Arrow Energy shareholders probably wouldn’t have been able to believe their luck when Royal Dutch-Shell and PetroChina lobbed a $3.5 billion takeover offer in March. The generous deal was been pitched at a 17% premium to Arrow’s value, according to the Independent Expert and represented a 35% premium to Arrow’s prevailing share price (of $3.48) before the announcement. Under the takeover, Arrow shareholders will receive $4.70 per share in cash, as well as shares in a new spin-off called Dart, which would own Arrow’s (mostly Asian) coal-seam gas assets.

The deal isn’t bad for Arrow shareholders, especially considering Arrow shares were trading at 60 cents in late 2006 (it listed on the ASX in 2000 for 20 cents a share with less than five employees). Admittedly, Arrow (like Origin Energy) has been the beneficiary of investor demand in previously unloved alternative and clean(er) energy sources in recent years.

Given that the generous offer most likely had little to do with Arrow’s management and very much to do with market conditions (and that ever looming and pesky issue of peak oil) shareholders would have been forgiven for thinking that they deserved the bulk of the riches flowing from such a bid. However, such a view would ignore the substantial influence that executives have in ensuring that they are very well remunerated for their sterling efforts in generating shareholder wealth. Or in the case of Arrow’s management, for being in the right place at the very right time.

Anyone for options?

Under the demerger proposal, the directors of Dart Energy will be receiving 13 million options in the spun-off company — this works out to a substantial 3.5% of the entity’s issued capital. The new chairman of Dart (and present CEO of Arrow) Nick Davies will collect 1.25 million options, Dart’s CEO-elect Simon Potter will be handed 3.65 million options while Arrow executive directors, haun Scott and Stephen Bizzell will be given 2.25 million options. The terms of the gifted options aren’t exactly onerous — the strike prices will be a mere 25% premium to the Dart’s VWAP after its first five trading days, with a third of the options vesting in only one year.

To make matters worse, it’s not as if the directors were struggling to begin with — Davies’ payout from the cash takeover will be worth more than $25 million while the 41-year old Bizzell’s payday will be almost $18 million (Bizzell also sold tens of millions of dollars of Arrow shares since the company’s 2009 annual report).

But that is certainly not the end of it.

Golden handshakes all round

Not only were Arrow bosses handed millions of options in  Dart Energy, but Arrow’s Scheme Booklet also notes that Davies will receive a “termination payment” of $1.15 million, Scott will get $699,393 and Bizzell $618,750. On top of that, the Arrow troika are also collecting retention payments should they be employed by Dart (this is on top of their termination payments and options granted). Davies is in line for retention payments of $512,500 while Scott will collect more than $312,000 if he graciously agrees to provide his services to Dart. (Davies will also receive $100,000 per month from Arrow for providing “transitional services”, Scott will collect $62,500 and Bizzell $60,000 per month).

In addition to all that, the Scheme Booklet also notes that Davies and Scott will also receive $US1,065,000 if the “Acquisition Scheme is implemented in respect of an incentive payment due from Arrow pursuant to pre-existing contractual entitlement”.

Just in case the Arrow directors weren’t being paid enough, the company just showed how generous it could be when it came to canceling options held by directors and employees.

Buried deep in the scheme documents it is revealed that Shell and PetroChina will (effectively) be paying $26.2 million for the “settlement and cancellation of Arrow’s share options”. The demerger booklet notes in the fine print that “the Cancellation Consideration was determined by deducting the exercise price for each Arrow option from $5.87”. The only thing is, Arrow shares are trading at about $4.85 (this is because investors seem to be valuing Dart at about 30 cents per share). Under the options payout figure derived by Arrow, Dart is allegedly worth a lofty $2.34 per share — an impressive number for a company that has no prospect of cash flow for years and that has been value by the market at about 1/8th of that amount.

Arrow’s Demerger Booklet claims that directors came up with their generous valuation after:

An assessment of the potential value of Dart Energy Shares … taking into account various research analyst valuations of Dart International’s assets, the value implied for Dart International by the initial Shell transaction, indicative valuations provided by investment banks in connection with the consideration of a possible initial public offering of Dart International and Arrow management’s internal DCF valuation of the Dart International’s assets, the New South Wales farm-in rights and the shareholdings in Apollo, LNG Limited and Bow;

The fact that Arrow directors personally benefit from the high valuation would no doubt have been a fortunate coincidence.

Some might suggest that Arrow directors such as Davies and Scott played a conflicted role in negotiating their own termination payments, while at the same time, negotiating the value being received by Arrow shareholders. Presumably, the more cash the executive directors received, the less shareholders would get. But that would be a cynical view.

Adam Schwab is the author of Pigs at the Trough: Lessons from Australia’s Decade of Corporate Greed, available from most bookshops and online at Booktopia.

Peter Fray

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