Taking Stock 25 April 2024

NEW ZEALAND’S balance sheet, and that of our councils, have been so damaged by the responses to Covid, and I would argue by incompetent leadership, that there must now be a risk of quick-fix solutions.

Selling off the commercial assets of councils and government is a standard quick-fix response.

That has been illustrated by local government, recently.

Auckland’s council sold some of its Auckland Airport shares. Wellington’s council, or at least some of them, want to sell down its airport shares.

Christchurch’s council considered selling down the holding company that has shares in several public assets, including its airport and lines company.

Of course, former foreign exchange trader and Prime Minister Key sold down electricity company shares in 2012, and David Lange’s government sold a number of Crown assets.

Asset sales are a conventional way of addressing excessive debt and are commonly a response of a new government happy to emphasise the failings of its predecessors that caused the excessive debt.

If this strategy is being discussed I do hope our current thought leaders have a memory and are observing the outcome of the British decision 20 years ago to allow key national assets to be sold.

At that time Britain agreed to a £5.1 billion sale of Thames Water (TW) to the Australian fund manager/investment bank, Macquarie. The Australian company borrowed 2.8 billion to pay for TW and funded the remainder with its investors’ money.

Ofwat, Britain’s water regulator, was supposed to manage the behaviour of Macquarie, as the new owner of Britain’s biggest water supplier.

One of Ofwat’s conditions was that the Macquarie debt (£2.8b) was to be ring-fenced within Macquarie and was not be transferred into TW, which would have left the debt to be repaid by profits from the water-selling prices – that is, repaid by water consumers.

Hmmm.

This is a long story. Bear with me.

The US investment giant Goldman Sachs is often referred to as a giant squid, sucking up other people’s money through its giant tentacles.

Macquarie is the Australian equivalent, variously referred to as the octopus that sucks up so much of other people’s money that it can grossly over-reward mediocre executives, leading to its nickname of “the millionaire’s factory”. Thousands of such mediocre past and present executives now live like earls.

The Thames Water saga supports Macquarie’s sobriquet.

Most New Zealander’s will know Macquarie as the investment bank here which, for example, won a few million from Key’s privatisation of the electricity firms. It was paid millions to help with one of the three sales.

Some New Zealand investors might also be familiar with its private wealth managers, who largely promoted all the various Macquarie pods around the world – “Macquarie airports”, “Macquarie toll roads”, “Macquarie sewerage plants” etc.

I hope some will recall the Macquarie fund that raised $96 million in New Zealand for a tiny (1%) holding in Thames Water, that the fund bought from Macquarie. This atrocity should be remembered. It was an issue that favoured Macquarie and Christchurch asset trader George Kerr.

Marketed as EPIC (Equity Partners Investments), fronted by Kerr (Pyne Gould Guiness), EPIC promised to pay 9.1% in annual interest.

In addition, Kerr promoted the possibility of capital gains through his management focus on “responsible and sustainable growth allied with the financial expertise of the Macquarie Group”.

The $1 shares in EPIC were all sold, and for a brief period of a year or two, the fund produced income at 9.1% as promised.

It then faltered. The shares collapsed to a value of around 10c, at which point Kerr/PGC sought to buy out the shareholders for 30 cents each.

The bid failed. 

A bright New Zealand business leader found a British buyer who would pay twice as much. That bid succeeded. The new buyer soon repaired the company, increasing its value to well above the EPIC list price.

Kerr had not only promoted the original EPIC issue. He also owned the management rights through EPAM (Equity Partners Asset Management) to manage EPIC’s assets, a task that was richly rewarded and appeared to have demanded very little time or skill.

Before TW’s value headed south Kerr sold EPAM to PGC, in which he was a major shareholder, for $18 million; a nice reward, one might say. PGC shareholders had little to celebrate. There is little evidence that indicates PGC has been advantaged by this $18m deal.

Investors in EPIC were furious with the outcome. They had lost at least a third of their capital and had received very little interest.

A meeting in the Pulman Hotel in Auckland in around 2012 was run by a Macquarie buffoon who came over from Australia to tell the group of seething EPIC shareholders that they were privileged to be working with the “world-class advisers” in Macquarie.

Someone stood up and told him that if he had vomited on the stage the audience would be less disgusted by his presentation.

I know this to be true. I know well the fellow who spoke out.

So New Zealanders were well and truly rorted by EPIC and EPAM.

The only comforting news is that the Macquarie buffoon was soon after released by Macquarie to ply his skills elsewhere.

Meanwhile, Macquarie was destroying Thames Water in London. It had funded its £5.1 billion purchase with investor money and the £2.8 billion loan.

It soon transferred the loan to TW, so that consumers of TW services were required to service that loan, a loan that did not exist before Macquarie arrived to buy Britain’s biggest water supplier.

Macquarie then extracted far more than £1 billion in dividends, effectively funded by debt.

Water prices rose beyond belief and now need to rise dramatically again as Thames Water (not Macquarie) is heading for liquidation, previously fined a record-breaking £20 million for pouring untreated sewage into the Thames and other rivers. (The company provided water AND sewerage systems.)

The regulator Ofwat did nothing when Macquarie transferred the debt into TW, breaching the specific conditions of the purchase.

When the company was dragged into court the judge noted that “there had been inadequate investment, diabolical maintenance, and poor management”. He added that these failings were “borderline deliberate”.

Thames Water serves 8 million water consumers. A further 13 million use its sewerage treatment.

These people today must pay the cost of the new debt, the fines, the vulgar dividends extracted, and the “borderline deliberate” under-investment. New owners will raise prices, of course. Consumers will pay even higher prices.

Macquarie had sold out (in 2017), having had an abundant return on its foray into UK water and sewerage ownership. Its return had been between “15 and 19%” per annum.

There are many lessons in this ugly recount of the UK attempt to sell assets to fix up balance sheets.

A cynic might start with the issue of which investor you allow to buy the asset. In my parlance, Macquarie would be a “never again” in Britain.

Others might focus on the regulatory failure to oversee the conditions of the sale.

Others might ponder the stripping of dividends paid for by debt and might recall the NZ era of Brierley.

My view is that there are many conflicts in the debate of fixing a bad government balance sheet by selling essential assets.

Any selling certainly must be done well and should be guided by non-conflicted private sector people, perhaps in conjunction with any good people in Treasury.

Some of the process might take heed of these thoughts: -

1. Any sale must be managed well. A bad sale (like NZ Steel, sold to Equiticorp, BNZ part sold to Brierley Fay Richwhite, NZ Rail to Fay Richwhite) would be worse than no sale at all.

2. The regulators must be empowered to control the new owners. In Britain a handy condition of the sale might have included the clause that the Crown could REPOSSESS the asset if the new owner breached its promises (as Macquarie did).

3. The new buyer must be subjected to due diligence enquiries by competent people. Thankfully Brierley, Equiticorp, and Fay Richwhite are not contenders. The buyer should comprise fit and proper people. Never let an asset fall into the hands of incompetent people, who “borderline deliberately” create illusory profits by slashing costs and degrading proper processes, enabling absurd dividends.

A real cynic might add that New Zealand should be careful about welcoming in all the rich, bonus-fed, overseas investment bankers whose flight from their home base often leads them to the South Pacific, where they reinvent history, and walk around in blue suede shoes pretending commercial skills not demonstrated by their career achievements.

The Thames Water saga should be included in the curriculum of every commerce facility at our academic facilities and recounted to every apprentice in the financial markets.

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CLEARLY, there is a gap between what the overseas investors think about New Zealand’s interest rates and what our financial commentators are opining.

In recent days New Zealand’s 10-year Government Stock rate has risen from around 4.45% to 4.93%, signalling that if foreign investors are going to fund our fiscal deficits and our planned infrastructural spending, they want more return.

This may reflect their view of the trajectory of our currency’s price.

Foreign investors who observe fiscal deficits and a need for funds to repair infrastructure, and to address weather-related damage, will see risk, and will demand more return to recognise that risk.

If they are also observing consistent, current account deficits (importing more than we export), they will want even more return for risk. They will fear currency devaluation.

Their strength will be the certainty that we need the savings of other countries, but those savers do not need us.

Eight years ago they would listen to the presentations of the likes of Bill English and our best financial market leaders.

Foreign investors approved of our financial management and our plans.

Those attitudes have reversed in recent years, coinciding with the degradation of our country’s balance sheet.

Our investors can choose for themselves whether the cause of the degradation was Covid or poor management of the economy.

Whatever the cause, foreign savings are not favouring NZ.

The last government stock tender was 62% funded by New Zealand-based investors and did not attract surplus enthusiasm.

Not many years ago our tenders were well over-subscribed because of foreign investors.

From all of this I infer that the chance of significantly lower interest rates in the next year or two must be low, in contrast to recent reports from various brokers forecasting imminent rate falls.

Perhaps the OCR might fall a little, but of more interest will be the long-term bond rates, whose pricing discloses the view of overseas investors.

Long-term corporate bond rates must be at a nice premium over long-term government stock rates.

Those real estate people currently forecasting a large drop in mortgage rates may be displaying extreme optimism.

I expect bank funding rates, and bond rates, to fall slowly and only incrementally.

Our sharemarkets may not like sticky inflation and high interest rates, at a time of falling household disposable income, rising unemployment and a likely prolonged recession.

Especially, those, like Ryman, and Synlait Milk, which will surely raise capital in the near future, may find the pricing of capital is not likely to favour the issuer.

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Travel

Our advisors will be in the following locations on the dates below:

1 May (pm) – Ashburton – Chris Lee

2 May – Timaru - Chris Lee

3 May (am) – Timaru – Chris Lee

6 May – Cromwell – Chris Lee

7 May – Cromwell – Chris Lee

15 May - Auckland (Ellerslie) – Edward Lee

16 May – Auckland (Albany) – Edward Lee

17 May – Auckland (CBD) – Edward Lee

27 May (am) – Christchurch - Fraser Hunter

28 May – Christchurch – Chris Lee

29 May (am) – Christchurch – Chris Lee

Seminars

Chris Lee will be holding a small number of investment seminars in May.

He will be discussing the economy – how to read the signals and avoid disasters – along with a presentation on a proposed gold mine in Bendigo, Central Otago, including the history of gold mining in the area and its plans for the future.

Location: Cromwell

Date: Monday May 6

Time: 7.15pm

Venue: Harvest Hotel

Location: Auckland

Date: Friday May 10

Time: 2.00pm

Venue: Milford Cruising Club

Location: Paraparaumu

Date: Monday May 20

Time: 11am

Venue: Southwards Car Museum

Location: Christchurch

Date: Monday May 27

Time: 1.30pm

Venue: Burnside Bowling Club

Reservations are required and can be made by emailing seminar@chrislee.co.nz or phoning 042961023.

Chris Lee

Chris Lee & Partners Limited