INSIDER

There has to be more going on, and going wrong, at Sigma Pharmaceuticals than yesterday's update reveals. After three weeks suspended from trade to grapple with earnings guidance for the year to January 2010, the company has now clarified that looming balance sheet write-downs are the major issue. Before the update, the market was in the dark about where Sigma's problems lay.

Apparently investors can look forward to a balance sheet hit in four major areas, although the size of write-downs and provisions won't be finalised until next week. Goodwill will be slashed in response to market pressures in the generics business, provisions are required against inventory and for redundancies, while downward adjustments will be made to licence carrying values.

Given that Sigma's present goodwill balance is $960 million with an additional $200 million of trademarks and licence fees, there is scope for significant write-downs - about $500 million looks to be in the ballpark. The company has also flagged that a full-year dividend is unlikely, while bank covenants will require "revision and renegotiation".

Despite the balance sheet and banking mess, Sigma was hoping that the update could convey at least a little optimism, noting

that "the board and management are confident Sigma's operation and trading performance

remains sound".

However, these words ring hollow coming after a three-week information vacuum when the company wouldn't even confirm what aspects of the annual accounts were proving troublesome.

Raising further questions is the timing of the suspension, which seems unusual if goodwill carrying value is the major issue. A well-oiled financial team typically prepares the long-term projections needed for a goodwill review before year end, getting a nod of approval from the auditor before the stresses of the full audit process take hold.

If Sigma was facing challenges in obtaining auditor sign-off on goodwill valuations, this should have been evident by the end of January, weeks before the company raised the alarm on February 25.

Investors should not expect a soft landing when the company reports next week.

ON THE HEDGE

An Alternative Investment Survey recently released by Deutsche Bank tells the story of the $US1.5 trillion ($1.6 trillion) hedge fund industry, where illusory superiority - the cognitive condition that sees almost all of us identify as above-average drivers - is as common as it is among Swedish car owners.

It seems that hedge fund investors start each day brimming with confidence in their own ability to pick winners. Indeed, when asked how they thought their investments would perform in the current year, more than 50 per cent of the 780 investors surveyed thought that they would generate returns of more than 10 per cent. However, only 15 per cent of the same group predicted that the hedge fund industry, as a whole, would generate returns at this level.

High levels of self-confidence look to be driving a resurgence in funds allocated to hedge funds - Deutsche estimates that the sector will receive $US221 billion of inflows this year. This is an impressive turnaround for an industry that over just three years has weathered the subprime meltdown, the Lehman collapse and the Madoff fraud.

It seems that additional funds flowing into the hedge fund sector are gravitating towards managers running strategies based around global macro changes as well as long-short equity strategies. Also popular in the present environment are distressed investment funds, while event-driven strategies, which focus on trading opportunities thrown up from corporate takeovers, are also popular as acquisition activity is expected to pick up in coming months.

The least popular hedge fund categories this year are cash and volatility arbitrage.

FEE FOR ALL

The judgment against JPMorgan in its dispute over a $50 million takeover defence fee owed by Consolidated Minerals will make headlines for a day or two, but should not have significant ramifications for the investment banking industry.

The circumstances of the Consolidated Minerals takeover were exceptional, coinciding with a strong run-up in the price of manganese that made the company an increasingly attractive acquisition target. As a result, the successful takeover offer from Palmary was more than double the price of the first bid received from Brian Gilbertson's Pallinghurst Resources.

As a result of the spirited bidding, the (quite standard) defence fee structure agreed to by Consolidated Minerals would ordinarily see the investment banking advisers receive a healthy percentage of the increase between the value of the first takeover offer received and the final successful bid. JPMorgan stood to receive a supersized fee - if only the drafting of their letter of appointment had been watertight.

However, Justice David Hammerschlag has seized upon the slightest of ambiguities in the appointment letter, allowing him to ignore the natural reading of the agreement and to instead calculate the "incentive fee" with reference to the uplift between Palmary's first offer and the final offer, rather than the difference between Pallinghurst's first offer and Palmary's final bid.

The difference between the two approaches makes a difference

of about $30 million to the JPMorgan fee.

There is no doubt that the judgment will see internal lawyers at investment banks scrambling to take refresher courses in the drafting of fee clauses, but there will be no additional impact on the economics of the takeover defence advisory business.

dsymons@fairfaxmedia.com.au