The €66 million payout to past and present workers that will follow Eircom's return to the stock market next week appears to vindicate their decision to back the takeover of the company by Valentia Telecommunications in 2001, writes John McManus

The support of the Eircom Employee Share Ownership Trust (ESOT) was critical. Neither of the two rival bids from Valentia and Mr Denis O'Brien's eIsland could succeed without the ESOT pledging the 15 per cent stake in the company it got in 1998 to ease the path to the original 1999 flotation.

As a result, the chairman of the ESOT, Mr Con Scanlon, found himself in the unlikely role of kingmaker. A full-time Eircom employee on secondment to the Communications Workers Union - of which he was general secretary - Mr Scanlon threw his weight behind the €3 billion bid from Valentia, led by Sir Anthony O'Reilly.

As revealed in the Eircom prospectus published last week, it has proved a very rewarding option for Mr Scanlon - personally as well as for the ESOT.

As part of the deal struck with Valentia, the ESOT doubled its stake in Eircom to just under 30 per cent and got two seats on the board. One of them was the deputy chairmanship, which Mr Scanlon took on.

According to the prospectus, Mr Scanlon earns around €106,000 a year in this role, which is similar to the salary he draws as a full-time trade union official.

The document also shows that last year Mr Scanlon had to resign from Eircom to "ensure a formal separation between his position as an employee and his duties as chairman of the ESOT". In return, he got a pension worth €1 million over 10 years and a lump sum of €230,000. He is also getting free shares worth more than €600,000.

Mr Scanlon and the ESOT board were faced with a difficult decision in mid-2001. There were two offers on the table that differed only marginally in price, with eIsland bidding slightly more - €1.3354 per share - than Valentia's €1.335.

The first problem for the ESOT was that, if it just took the cash, it lost its influence over the company and faced a tax bill. As a result, both bidders were offering the ESOT the chance to stay on board and reinvest in the company, increasing its stake to 30 per cent, with appropriate board representation.

This in itself was not enough to solve the problem because the proposed deals were highly leveraged and involved the backers putting up around one-third of the purchase price of roughly €3 billion. The ESOT share of this would only come to around €200 million, meaning that it still had some €250 million in change left over from the sale of its original stake.

Valentia proposed that the ESOT invest this in the company by way of preference shares that would form part of the underlying equity and required the ESOT to join the Valentia consortium.

The eIsland proposal was more complex. The ESOT could receive the balance in loan notes - which were exchangeable for preference shares - but they did not form part of the equity of the takeover vehicle. As a result, the notes could be passed on to the members immediately.

E-Island calculated that the members could receive a €15,000 tax-free takeover bonus, although the exact size of the figure was disputed.

There was no cash payment under the Valentia deal, but the ESOT opted for it, saying it stacked up for fiduciary reasons, including its financial structure and the make-up of the consortium.

The two offers were put to the members in the vote and the Valentia offer - in which the ESOT was a participant - was backed by more than 90 per cent after receiving the support of the Communications Workers Union.

It only emerged in recent months that the ESOT was only able to back the Valentia deal and join the consortium because it had an undertaking from the Minister for Finance, Mr McCreevy, to introduce legislation that would allow the ESOT to hold preference shares under the same attractive tax terms as it held ordinary shares.

Without this undertaking, the ESOT would have been in breach of its fiduciary responsibilities.

Sources close to the former eIsland consortium are claiming privately that had they been made aware of this, they might have changed their bid, but the issue is essentially historical.

Although there was no pay-out to ESOT members under the Valentia deal, they still shared €133 million - the maximum that could be paid tax-free - in 2002 when the ESOT passed on the shares it received in Vodafone as a result of its purchase of Eircell.

In 2003, ESOT members only shared €66 million - half the maximum possible payment - as the ESOT marshalled its resources to position itself to participate in the refinancing of the group in late 2003 and enhance its influence in the coming flotation. This year, members are in line to get €133 million, the first €66 million of which will be paid post-IPO.

It is worth noting that, if the ESOT had gone with the e-Island offer, it could have, in theory, paid out the maximum in all three years, retained half of the Vodafone shares and still have 30 per cent of the company.

The average ESOT member would have received an additional €6,500 and be in line for more Vodafone shares.

It is a point that is not lost on some members, who question the wisdom of continued reinvestment and point out that they have not been formally asked by the trustees as to what they want to happen. Many would prefer to have received more money up front, even if it involved a tax liability.

Following the IPO, the ESOT's stake in the company will be worth around €360 million. In theory, it could pass these shares on within two years in a tax-efficient manner and wind itself up, although it has until 2014 to actually do so.

A quick exit is unlikely as the objectives of the ESOT include exerting collective influence on behalf of its members - and its actions to date indicate that it gives this a high priority. As its stake in the company falls so will its influence.

Provided its stake remains above 18 per cent, it can nominate three directors, one of whom is the vice-chairman.

This will fall to two directors (including the vice-chairman) if the stake slips to between 18 and 10 per cent. If the stake goes below 10 per cent, Mr Scanlon will lose his €105,000 a year job, as the ESOT can nominate one director only, provided it has more than 1 per cent.

Serious Money, page 10