64 of the Code by stating in the target company statement in response to the partial offer by Marlborough for Horizon that the valuation range of $3.96 to $4.68 per share did not reflect the full value of Horizon, if they had no reasonable basis for making that statement."

[20]  The Panel recognised that the determination of those issues would involve consideration of specialised technical information due to the complex regulatory environment in which Horizon's lines business operates. Accordingly, the Panel retained Mr Stephen Gale of Castalia Strategic Consultants as an expert adviser to assist the Panel with those technical considerations.

[21]  The Panel retained Mr Brendan Brown QC as Counsel assisting the Panel in relation to the section 32 meeting.

[22]  On 9 March 2010 the Panel gave written notice to Marlborough Lines, Horizon and Cameron Partners that it would hold a section 32 meeting to determine those two issues. The notice advised that the section 32 meeting would be held on Friday 12 March 2010 and would resume on Tuesday 16 March 2010.

[23]  At the same time as giving notice of the section 32 meeting, the Panel summonsed Horizon and Cameron Partners to attend the section 32 meeting by their authorised representatives. The Panel also summonsed documents held by Horizon and Cameron Partners relating to Marlborough Lines' offer. The Panel received five large lever-arch folders of documents from Cameron Partners and around two volumes from Horizon.

[24]  The Panel received the summonsed documents on 11 and 12 March 2010. The Panel was appreciative that the parties provided those documents in advance of the section 32 meeting. However, the Panel was concerned by the level of redaction undertaken in some of the documents provided by Horizon. The Panel recognises the entitlement to claim legal professional privilege in respect of legal advice provided to Horizon. However, the Panel considers that claim to privilege was extended too broadly in some of those documents, a view the Panel was able to form in the circumstances where documents provided by Cameron Partners were not similarly redacted.

The Panel's determination of issues at section 32 meeting

The Panel's administrative and procedural meeting on 12 March 2010

[25]  The first part of the section 32 meeting, held on Friday 12 March 2010, was for consideration of administrative and procedural matters in anticipation of a foreshadowed request for an adjournment of the hearing of the substantive issues ("procedural hearing"). The Panel then adjourned the section 32 meeting to a later date, as a result of a request for adjournment by Horizon, to consider the substantive issues ("substantive hearing").

[26]  It is unusual for the Panel to divide a section 32 meeting into procedural and substantive hearings or to entertain applications for adjournment. However, the Panel considers it was appropriate in this case. A section 32 meeting must be held within seven days of the Panel giving notice of the meeting. The provisions anticipate a takeover in progress. In the present case there was no takeover underway. The Panel was concerned that the seven day timeframe might not give Horizon adequate time to prepare its defence, in accordance with the principles of natural justice (which must be considered in the context of whether a takeover is, or is not, in progress). The Panel therefore considered it appropriate to entertain applications to adjourn the substantive hearing to a date later than the scheduled Tuesday 16 March 2010 date.

[27]  In the event, Horizon made an unopposed adjournment application and the substantive hearing was adjourned to Monday 22 March 2010. That date was chosen, rather than the date proposed by the Panel of 29 March 2010, because of the unavailability of Horizon representatives on, and for a substantial period following, 29 March 2010 because of international travel commitments. The Panel also heard submissions on the status of Cameron Partners (which was a witness, not a party) at the hearing, the treatment of documents received under summons, and the timing for receipt of legal submissions.

Additional issue included for the substantive hearing

[28]  The Panel reviewed the summonsed documents in advance of the substantive hearing. During that review, it became apparent that a material portion of the uplift to Horizon's forecast profit, announced in the revised profit outlook, was the result of a change in the application of an accounting treatment relating to the capitalisation of costs for capital works undertaken for Horizon by Horizon's contracting division, HEC.

[29]  Prior to the change of the application of the accounting treatment, only the materials and labour costs of the capital works were treated as expenses. Following the change, a greater proportion of the total costs of the capital works (i.e., over and above materials and labour costs) were treated as capital expenditure. This had the effect of reducing actual and forecast expenditure for the year, and increasing forecast profit.

[30]  Neither the change in the application of the accounting treatment, nor its impact on forecast profit, was disclosed in the revised profit outlook.

[31]  The Panel met on 22 March 2010 prior to the substantive hearing to discuss the summonsed material. The Panel considered that the change in the application of the accounting treatment was integrally connected with the issue of the revised profit outlook by reason of being one of the matters apparently giving rise to the revised profit outlook. The Panel considered from its review of some of the summonsed material that Horizon and/or its directors may not have complied with rule 64 of the Code by omitting to disclose the change in the application of the accounting treatment in the revised profit outlook announcement.

[32]  The Panel noted that the non-disclosure issue had not been included in its 9 March 2010 notice of the section 32 meeting. The Panel had not been aware of the non-disclosure issue when the notice of meeting was sent.

Substantive hearing

[33]  The substantive hearing was held in Wellington on Monday 22 March 2010. Prior to the commencement of the meeting, Mr Brown QC, Counsel assisting the Panel, in the presence of the Chairman of the Panel consulted Mr Cooper for Horizon about the Panel's desire to include the additional non-disclosure issue for consideration at the substantive hearing. It was noted that the alternative was to adjourn the meeting, issue a further or amended notice and hold the meeting at a later date which would have implications for the Horizon representatives' travel intentions. Mr Cooper recognised that the additional non-disclosure issue arose in the context of the first of the issues in the notice of 9 March 2010. It was agreed that he would advise by the morning tea adjournment if Horizon took any objection to the additional issue being addressed at the hearing. In the event no objection was raised by Horizon to the inclusion of the additional non-disclosure issue and the substantive hearing also addressed that issue.

[34]  All persons giving evidence at the meeting did so on oath. A transcript of the proceedings was taken. It was distributed to the parties to the hearing on 24 March 2010.

[35]  The Panel began its deliberations at the end of the section 32 meeting. The Panel's determination and its reasons are set out below.

Rule 64 and relevant jurisprudence

[36]  The three issues considered by the Panel at the section 32 meeting concern the prohibition in rule 64 of the Code against misleading or deceptive conduct in relation to transactions regulated by the Code.

[37]  Rule 64 of the Code provides: 

"64 Misleading or deceptive conduct

(1) A person must not engage in conduct that is-

(a) Conduct in relation to any transaction or event that is regulated by this code; and

(b) Misleading or deceptive or likely to mislead or deceive.

(2) A person must not engage in conduct that is-

(a) Incidental or preliminary to a transaction or event that is or is likely to be regulated by this code; and

(b) Misleading or deceptive or likely to mislead or deceive."

[38]  "Engaging in conduct" is defined by rule 2(2) of the Code: 

"engaging in conduct means doing or refusing to do an act, and includes,-

(a) Omitting to do an act; or

(b) Making it known that an act will or will not be done."

[39]  Rule 64 is similar in wording to the civil prohibition against misleading or deceptive conduct in trade in section 9 of the Fair Trading Act 1986. The jurisprudence surrounding section 9 of the Fair Trading Act is relevant to rule 64 of the Code. The Panel has previously considered the application of rule 64 in its determination relating to the partial takeover offer by the group of investment funds collectively known as the "Knott funds" for Rubicon Limited (6 July 2009).

[40]  When considering conduct in relation to rule 64, the Panel must first determine whether the particular conduct falls within the scope of rule 64. If the conduct does fall within the scope of rule 64 the Panel must then decide whether it is satisfied or whether it is not satisfied that the conduct complied with rule 64. These steps are described in more detail below.

[41]  When deciding whether conduct falls within the scope of rule 64 the Panel addresses two questions: 

(a) Does the allegation relate to "engaging in conduct" (noting that an omission to do something can constitute "engaging in conduct")?; and

(b) Is the alleged conduct: 

(i) Related to a transaction or event that is regulated by the Code; or

(ii) Incidental or preliminary to a transaction or event that is, or is likely to be, regulated by the Code?

[42]  If both questions are answered in the affirmative, the alleged conduct falls within the scope of the rule. The Panel then must consider whether it is satisfied that the conduct complied with rule 64.

[43]  This involves an inquiry into whether the alleged conduct "was misleading or deceptive or likely to mislead or deceive". The question must be examined objectively, and in the particular circumstances of the matter. This depends on the context, including the characteristics of the person or persons said to be affected.1

[44]  This involves consideration of the following:

(a) Define the target audience(s) of the conduct at issue:

(i) There may be more than one distinct audience for the impugned conduct;

(ii) For the conduct to be misleading, the nature of the members of the target audience is relevant. Conduct towards a sophisticated business person may be less likely to be objectively regarded as being capable of misleading or deceiving than similar conduct directed towards, for example, a consumer.2

(b) Assess the circumstances in which the conduct occurred and the person or persons likely to be affected by it.3 Would a reasonable person in the claimant's, or in the target audience members', situation likely to have been misled or deceived? This involves taking the hypothetical reasonable member of each target audience and asking whether it would be reasonable for that person to be led to an erroneous assumption or misconception as a result of the conduct.

(c) It is not necessary to establish that the conduct actually misled or deceived anyone.

(d) If the conduct objectively had the capacity to mislead or deceive the hypothetical reasonable person of one or more of the target audiences, there has been a breach of rule 64. If someone was in fact misled or deceived, that may well be enough to show that the requisite capacity existed.4

[45]  An omission to disclose information may be misleading where, in the circumstances, there would have been a reasonable expectation that the material information known to the holder would be disclosed. The reasonable expectation is the expectation of the reasonable target audience member, viewed objectively.

[46]  Where the impugned conduct involves expressions of opinion, the opinion must be:

(a) honestly held; and

(b) reasonably based; and

(c) not demonstrably wrong

at the time that it was expressed or relied upon.5

Issues 1 and 2: Revised Profit Outlook

[47]  The first two issues considered by the Panel were:

(a) Whether Horizon and/or the directors of Horizon acted in compliance with rule 64 of the Code by issuing a revised profit outlook on 28 September 2009 if there was no reasonable basis for issuing the revised profit outlook.

(b) Whether Horizon and/or the directors of Horizon acted in compliance with rule 64 of the Code, by issuing a revised profit outlook on 28 September 2009 that omitted to include information regarding the change in the application of the accounting treatment, including the impact of the revised profit outlook.

[48]  As both issues concern the revised profit outlook they are considered together below.

Facts (relevant to both issues), ascertained from evidence provided to the Panel

[49]  Horizon operates in the Eastern Bay of Plenty region. During 2009, New Zealand had a particularly cold winter which impacted upon the demand for electricity. The company was also operating in an industry subject to regulatory oversight by the Commerce and Electricity Commissions.

[50]  As an electricity lines business, Horizon needs to conduct maintenance on its existing infrastructure assets. It also needs to undertake capital works to replace old infrastructure and create new infrastructure to expand its capacity to meet increasing demand.

[51]  Prior to March 2008 Horizon employed external contractors for most of this maintenance and capital work. The materials for capital works were supplied by Horizon, and external contractors built and installed those capital works. Horizon's in-house contracting business, HEC, was relatively small.6

[52]  In March 2008 Horizon purchased the business of its major contractor, Total Power Services.7That business was merged with HEC, expanding its contracting capacity. Following the merger, most of Horizon's capital and maintenance work was carried out within the Horizon group, by HEC. HEC also did contracting work for external parties.8

[53]  Horizon produces group financial statements consolidating Horizon's accounts with those of HEC. As part of this consolidation, transactions between Horizon and HEC are eliminated so that the group financials present as if Horizon and HEC were a single entity. According to Horizon's internal management policy on the accounting of internally constructed assets, assets created by the capital works undertaken by HEC for Horizon ("internally constructed assets") are to be treated as if those assets had been constructed/purchased by Horizon itself.

[54]  The accounting treatment of constructed/purchased assets is covered in NZ IAS 16 - Property Plant and Equipment. This requires such assets to be measured "at cost". "Cost" is defined as the purchase price and any costs "directly attributable to bringing the asset to the location and condition necessary to operate it in the manner intended" [emphasis added]. The cost of constructing an asset internally is determined using the same principles as for acquiring an asset from a third party. Internal profits are eliminated and administration and general overhead costs cannot be included in the cost of the asset.9

[55]  NZ IAS 16 gives some examples of directly attributable costs. They include costs of employee benefits arising directly from construction, costs of site preparation and professional fees. According to Horizon's intercompany eliminations policy, although the examples provide some guidance, the accounting standard allows some judgment to be exercised as to which costs are "directly attributable" to the construction of the assets and can therefore be capitalised.

[56]  In the 2009 financial year, Horizon's application of the accounting treatment of the costs of internally constructed assets ("accounting treatment") was to only classify expenditure on labour and materials for capital works as "directly attributable" to the construction of the resulting capital assets. Consequently, only those costs were capitalised. All HEC's remaining costs were expensed.10 This treatment resulted in additional expensed costs, and therefore in reduced reported profit and reduced capitalised asset values.11

[57]  The Panel was told, and documents show, that Horizon's auditors PricewaterhouseCoopers ("PwC") had discussed the issue of the accounting treatment with management in the course of the 2009 audit. PwC also raised this issue at Horizon's audit committee meeting in May 2009.12 PwC suggested that Horizon may wish to consider capitalising a greater proportion of the costs of the internally constructed assets. Although PwC accepted that the historic application of the accounting treatment was materially correct, it described the treatment as conservative and not standard practice for the industry.13

[58]  According to Mr Tait's affidavit,14 Horizon's management was working on reviewing the costing methodology for the 2010/2011 financial year. Management's enquiries showed that other electricity lines businesses capitalised most of the costs of internally constructed assets so as to approximate what would have been paid for the asset from a third party.

[59]  Capitalising a greater proportion of Horizon's costs of internally constructed assets would have the effect of reducing expensed costs thereby increasing profitability for the year. The higher capitalised cost of the asset would then be depreciated in future years.15

[60]  According to Mr Tait's oral evidence, during March 2009 the Horizon Board signed off on budgets prepared by management for the 2009/2010 financial year. Those budgets estimated Horizon's after tax profit for the 2009/2010 financial year as being approximately $4.5 million.16 In his affidavit, Mr Tait explained that, although Horizon management had begun reviewing the treatment of the costs of internally constructed assets at the time the budgets were prepared, the work was not sufficiently advanced to be presented to the Board.17Accordingly, the forecast after tax profit of $4.5 million in the 2010 budget was on the basis of the existing accounting treatment of capitalising only the labour and material costs of internally constructed assets.18

[61]  One feature of the 2009/2010 financial year budget was a doubling of capital expenditure from $1.1 million to $2.4 million. This exacerbated the effect of the accounting treatment which increased the expected elimination value in the group accounts from $438,000 to $881,000 (gross).19

[62]  Horizon's 2009 annual meeting of shareholders was held on 6 August 2009. The Chairman's address to that meeting announced that Horizon's current underlying after tax profitability for the year ending 31 March 2010 was around $4.5 million.

[63]  The management report provided to the meeting of the Horizon Board held on 1 September 2009, included calculations showing Horizon's net profit after tax for the year to date as being $872,000 above budget.20 The Board report said "Attached to this report is a Year End forecast for the group that shows a forecast profit of $5.3 million versus the budget of $4.4 million, an increase of $0.9 million. This profit forecast takes into account above budget performance year to date and likely variations for the remaining eight months of the year."

[64]  The Board Minutes record, and Mr McDonald said during his oral evidence, that the Board determined that, given the indicative nature of the figures and that it was still an early stage of the financial year, on balance, no additional disclosure to the market was required.21

[65]  Mr Tait, in his affidavit, said: 

"On 1 September 2009, I chaired the monthly Horizon Board of Directors meeting. At the meeting Horizon management advised the Board that a draft revised forecast for the full financial year showed a profit of $5.3 million compared with the budget figure of $4.4 million. The information provided to the Board at this meeting noted that the forecast increased profitability was attributable to: 

 

(a) line revenue gains (i.e., increase in sales as a result of a colder than expected winter);

(b) positive movements in derivatives; and

(c) savings in operational costs.

 

In light of this information, the Board considered whether it was necessary to give revised profit guidance to the market. At this stage (i.e., 1 September 2009), detailed revised forecast had not been prepared. We had only a spreadsheet prepared for the purposes of our Board meeting. Given that the company had only four months of actual figures for the current financial year (April to July 2009), and the detailed forecasts for the balance of the year were still to be completed, we decided that it was premature to make a disclosure to the market. However, the Board instructed management to complete detailed forecasts for the balance of the financial year for the Board to consider."22

[66]  Horizon said that they kept the profit outlook under review by the Board and management through the course of the year.

[67]  On 14 September 2009 Marlborough Lines issued its takeover notice announcing its intention to make a partial offer for Horizon on 29 September 2009. Under the Code, Horizon had to prepare a target company statement in response to Marlborough Lines' offer. A target company statement must contain or be accompanied by a report on the merits of the offer by an independent adviser. Horizon appointed SCF to act as independent adviser and the Panel approved that appointment.

[68]  At around the same time, the Board appointed Cameron Partners as strategic advisers for the purpose of assisting Horizon with its response to the Marlborough Lines' offer.

[69]  An independent adviser's report on a takeover offer will normally contain a valuation of the target company. The primary valuation methodology adopted by SCF in its report on the Marlborough Lines offer for Horizon was discounted cash flow ("DCF"). DCF requires a forecast of future cash flow, usually for at least the next five to 10 years. Independent advisers generally rely on a model provided by target company management, and adjust the underlying assumptions as they consider appropriate.

[70]  Accordingly, Horizon needed to provide SCF with detailed management forecasts for the next five to 10 years. According to oral evidence given to the Panel by Horizon's Chief Executive Officer, Mr Ajay Anand, at the time of receiving the takeover notice, Horizon did not have detailed management forecasts for that period. It had to prepare those detailed forecasts in addition to the detailed forecasts for the 2009/2010 financial year that had been requested by the Board at the 1 September 2009 Board meeting.23

[71]  Mr Tait said in his affidavit, and Mr McDonald said in his oral evidence, that during the preparation of those forecasts, Horizon reviewed its accounting treatment of costs for internally constructed assets having regard to PwC's earlier advice. As a result of that review management recommended that Horizon change its practice so that a greater proportion of the costs of internally constructed assets were to be capitalised (i.e., beyond labour and material costs).24

[72]  This change in the application of the accounting treatment was recorded in an internal Horizon document entitled "intercompany eliminations for group reporting" and confirmed by PwC in a letter dated 25 September 2009 to the Directors of Horizon as complying with NZ IFRS and being appropriate for Horizon's business. The change had the effect of reducing forecast expensed costs for the 2009/2010 financial year, thereby increasing forecast profit by a corresponding amount. The intercompany elimination was reduced from $881,000 to $146,000 with a corresponding increase in forecast pre-tax profit of $735,000.

[73]  During the section 32 meeting, the Panel asked Messrs Tait and McDonald why Horizon, which had been aware of the accounting issue since it had been raised by PwC in early 2009, had not seriously progressed it until Marlborough Lines' proposed offer was announced. Messrs Tait and McDonald both said in their evidence that, in hindsight, Horizon arguably should have progressed the accounting issue earlier in the financial year.25 However, Mr McDonald explained that the issue had not been progressed because: 

(a) Horizon had invested in a relatively low level of capital works during the 2009 financial year.26 A change in the application of the accounting treatment for internally constructed assets would not have made a material difference to the figures in Horizon's 2009 financial statements.27 Therefore it had not been required to review the accounting issue before finalising those financial statements.

(b) There had been two changes in senior accounting personnel during the calendar year. As Mr Tait's affidavit explained, Horizon's previous CFO, John Calleja, had left in February 2009. The current CFO, Todd Campbell, started in May 2009 and needed some time to familiarise himself with the role. In the interim, Horizon had employed a temporary CFO to attend to matters which were largely around the preparation of the annual financial statements in the busy end of year period and preparation for the annual meeting of shareholders.28 Mr McDonald told the Panel that, as a result of this upheaval, he had forgotten about the accounting issue.29

[74]  The documentary evidence provided to the Panel included the updated profit forecasts, showing a forecast after tax profit for the 2009/2010 financial year of approximately $6 million. This was $1.5 million above the $4.5 million figure announced in the Chairman's address to the 6 August 2009 annual meeting of shareholders. Approximately $735,000 pre-tax or $510,000 post-tax of that $1.5 million was attributable to the effect of the change in the accounting treatment. 30 According to the Board Minutes and Mr Tait's affidavit, these updated forecasts were presented to the Horizon Board meeting on Sunday, 27 September 2010. The Board decided that those figures were "materially different from the indications previously given to the market" and should be announced to the market pursuant to Horizon's continuous disclosure obligations.31

[75]  On 28 September 2009, Horizon issued a revised profit outlook announcing the increased profit figures. The revised profit outlook announcement did not mention the change in the application of the accounting treatment. The revised profit outlook announcement states: 

"28 September 2009 

 

REVISED PROFIT OUTLOOK 

 

Horizon Energy Distribution Limited ("the Company") has increased its forecast after tax profit to around $6 million for the year ended 31 March 2010. 


At its Annual Shareholders Meeting on 6 August 2009 the Chairman, Mr Rob Tait stated that the current underlying after tax profitability of the Company was around $4.5 million. 

 

The forecast profit for the current year has been increased as a result of increased revenue, cost savings, and mark to market gains on the Company's interest rate derivatives. 


The additional revenue results from increased electricity consumption during the relatively cold 2009 winter. Normal consumption levels are forecast to the end of the financial year. 


Mr Tait said that the cost savings are particularly pleasing and reflect the close scrutiny of all costs within the company. 
The Board of Horizon Energy expects to release its half year result and its announcement of an interim dividend at the end of November 2009. 
..."

[76]  The same day Mr Tait sent an e-mail to Mr Kenneth Forrest, the Managing Director of Marlborough Lines, attaching the revised profit outlook announcement. That e-mail said:

"Hello Ken 


Attached is a copy of the announcement made to the NZX today with a revised profit outlook for Horizon. 
No doubt all lines businesses have enjoyed an uplift in revenue as a result of the cold winter, however, the savings in cost reflect a lot of work undertaken by Ajay and his team in re-organising and refocusing the whole company over the past year. 


The gains from the interest rate derivatives are also pleasing and reflects [sic] some very good swap contracts put in place over the past year. There is a degree of uncertainty on where interest rates will go however, based on our advice in this regard we are set to enjoy some useful gains this year. 


We are working hard on the preparation of the Target Company Statement and expect this to be out by the 13th October. 


With kind regards, 
Rob..."

[77]  Prior to the issuance of the revised profit outlook, the documentary evidence provided to the Panel shows a robust e-mail discussion amongst Horizon's directors, senior management and advisers about what the revised profit outlook announcement should say, including the extent to which it should mention and explain the contribution from the change in the application of the accounting treatment. Some within Horizon, and Cameron Partners, took the view that the announcement should include a breakdown of the profit uplift. Others were firm in their view that there should be no breakdown.

[78]  Mr Toby King, director of Cameron Partners, in an e-mail to Messrs Tait, Anand, Campbell, McDonald, de Farias (a Horizon director) and Boyle (a Horizon director) dated 28 September 2009, said that Cameron Partners believed the revised profit outlook announcement would be strengthened by including a breakdown of the profit contributions from each category referenced (or at least an indication). Cameron Partners' stated main concern was that the quantum of the change in accounting treatment of internally constructed assets warranted some mention.

[79]  Early drafts of the announcement made reference to the change in the application of the accounting treatment, including one draft which contained the following paragraph: 

"...The Company has changed how it records capital assets constructed by its own contracting division. This change, confirmed by the Company's auditors and in line with the accounting treatment adopted by most lines businesses will result in increased profit from that forecast at the time of the ASM announcement..."32

[80]  Todd Campbell, CFO of Horizon, after discussing the policy change, said in an e-mail on 28 September 2009 to Board members:

"I would prefer that we do not go into this detail in the announcement as although it moves us in line with standard practice accounting treatment it may open us up for increased scrutiny/criticism on changes to accounting practices given the current process we are going through."

[81]  In the final version of the revised profit outlook announcement, as released to the market, all references to the change in the application of the accounting treatment were removed. Mr Tait agreed during his evidence at the section 32 meeting that the contribution from the change in the application of the accounting treatment was incorporated under the heading of "cost savings" in the final version of the revised profit outlook.33

[82]  The Panel questioned Messrs Tait and McDonald about the decision not to explicitly mention the change in the application of the accounting treatment in the revised profit outlook announcement, particularly given that Mr Tait had initially appeared to favour disclosure while Mr McDonald had consistently argued for non-disclosure.

[83]  Mr Tait acknowledged that he had favoured disclosure but that he had agreed with other directors that there was a need for a simple, clear, uncomplicated announcement. He said that in his view what was in the announcement would have had little impact on the offer. Mr McDonald said that company profit announcements usually emphasised the headline figure, and pointed to elements that were not sustainable. This was why the announcement mentioned the gain from the unusually cold winter, and the mark to market gains on derivatives. He said that he did not see the change as one of accounting policy, but as a correction of something that was wrong. Messrs Tait and McDonald also said that all relevant information about the uplift to forecast profit would be included in the independent adviser report and the target company statement.34

[84]  In fact, neither the independent adviser report nor the target company statement disclosed or explained the change to the application of the accounting treatment.

Does rule 64 apply?

[85]  The two instances of conduct by Horizon and its directors alleged to have breached the Code were: the issuance of the revised profit outlook itself and the non-disclosure in the revised profit outlook of the change in the application of the accounting treatment for internally constructed assets. The first question is whether those instances of conduct fall within the scope of rule 64.

[86]  As noted above this involves a two stage inquiry. Do the instances of conduct in question: 

(a) Constitute "engaging in conduct" in terms of rule 2(2) of the Code, set out in paragraph 38, above?

(b) Relate to a transaction or event that is regulated by the Code, or are they incidental or preliminary to a transaction or event that is or is likely to be regulated by the Code?

[87]  Both limbs of the test are broadly drafted and the scope of the rule is wide.

[88]  The Panel considers the issuance of the revised profit outlook constitutes the "doing of an act" and therefore constitutes "engaging in conduct" in terms of rule 2(2) of the Code. The Panel considers that not disclosing the change in the application of the accounting treatment in the revised profit outlook and its effect constitutes "an omission to do an act" and therefore constitutes "engaging in conduct" in terms of rule 2(2) of the Code.

[89]  The revised profit outlook was announced soon after Marlborough Lines issued its takeover notice and the day before the offer opened. The Panel therefore considers that both the issuance of the revised profit outlook and the non-disclosure of the change in the application of the accounting treatment "relate" to Marlborough Lines' offer, a transaction that was regulated under the Code.

Issue 1: Was the issuance of the revised profit outlook misleading or deceptive?

Submissions from Horizon and Marlborough Lines

[90]  The Panel was assisted by submissions made on behalf of the parties by their legal advisers, given both in advance of the section 32 meeting and following its conclusion.

[91]  Mr Kós QC for Marlborough Lines submitted that there was no reasonable basis for the prediction in the revised profit outlook announcement that Horizon's after tax profit for the 2009 financial year would be $6 million.

[92]  Mr Kós queried where the "additional revenue... from increased electricity consumption over the relatively cold 2009 winter" came from.

[93]  Mr Kós noted that, in any case, by the time Horizon released the revised profit outlook it knew what additional revenue the cold winter had generated. Mr Kós noted that, despite that, neither the $401,000 projected for the cold winter increased revenue nor the $693,000 overall increase (cold winter plus increased fixed charge revenue plus additional connection income) seemed to be reflected in the other information released shortly afterwards including the independent adviser report and the six-monthly result. Mr Kós submitted that, on the basis of the same information, responsible directors would have doubted the basis for the management figures.

[94]  Mr Cooper argued that it was important to note from the outset that the revised profit outlook was an expression of opinion. Mr Cooper submitted that the revised profit outlook was Horizon's best estimate of its profit for the financial year ended 31 March 2010, but this was, of course, subject to any number of changing factors between 28 September 2009 and 31 March 2010. Mr Cooper submitted that outlooks and forecasts of this type were by their nature opinions as to future performance.

[95]  Mr Cooper referred to the 2009 decision of the Court of Appeal in Premium Real Estate v Stevens [2009] 1 NZLR 148 (which the Panel has applied in its determination of this issue).

[96]  Mr Cooper submitted that the leading case considering the application of the "misleading and deceptive" test to a revised profit guidance issued during a takeover offer was the decision of the Federal Court of Australia in Bell Resources Ltd v BHP (1986) ATPR 40 - 702. Bell Resources (and others) had made a takeover offer for BHP. During the offer period, the directors of BHP issued a forecast of profit for the current financial year. Bell Resources alleged that this was misleading.

[97]  Mr Cooper summarised the Court's main findings in the case, which include the following points:

  • The forecast was honest and reasonably based and therefore none of the representations was untrue;
  • A forecast should be realistic - not exaggerated optimism or deliberately conservative;
  • It is reasonable for the board of directors to accept the advice of the most senior and experienced executives in each of the company's operating divisions, even if they are aware that more junior staff may have divergent views;
  • In a case where shareholders have particular reason to be unsure of the long-term worth of their shares, there is a strong case - perhaps even a positive duty for the directors to issue a considered profit forecast.

Panel's consideration

[98]  The revised profit outlook was a statement of the Horizon directors' opinion at 28 September 2009 of Horizon's forecast profitability for the 2009/2010 financial year. To determine whether the issuance of the revised profit outlook was misleading or deceptive in contravention of the prohibition in rule 64, the Panel considered the following legal tests: 35 

(a) Was the opinion honestly held?

(b) Was the opinion reasonably based? and

(c) Was the opinion not demonstrably wrong?

[99]  The Panel considers that the evidence provided to the Panel supports the view that the directors of Horizon, at the time they authorised the release of the revised profit outlook announcement on 28 September 2009, honestly held the opinion that Horizon's forecast after tax profitability for the 2009/2010 financial year would be approximately $6 million.

[100]  The Panel considers that the evidence provided to the Panel clearly supports the directors of Horizon on 28 September 2009 having had a reasonable basis for holding the opinion that Horizon's after tax profitability would be approximately $6 million. The evidence provided to the Panel, both documentary and verbal, indicated that the directors of Horizon relied on detailed management forecasts that had been prepared following the indicative forecasts that had been presented to the 1 September 2009 Board meeting.

[101]  A material component of the increased profit forecast since August 2009 was the change in the application of the accounting treatment. PwC had confirmed in its letter to Horizon of 25 September 2009 that the change complied with NZ IFRS and was appropriate for Horizon's business. The Panel considers that there was nothing inherently misleading about the adoption of the change in accounting treatment and the directors' opinion of Horizon's increased profit was not demonstrably wrong.

[102]  The Panel determines under section 32(3)(a) of the Act that it is satisfied that Horizon and the directors of Horizon acted in compliance with rule 64 of the Code when issuing the revised profit outlook on 28 September 2009.

Issue 2: Was the non-disclosure of the change in the application of the accounting treatment misleading or deceptive?

Submissions by Horizon and Marlborough Lines

[103]  The Panel was assisted by submissions made on behalf of the parties by their legal advisers.

[104]  Mr Kós for Marlborough Lines submitted that the non-disclosure of the change in the application of the accounting treatment was misleading or deceptive. He noted that none of Horizon's communications to the market, to Marlborough Lines or to the Panel during the period under consideration, identified that the dominant source of the "cost savings" was a change in accounting policy which would not affect the long term earnings of the business. Mr Kós submitted, inter alia, that the policy change represented 30% of the increased net profit before tax, and that the implication of the statement was that the cost savings were a consequence of efficiency improvements, but, had their true nature been disclosed, the market would have been properly informed as to the fact that the associated effect on net profit after tax would not affect the underlying level of earnings or cash flow over time.

[105]  Mr Kós further submitted that the fact that the largest single component of the upgrade to forecast earnings in the revised profit outlook was due to an accounting change, rather than the implied efficiency gain, was material to interpreting the financial performance of the company and to the market perception of Horizon. He also argued that Marlborough Lines was harmed by this misleading information as understanding the true nature of the profits upgrade may have affected its response to the change in the profit guidance and the resultant failure of its bid.

[106]  Mr Cooper for Horizon argued that the non-disclosure of the change in the application of the accounting treatment was not misleading or deceptive. He argued that the revised profit outlook was not seeking to inform the market about every aspect of Horizon's likely financial performance for the year but only to update the previous statement about forecast net profit after tax, and therefore it did so in brief and simple terms. Mr Cooper noted that, as with the August profit announcement, it did not purport to give a breakdown of the figure.

[107]  Mr Cooper argued that Horizon shareholders were not aware of the detailed basis for the August forecast of $4.5 million and there was no need for them to be made aware of the detailed basis for the revised profit forecast in September. He submitted that there could be nothing misleading about announcing a revised forecast without detailed explanation of the revision in circumstances where the only previous forecast had also been given without detailed explanation.

Panel's consideration

[108]  The non-disclosure of the change in the application of the accounting treatment of the costs of internally constructed assets was an omission to do an act. The test to determine whether such omissions are misleading or deceptive in terms of rule 64 is as follows: 

(a) Would the hypothetical reasonable member of each target audience of the conduct reasonably expect the information to be disclosed to them?

(b) Was the information material to that reasonable audience member?

[109]  The target audiences of the revised profit outlook include:

(a) Unsophisticated investors, including retail shareholders in Horizon and the general investing public;

(b) Sophisticated investors, including institutional shareholders in Horizon such as EBET;

(c) The takeover suitor, Marlborough Lines;

(d) The independent adviser SCF; and

(e) Market commentators and analysts.

[110]  The documentary evidence provided to the Panel indicates that SCF was provided with detailed information about Horizon's business. This included not only the revised profit outlook but also management forecasts for at least the next five years and access to senior management. The Panel infers that SCF formed its views about the performance and value of Horizon with regard to all the information it received. The Panel considers that a competent expert adviser with access to that information would place little or no reliance on a brief market announcement when forming its own valuation opinions. The Panel considers that the reasonable expert in the shoes of SCF would have reasonably expected the change in the application of the accounting treatment to have been disclosed to it, but would not have relied on its disclosure (or its absence) in the revised profit outlook announcement.

[111]  However, neither Marlborough Lines, the classes of sophisticated and unsophisticated investors, nor any market commentator or analyst were provided with the detailed information about Horizon's business that was provided to SCF. Instead, their primary source of information about the profitability and value of Horizon was, prior to the release of the target company statement and independent adviser report, market announcements by the company itself.

[112]  Neither the revised profit outlook announcement, nor any other publicly available documents, explicitly disclosed the change in the application of the accounting treatment, which accounted for a material portion, some one third, of the uplift in forecast profit. Instead, the change in the application of the accounting treatment was indicated by Mr Tait to be subsumed under the wider heading of "cost savings".

[113]  The Panel considers that the revised profit outlook could reasonably have led the reasonable member of the target audiences identified in paragraph 109 (b) (EBET), (e) (market commentators) and potentially the more astute members of (a) to the erroneous belief that the "cost savings" referred to in the revised profit outlook announcement were wholly comprised of efficiency gains or spending reductions and therefore that the performance of Horizon's businesses had improved to the extent of those gains.

[114]  In fact, a material portion of the uplift resulted from a change in the application of an accounting treatment under which some of the costs of internally constructed assets were reclassified from overhead expenses to capital expenditure. Accordingly, the Panel considers that the reasonable member of target audiences (b), (e) and potentially (a) would have had a reasonable expectation that, in the circumstances of a takeover offer, the change in the application of the accounting treatment, and its effect on profitability, would be disclosed in the revised profit outlook announcement.

[115]  During the section 32 meeting Mr McDonald suggested that Horizon shareholders would have understood that a portion of the uplift in forecast profit would have resulted from the increased capitalisation of costs for internally constructed assets because shareholders had been told at earlier times that Horizon had acquired a contracting business to undertake capital works.36 The Panel disagrees. In the Panel's experience it is asking too much of a reasonable shareholder to have understood from those circumstances that Horizon had changed its application of an accounting treatment relating to the characterisation of costs for internally constructed assets.

[116]  The Panel considers that the effect of the change in the application of the accounting treatment was material. The reasons for the uplift in forecast profit could have had an influence on the reasonable Horizon shareholder's understanding of the reasons for Horizon's improved profitability. This could have had an influence on the reasonable investor's decision to buy or sell Horizon shares during the offer period. The change in the application of the accounting treatment comprised a material proportion of the uplift in forecast profit. Omitting to disclose that change and subsuming it under the heading of "cost savings" was likely to have led members of the target audiences identified in paragraph 109 (b), (e) and potentially (a) to the erroneous conclusion that the component of the uplift attributable to the change was attributable to efficiency gains and therefore improved performance in Horizon's businesses.

[117]  The Panel considers that Marlborough Lines' position is different from that of Horizon shareholders. The submissions made on behalf of Marlborough Lines to the Panel indicate that Marlborough Lines, an industry player, did not believe that the revised profit outlook was feasible on the basis of cost savings. Marlborough Lines had complained that the revised profit outlook was "unconvincing" and that its announcement on the day before the Marlborough Lines takeover offer opened was a defensive tactic by Horizon. Accordingly, the Panel considers Marlborough Lines did not form an erroneous assumption that the "cost savings" were wholly comprised of efficiency gains.

[118]  However, had Marlborough Lines known that a significant proportion of the uplift in profitability was due to a change in the application of an accounting treatment relating to internally constructed assets, it may have had a different understanding of the on-going profitability of Horizon. It was reasonable for Marlborough Lines, having issued a takeover notice, to have expected the omitted information to have been disclosed. That information was material to Marlborough Lines in the circumstances of its takeover offer.

[119]  The Panel determines under section 32(3)(b) of the Act that it is not satisfied that Horizon or the directors of Horizon acted in compliance with rule 64 of the Code by omitting to disclose the change in accounting treatment and its impact on Horizon's profitability in the revised profit outlook issued on 28 September 2009.

Issue 3: Directors' statement

[120]  The third issue is whether the directors of Horizon acted in compliance with rule 64 of the Code by stating in the target company statement in response to the partial offer by Marlborough Lines for Horizon that the valuation range of $3.96 to $4.68 per share did not reflect the full value of Horizon. This would turn on whether the directors of Horizon had a reasonable basis for their opinion as expressed in that statement.

Facts

[121]  SCF was the independent adviser for Marlborough Lines' offer. SCF's independent adviser report assessed a valuation range for Horizon of between $3.96 and $4.68 per share. The primary valuation methodology adopted was a DCF, based on the management forecasts provided by Horizon. As required by the Code, SCF's independent adviser report accompanied Horizon's target company statement which was released to the market on 13 October 2009.

[122]  The Code also required that the target company statement include a recommendation by the Horizon directors in relation to the Marlborough Lines offer. The Horizon directors unanimously recommended that shareholders reject the offer. A number of reasons were given, including, at paragraph 15.2(b) of the target company statement: 

"... The Directors assess that the Independent Adviser's valuation range does not adequately reflect the Board's view of the full value of Horizon..."

[123]  Paragraph 15.3(b) reiterates this view and expands on the reason:

"...Horizon Energy has re-developed its strategic plan in the last 12 months and is focused on growing the business over the next three to five years. Over the last year, Horizon has: 

 

(i) Reorganised and refocused its total business;

(ii) Completed key employee appointments across the business;

(iii) Expanded the existing range of services provided by its contracting services to include glove and barrier, technical services, refrigeration and data and security cabling services;

(iv) Been actively searching for value-adding acquisition opportunities in line with its stated strategy."

[124]  Following receipt of Marlborough Lines' request for a section 32 meeting, the Panel was given a copy of Cameron Partners' indicative "Valuation Notes". That indicative valuation contained figures for low, base and high case scenarios. The low case figure was marginally higher than the $3.96 per share low end of SCF's valuation. The high case figure was significantly higher than the $4.68 per share high end of SCF's valuation range. Overall the Panel considers that the Cameron Partners valuation range was materially higher than the SCF valuation range.

[125]  At the request of Horizon the value range included in the Cameron Partners valuation was not disclosed to Marlborough Lines and it is not disclosed in this determination. Horizon considers it is commercially sensitive and the Panel accepted that submission.

[126]  At the section 32 meeting the Panel heard evidence from Mr Toby King for Cameron Partners and from Messrs Tait and Anand about how the Cameron Partners report had been prepared.37 According to that evidence, Horizon management provided Cameron Partners with the same management forecasts and financial model that had been provided to SCF. Cameron Partners then used this model, adjusting the underlying assumptions as it considered appropriate.

Does the conduct fall within the scope of rule 64?

[127]  The Horizon directors' statement clearly falls within the scope of rule 64. The statement was made in the target company statement, a document that the Code required the Horizon directors to prepare in response to the Marlborough Lines offer.

Was the Directors' statement misleading or deceptive?

Submissions from Horizon and Marlborough Lines

[128]  Mr Kós submitted, inter alia, that the statement by the Horizon directors in the target company statement breached rule 64. He submitted that the independent adviser report overlooked no material information, having taken into account the revised profit outlook, all the new information on which it was based, the ODV/RAB valuation and other factors.

[129]  Mr Kós; also argued that the valuation methodology adopted in the independent adviser report was already generous despite the directors asserting that it was (to some extent at least) conservative. He submitted that the multiples used in the independent adviser report's capitalisation of earnings valuation of 8.5x to 9.5x were themselves already at the upper end of a reasonable range and the effect of favouring a discounted cash flow based result was that the multiples rose to 8.8x to 10.0x.

[130]  Mr Kós further argued that the directors' assessment disregarded market evidence. He noted that Horizon's share price had never reached $4.68, let alone higher. He submitted that any margin above the upper level of the independent adviser's valuation range for Horizon, $4.68, itself therefore represented an unrealistic premium to previous market prices and that any sensible director would have had to query the likelihood of such premia and values being achieved.

[131]  Mr Kós also submitted that any assessment of potential value should have taken into account the significant down-side regulatory risk faced by Horizon. He noted that the regulatory environment for lines businesses was currently in a state of flux with new regulations coming into force on 1 April 2010 but the exact effect of which was not yet known He submitted that there was a reasonable likelihood that Horizon would have to reduce its lines charges once those regulations came into force but that this risk was not factored into the valuations relied on by the Horizon directors.

[132]  Mr Cooper argued that the statement by the Horizon directors in the target company statement did not breach rule 64. He argued that Horizon's directors genuinely held the opinion stated in the target company statement that the SCF valuation range did not reflect the full value of Horizon. He submitted that the reasonableness of the Horizon directors' opinion was confirmed by expert advice provided to them by Cameron Partners. He submitted that the Horizon directors must be entitled to rely on that advice and it cannot be unreasonable to state an opinion as to value when that opinion is supported by qualified, independent, expert advice. He submitted that directors would be in an impossible position if they could not rely on such advice.

[133]  Mr Cooper argued that the "other factors" referred to in their statement in the target company statement were relevant to the directors' opinion of value and noted that Mr Tait's evidence confirmed this. He also noted that much of Marlborough Lines' submission on this point amounted to criticism of the independent adviser report, which was not relevant to the issues in the Panel's 9 March 2010 notice of meeting. He noted that Cameron Partners had had access to the full information that was given to SCF and conducted its valuation on the basis of that information, assessing a materially higher valuation.

Panel's consideration

[134]  The directors' statement was a statement of opinion. As noted above, the tests to determine whether the statement in the target company statement was misleading or deceptive in contravention of the prohibition in rule 64 are as follows: 

(a) Was the opinion honestly held?

(b) Was the opinion reasonably based? and

(c) Was the opinion not demonstrably wrong?

[135]  The Panel considers that the Horizon directors' opinion was honestly held. Messrs Tait and McDonald gave evidence on oath that indicated that the Horizon directors believed that the valuation range assessed by SCF did not adequately reflect the full value of Horizon. Horizon's management forecasts formed the basis for Cameron Partners' valuation. There was no evidence that Horizon's directors thought those management forecasts were unreasonable.

[136]  Although the conclusion is finely balanced, the Panel considers that the Horizon directors' opinion was reasonably based.

[137]  Messrs Tait and McDonald indicated in their evidence to the Panel that the directors' opinion was based on a number of factors, of which the Cameron Partners' valuation was only one.

[138]  The Panel has difficulty accepting that some of the factors quoted in the target company statement in support of that opinion could reasonably form the basis for the directors' opinion of Horizon's value. Those factors, for example "the reorganisation and refocusing of the total business" and "actively searching for value-adding acquisition opportunities" (paragraph 15.3(b)(i) and (iii) of the target company statement) were, the Panel considers, too insignificant to provide a reasonable basis for an opinion about the extent of Horizon's full value over and above that assessed by SCF in the independent adviser report. However, the Panel acknowledges that the directors were entitled to rely on advice provided by Horizon's strategic advisers, Cameron Partners, a reputable firm with competence in the relevant area of the electricity industry. Accordingly, the focus of the Panel's inquiry was on whether it was reasonable for the Horizon directors to base their opinion on the indicative valuation prepared by Cameron Partners.

[139]  During the hearing, the Panel, with the assistance of its independent expert Mr Gale, queried a number of the assumptions that had been adopted by Cameron Partners in its indicative valuation. This questioning indicated that differences of view could reasonably be taken on most key assumptions in the valuation, including in relation to the future impact of electricity industry regulation on lines businesses.

[140]  The Panel also heard evidence from Dr Hudson, an expert witness for Marlborough Lines. Dr Hudson commented in particular on the uncertain future regulatory environment for electricity lines companies until the Commerce Commission settles how it is going to administer its new regulatory processes.

[141]  The Panel considers that there was scope for differences between experts about the assumptions adopted by Cameron Partners in its indicative valuation. It follows that it was not unreasonable for the Horizon directors to rely on the resulting valuation as a basis for their opinion, provided, with their experience as directors of Horizon, they honestly believed the valuation to have been reasonable. It is apparent from the evidence that the Board believed that in Cameron Partners they had an independent adviser that had strong knowledge and experience in the electricity lines business, and that the Board was comfortable with the indicative valuation.

[142]  The Panel considers that the Horizon directors' opinion on Horizon's value was not demonstrably wrong. In the field of valuation, there may be a broad range of views amongst equally competent experts as to value.

[143]  The Panel determines under section 32(3)(a) of the Act that it is satisfied that the directors of Horizon acted in compliance with rule 64 of the Code in making the statement in the target company statement that "The Directors assess that the Independent Adviser's valuation range does not adequately reflect the Board's view of the full value of [Horizon]".

Panel determinations

[144]  The Panel determines as follows:

(a) The Panel determines under section 32(3)(a) of the Act that it is satisfied that Horizon and the directors of Horizon acted in compliance with rule 64 of the Code when issuing the revised profit outlook on 28 September 2009.

(b) The Panel determines under section 32(3)(b) of the Act that it is not satisfied that Horizon or the directors of Horizon acted in compliance with rule 64 of the Code by omitting to disclose the change in accounting treatment and its impact on Horizon's profitability in the revised profit outlook issued on 28 September 2009..

(c) The Panel determines under section 32(3)(a) of the Act that it is satisfied that the directors of Horizon acted in compliance with rule 64 of the Code in making the statement in the target company statement that "The Directors assess that the Independent Adviser's valuation range does not adequately reflect the Board's view of the full value of [Horizon]".

Panel comment

[145]  If the section 32 meeting had been held while the Marlborough Lines takeover offer for Horizon was still in progress, the Panel would have required Horizon to issue a correcting statement clarifying the quantum of the uplift in forecast profit announced in the revised profit outlook that was attributable to a change in the application of an accounting treatment.

[146]  One of the issues raised by Mr Kós in his submissions following the section 32 meeting was whether Cameron Partners' indicative valuation should have been included in Horizon's target company statement pursuant to clauses 18(5) and 24 of Schedule 2 of the Code. This issue was not included in the Marlborough Lines' request for a section 32 meeting because Marlborough Lines did not become aware of the existence of Cameron Partners' valuation until after the Panel's 9 March 2010 notice of the section 32 meeting had been sent out. The issue was not before the Panel at the section 32 meeting and the Panel makes no finding or determination on it.

Remedies

[147]  The Panel has made a determination under section 32(3)(b) of the Act that it is not satisfied as to compliance with the Code in relation to the non-disclosure in the revised profit outlook announcement of the change in the application of the accounting treatment. The Panel considers that the mischief arising from that breach of the Code is remedied by this determination which discloses that change. Given that Marlborough Lines' offer closed on 30 October 2009, the Panel has decided not to pursue any further remedies.

Costs

[148]  Under the Takeovers (Fees) Regulations 2001 the Panel may require payment to it of fees for work carried out by Panel members and staff and the costs of obtaining expert advice and assistance in relation to the section 32 meeting. The Panel has given guidance as to how it will apply those regulations in its Administrative Guidelines (3 November 2003). The Panel reserves its decision on the matter of fees and costs and will advise the parties in due course.

 

DATED at Auckland this 10th day of May 2010 

SIGNED for and on behalf of the Panel 

by the Chairperson

David Oliver Jones

 

Footnotes

  1.   Red Eagle Corporation Ltd v Richard Ellis [2010] NZSC 20, at paragraph [28].
  2.   Idem; Taco Company of Australia Inc v Taco Bell PTY Ltd (1982) 42 ALR 177, at 202 in relation to the public at large, the matter is to be considered by reference to all who come within the section "including the astute and the gullible, the intelligent and the not so intelligent...".
  3.   Idem Red Eagle; Goldsboro v Walker [1993] 1 NZLR 394 at 401.
  4.   Idem Red Eagle.
  5. Premium Real Estate Limited v Stevens [2009] 1 NZLR 148, at paragraph [54].
  6. Tait affidavit 18/3/10, para 16.
  7. Idem.
  8. Idem.
  9. NZ IAS 16, and Horizon's intercompany eliminations policy.
  10. Tait affidavit 18/3/10 para 17 and Horizon's intercompany elimination policy.
  11. Horizon's intercompany eliminations policy.
  12. Tait affidavit 18/3/10 para 17. Horizon's intercompany eliminations policy.
  13. Horizon's intercompany eliminations policy, McDonald Transcript pg 60 ln 9.
  14. Tait affidavit 18/3/10 para 19.
  15. Horizon's intercompany eliminations policy.
  16. Tait Transcript pg 26 ln 8 - 9.
  17. Tait affidavit 18/3/10 para 19.
  18. Tait 18/3/10 affidavit.
  19. Horizon intercompany eliminations policy. The elimination value is the amount designed to eliminate all intergroup "profits" and directly reduces the group profit by the same amount.
  20. Management report and Board Minutes 1 Sept 09.
  21. Board minutes 1 Sept 09. McDonald Transcript pg 69, ln 11.
  22. Tait affidavit 18/3/10 para 13 - 14.
  23. Anand Transcript, page 29 ln 16.
  24. Tait affidavit 18/3/10 para 24 - 27..
  25. Tait Transcript pg 27, ln 34. pg 32, ln 11. pg 32 ln 24. McDonald pg 60, ln 13.
  26. McDonald Transcript, pg 60 ln 5.
  27. McDonald Transcript, pg 60 ln 12, Tait pg 25, ln 33.
  28. Tait 18/3/10 para 18. Tait Transcript pg 26, ln 2.
  29. McDonald Transcript pg 61, ln 13. Tait pg 33, 18.
  30. Tait affidavit 18/3/10 para 27.
  31. Tait affidavit 18/3/10 para 28, 29. Horizon Board Minutes 27 Sept 10.
  32. ASM refers to the 6 August 2009 annual meeting of Horizon shareholders.
  33. Tait Transcript pg 45, ln 26.
  34. Tait Transcript pg 36, ln 28, pg 53, ln 23, pg 55, ln 18, McDonald Transcript Pg 66 ln 20.
  35. Premium Real Estate, op cit footnote 5.
  36. McDonald Transcript pg 72, ln 16.
  37. King Transcript pg 108, ln 1. Tait/Anand Transcript pg 88, ln 3 et seq.