Contact change is governance lesson
The cancellation of international geothermal investment plans by Contact Energy last week provided a number of lessons in governance.
But first some context. Back in February, Contact Energy shocked investors when they proposed spending $1b on global geothermal projects. This followed numerous assertions over several years that their shareholders would benefit from capital management and higher dividends.
Some $450m was wiped from Contact’s market capitalisation on the day of the announcement and the share price continued to sag in the subsequent weeks. Institutional investors engaged with Contact (and majority shareholder Origin) questioning the proposal. The business media also jumped on the band wagon.
In an about turn last week, Contact took off the table proposals to spend cash on global geothermal projects and instead delivered a 50 cent special dividend, enhanced dividend policy and a commitment to ongoing capital management. Several ticks, and a positive share price reaction.
Perhaps investors brought forward a review, or there were no worthy global geothermal projects or Contact’s largest shareholder, Origin Energy, wanted a large dividend. Whatever the driver, Contact’s share price has recovered somewhat and investors will receive a fully imputed, 50 cent special dividend.
We may never know why the about face, but there are many lessons. Not for the first time governance has galvanised investors in Contact Energy. But the lessons this time may be different.
Firstly, investors ascribe a lot of value to even brief comments made by companies. When these comments relate to spending decisions and are contrary to expectations, management and boards need to step back announcing intentions to the market. Contact had repeatedly told investors that when it completed major projects, specifically Te Mihi, capital expenditure would be rolled back and investors would see higher dividends and maybe even capital management (a euphemism for buy backs and special dividends).
In February the shock came in one sentence, a suggestion that Contact was looking at global geothermal projects. It was only a few words and it seemed an unlikely step, but in answers to questions the media latched onto speculation of a $1b investment tag which Contact did little to dampen down. Consequently investors took it as a potential risk where the rewards were poorly understood.
The first lesson is to avoid statements that increase uncertainty and, if the storyline is wrong, move quickly to get the right message across. Continuous disclosure has a lot to answer for if all it does is increase price volatility. Partial disclosure of a half thought out idea can destroy investor confidence. It may be a fine line, but one the investment industry and regulators should discuss.
Lesson two. Directors sometimes need to front up to investors. A key role of directors is to act in the interests of all shareholders, and as guardians of shareholder wealth. Institutional investors have long called (some might say howled) for a greater display of independence from Contact’s independent directors.
Contact’s CEO Dennis Barnes appears to have a long-term incentive plan aligned with shareholders so we assume the share price collapse was a wakeup call.
Furthermore, Origin Energy has an eyewatering debt profile associated with the large AP-LNG project in Queensland. Origin has also recently suffered a credit downgrade and trades on a lower credit rating than Contact, which in itself is a little unusual. We struggle to fathom why Origin would want Contact to spend $1b on fresh global geothermal projects no matter the potential economics. Origin would like the cash and said as much at a recent Sydney investment conference.
Lesson three, investors like clear investment hurdles.
For instance, say Contact had decided to proceed and invest offshore, perhaps alongside Origin, or on their own. How would we value such an investment? Without details it is probable that markets write-off a large portion of that capital until results became clear or the nature of the risks could be modelled. For any company there ought to be relevant hurdles to spending shareholder capital, and the hurdles should probably be higher to invest overseas in green fields. Sometimes companies like to hide behind the need to retain competitive information, but that shouldn’t be a defence for not outlining a financial strategy. Companies that recognise the need for projecting investment hurdles and milestones are generally rewarded by the equity market.
However, the recent episode with Contact Energy serves as an additional reminder of the value that investors place in good governance with clear and consistent communication.