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This emailed client newsletter is confidential and is sent only to those clients who have requested it. In requesting it, you have accepted that it will not be reproduced in part, or in total, without the expressed permission of Chris Lee & Partners Ltd. The email, as a client newsletter, has some legal privileges because it is a client newsletter.
 
Any member of the media receiving this newsletter is agreeing to the specific terms of it, that is not to copy, publish or distribute these pages or the content of it, without permission from the copyright owner. This work is Copyright © 2010 by Chris Lee & Partners Ltd. To enquire about copyright clearances contact: copyrightclearance@chrislee.co.nz

TAKING STOCK 30 March 2017
 
The Fletcher Building mis-announcements just two months ago, now corrected by a statement that additional undiscovered losses of $100 – 150m will affect their annual result, leaves investors with three obvious hanging questions.
 
1. Will the governance failure of a major NZ company be the tipping point that changes foreign investment allocations to New Zealand?
2. Will the new losses remove the favoured status with governments and councils that Fletchers has enjoyed for decades?
3. Will the losses simply reflect the age old wisdom, that in boom times the mindless chase for rivers of gold inevitably ends in disaster, as greed and human stupidity lose touch with good standards?
 
I guess the good news is that the best informed investment bankers in NZ are reasonably confident that Fletcher Building’s crass errors will not greatly change foreign investment attitudes to New Zealand.
 
Foreign investors know that the construction industry is cyclical; they have long reckoned for decades that Fletcher Building has rested on poorly constructed piles, and they know that their reason to allocate funds generously to New Zealand is not motivated by respect for our construction sector, or even our manufacturing sector.
 
I am told that foreign investors, so essential to our living standards, will continue to allocate capital to New Zealand.
 
They may sell their FBU shares, they may even buy them back if the price keeps falling, but their confidence in NZ has little to do with a company that any old-timer will tell you has been one of our worst managed companies, for at least two decades.
 
Will the failure of Fletcher Building to monitor progress on its contracts accurately affect its favoured status with national and local politicians?
 
Even this seems an unlikely outcome, given the weakness of our other contracting companies, themselves with poorly-chosen directors.
 
We have seen the worst of them, Mainzeal, survive for years against all odds, dreadfully governed, majority owned by a paper tiger with no teeth (ie hopelessly inadequate wealth).  Mainzeal collapsed two years ago, in boom times, owing hundreds of millions.
 
Mainzeal’s chairman, Jenny Shipley, is the least credible chairman of any construction company that I have observed in my career.  Nor would Paul Collins be on any board that I selected.
 
The construction industry is failing in boom times.
 
In boom times, there is always enormous pressure to complete projects in time and within budget.
 
While all these underlying very real challenges were simmering, you had directors and executives chasing the headline deals, seeking personal glory, bonuses or just shareholder satisfaction.
 
Contracts that were clearly beyond their physical capacity, which I define as access to capital, skilled management, trained labour and materials, were often chased unwisely by companies  in effect diving headfirst into a river, apparently in pursuit of gold or aiming to protect their patch.
 
I doubt that Fletchers would be building the Sky City Convention Centre for example, had there been no motivation, other than profit.
 
It is conceivable that Fletchers bid for this contract because there was the threat of a new international contractor agreeing to a deal the Crown was promoting.  The Chinese are an intimidating potential competitor.
 
New entrants might develop long term government relationships and might set their glass, cement, steel, aggregate and timber at prices that might jolt New Zealand into a rebellion against the absurd prices we allow Fletchers and Carters to charge.
 
Perhaps Fletchers accepted the risk of the Sky City contract, hoping the margin within the materials might offset the risk.
 
I now believe that Fletchers will lose $80 million or more on this Sky contract.
 
I believe a slightly smaller loss will arise from the Justice Precinct that Fletchers is building in Christchurch.
 
Some of the losses may be nailed home to the interminable delays that occur in boom times, in areas like bureaucracy, compliance and consents.
 
Fletchers might have tendered when steel prices were at their lows, but might only now be buying at today’s prices, nearly 50% higher than they were just a few months ago.
 
Delays have other costs.
 
Boom times always must breed interminable delays.
 
Governance is always a problem in New Zealand.
 
In the words of our leading bankers, most listed companies accept inferior directors not to save money but simply because we have so few skilled directors.
 
We accept hand-me-down executives and directors who have failed in Britain, the USA or Australia.  Our media often give credibility to newcomers with very modest credentials.
 
Muppets abound.  Shareholders rarely are well informed when they vote for directors.
 
There are several logical causes of the toxicity in the construction sector.
 
Among them are:
 
- Shortage of skilled labour
- Shortage of experienced quantity surveyors
- Short cuts in management training, labour skill development and succession planning
- Poor supervision, made poorer by government cost-cutting in the areas of supervision (think Pike River Coal)
- Dreadful governance (think Mainzeal, perhaps just one example)
- Short termism, a New Zealand disease (indeed an epidemic illness)
 
During periods of boom, greed and vanity prevail.
 
Fletchers Building were awarded by the National Government a role to supervise the rebuilding of houses in Christchurch.
 
For an over-riding 2.5% clip of the ticket on every building contract, FBU was granted control, enabling it to pass on to chosen sub-contractors the work in restoring or rebuilding tens of thousands of homes.
 
Might you imagine those lucky sub-contractors might have decided where they buy their building materials?
 
Do you imagine they may have accepted Fletchers utterly-absurd dictate that it pays its creditors six maybe nine, months after receiving a bill?  (What happened to the 20th of the next month?)
 
Do you imagine that those estimating the costs of restoration were efficient and accurate in most, or all, instances?  Were shortcuts occurring every day?
 
So to summarise, New Zealand faced an urgent, massive rebuild requiring a depth of skilled labour that did not exist here.
 
Certainly we could import labour from Ireland, the Philippines, and maybe Spain and we could train Pacific Islanders seeking the sort of salaries not available in their homeland.
 
The demand for labour and experienced skilled people far, far exceeded supply.
 
Mistakes on a huge scale were inevitable.  Mistakes and shortcuts cost money.  Problems do not always surface until later and are then harder to repair.
 
Think of a road built on unidentified peat.
 
We have seen Hawkins, barely a tenth the size of Fletcher Building, also weakly governed, bumble its way through a boom only to fall prey to Downers, itself often under threat in the past because of tendering errors and naivety, most notably with an Australian railway contract.
 
Downers, to its credit, has retained enough capital market support, to survive, and to be able to buy out Hawkins (and spend a billion on Spotless, in Australia).
 
Given that these developments have happened in boom times, the outcome of earthquake recovery and immigration led growth, one must ask whether boom times – great demand for construction services – produces boom profits or boom and bust cycles.
 
This question – of what follows booms times – leads to a couple of subjects well worth discussing.
 
 _ _ _ _ _ _ _ _ _ _ _ _
 
 
The first discussion is the inevitability, in New Zealand, of failures during boom times, such as we are now observing.
 
Most would describe boom times as the period when a great number of projects must be completed, meaning the building companies have an ample forward book of projects.
 
Fletcher Building is currently loaded with future projects, to an amount around $3 billion.
 
You might surmise that a margin of just a few per cent would produce hundreds of millions of surplus, yet we are told that construction contributes only a modest (tens of millions) sum to Fletcher’s $600-700m of profit.
 
In the case of FBU there is at least as much again in the margin generated by the company’s dominant position in building material, enabling it to obtain margins that in most developed countries would be seen as extortionate.
 
I well recall a regional manager for Fletchers, of a previous decade, explaining how he would ration products to his clients based on their value as a client, price never being debated, because supply was controlled.
 
Fletchers, like Todds, made much of their family wealth through import licensing, a politically-controlled process that maybe, just maybe, involved political patronage.
 
During a boom time you would imagine Fletchers would make profits from all its contracts, from its absurd building material margins, and from its privileged positon with any National government.
 
Boom times, however, breed shortcuts and eventually are toxic, at least in New Zealand.
 
What will the outcome be when, in an era of growing executive greed, you have poor governance, a shortage of skill, a huge shortage of trained labour and a duopoly controlling the prices of materials?  And executive bonuses.
 
Put it another way.
 
If you were wanting to have your home built beautifully, would you want to be building during a boom, or at a time when the industry was starving of good projects.
 
In recent days there have been various commentators pondering the likelihood of new international companies arriving here, with bigger and better gear, more capital, more experience and higher standards.
 
Those commentators have not been paying attention.
 
The huge European company (French-based) Vinci arrived five years ago and bought 55% of the 40 year old Christchurch contractor March Construction, a specialist drainage contractor but also a company with expertise in demolition, piling, road construction and earthmoving.
 
Vinci is a colossus, tens of times the size of Fletcher Building.  It owns in Europe airports, toll roads, bridges and pipelines.  Its revenues are in tens of billions, in some years.
 
Recently it exercised its option to take 100% of March Construction.
 
It has gear and capital that no New Zealand company can match.
 
Its subsidiary, Heb, has won a major role in the Transmission Gully project.
 
We should welcome Vinci’s arrival but it would be an even greater help if a building materials supplier of similarly immense size, arrived here to offer materials at international prices.
 
If boom times were to produce this result – much lower costs of materials – then all the disasters that occur during boom times might be offset by a long-term benefit.
 
The summary we do now have to accept is that Mainzeal, moronically governed, went broke in boom times, owing creditors more than a hundred million.  Its directors face litigation.
 
Hawkins is having to merge with Downers.
 
Fletchers had hidden losses, totalling more than a hundred million through under-pricing its tenders, or so it says.
 
New Zealand cannot build anywhere near enough houses to meet demand, leading to a social disaster, with an increasing number of younger and lower-earning families excluded from buying homes in our more desirable, employment-providing, cities.  Who wants boom times?
 
If you extract Fletchers from the sector and just focus on its history, you will find a company that has under-delivered for decades.
 
It built on its construction company history, diversifying into many sectors, particularly when the egotistical and autocratic Hugh Fletcher was at the helm in the 1980s and 90s.
 
Hugh Fletcher, an academic, lacked commercial skills, was a poor communicator, lacked street wisdom, lacked negotiation skills, and was far from insightful.  His eventual retirement was not lamented.  His parents and grandparents did not pass on all their best genes, as was the case with the Todd family.
 
I well recall the noted financial markets participant and commentator Frank Pearson questioning whether Fletchers would survive, at an analysts’ meeting in Wellington, in the early 1990’s.
 
Fletcher Challenge, as it was then, was raising money through capital notes at 14 and later 11 per cent, its share price was not much above $1.00, and it was making grandiose purchases of over-priced assets in the sunset paper industry, in Europe.
 
It thought it could defeat trade unions in the northern hemisphere, with whom it battled during its period of expansion.
 
It brought into oil and gas exploration and production and later sold at the wrong time.
 
It was involved in the car industry, the rural sector, the finance company sector and it thought it could make money through forestry ownership.  It tried to be a conglomerate, perhaps like Lonrho in London, for whom I worked in the 1970s.
 
Sir Ron Trotter was charged, eventually, with sorting this out.
 
The result was the division of Fletcher Challenge into four companies, Fletcher Forest, Fletcher Paper, Fletcher Energy and Fletcher Building.  Trotter eventually reached a logical conclusion.  Wrightsons was sold.  The finance companies were closed.
 
All those creations except Fletcher Building long since have been hocked off, the grandiose multi-national that was contrived now a distant memory, thank goodness.
 
Fletcher Building reverted to its origins, has had various chief executives, various chairmen, yet has never delivered on its potential, given its favoured status and its dominance of the building materials market.  It has had a smattering of strong directors.  None stayed for long enough to make a difference.
 
Hugh Fletcher has long gone and Mark Adamson now sits as chief executive but once again the company’s contrivance – its desire to own companies overseas – has blighted its performance.
 
Once again Fletchers as a company has become bloated, owning poorly selected, poorly priced offshore subsidiaries, poorly governed and poor performing, despite the very real advantages it has in New Zealand.
 
My solution would be for Fletchers to revert to being governed by people with relevant construction industry experience, perhaps topped up by people able to communicate with governments, with legal and capital market connections, and (he says between gritted teeth) people with enthusiasm for all the compliance stuff.
 
Fletchers need governance by experienced, industry-savvy people, not by product managers or marketing whizzes.
 
It is not like a tech company that needs creative people to imagine a new world.  It needs to construct.
 
It needs at least some directors who have worked in engineering and on construction sites and it needs people with developed negotiation skills and communication expertise.
 
Its chief executive is apparently an admired character.
 
His team is ever-changing.  He has just lost one of his most experienced, hands-on managers.
 
The modern plea is for boards that boast gender and racial diversity and see the world in virtual reality.
 
I am not sure that the construction sector needs to prioritise any governance and executive ambition, other than attracting people at board and executive level who understand and have experience in the construction sector, and communicate clearly and often.
 
It simply must develop more expertise and better processes to avoid a repetition of the decades of errors that have stopped the company from exploiting its highly advantaged position.
 
How does one explain $100 - $150m of money that has disappeared just a few weeks after the CEO had soothed the market, with no reference to those losses?
 
(Perhaps those who destroyed the finance company sector might step-up, and explain how hundreds of millions can vanish!)
 
There is a logical alternative.  Perhaps Adamson is preparing to sell the construction business and simply retain its retail building materials business.
 
Retail is where the easy money sits.  And it is where product managers might be useful.
 
Capital markets will be paying attention.
 
How ambitious is Fulton Hogan?
 
Does Fletcher Building restore its construction advantage, or does it revert to being a retailer of high-margin building materials?
 
 _ _ _ _ _ _ _ _ _ _ _ _
 
 
TRAVEL
 
I will be in Nelson on April 20 talking to a NZ Shareholders Association group, and meeting with clients and investors.
 
Michael will be in Tauranga on 18 April (morning).
 
Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.
 
Edward will be in the Wairarapa on 26 April, Napier April 27 and Taupo on April 28.
 
Anyone wanting to make an appointment please contact us.
 
 
Chris Lee
 
Managing Director
Chris Lee & Partners Ltd

COPYRIGHT
This emailed client newsletter is confidential and is sent only to those clients who have requested it. In requesting it, you have accepted that it will not be reproduced in part, or in total, without the expressed permission of Chris Lee & Partners Ltd. The email, as a client newsletter, has some legal privileges because it is a client newsletter.
 
Any member of the media receiving this newsletter is agreeing to the specific terms of it, that is not to copy, publish or distribute these pages or the content of it, without permission from the copyright owner. This work is Copyright © 2010 by Chris Lee & Partners Ltd. To enquire about copyright clearances contact: copyrightclearance@chrislee.co.nz

TAKING STOCK 23 March 2017

David Colman writes-

US Infrastructure Spending

It seems drivers on US country roads must spend a lot of time dodging potholes. A New Zealand company might help with the solution!

Many US counties have struggled to perform road maintenance for over a decade and argue there is a lack of funding at a state and national level.

County supervisors will be hoping that President Trump’s massive planned infrastructure spending will filter down to them and result in the filling in of potholes, laying of new seal and digging of drains. State administrators will have similar optimism regarding major roads and highways which have also been described as underfunded.

Where is the money going to come from?

The President has stated that both public and private funding will be used which would necessitate taxes and tolls at least to fund the estimated One Trillion Dollar plan.  Road taxes, collected properly, might be the answer.

Tax is gathered from vehicle users through registration fees, or similar, and as part of the cost of fuel at the pump with trucks paying additional road user charges as they are a far greater burden on infrastructure due to their size, weight and frequency of use.

In efforts to define criteria for highway funding in 2012 the US Congress enacted the ‘Moving Ahead for Progress in the 21st Century’ bill, more commonly known as ‘MAP-21’ which includes requirements for trucks and trucking companies.

The Federal Motor Carrier Safety Administration (FMCSA) requires trucks in the USA, manufactured after 2000, to have a compliant Electronic Logging Device (ELD) in use before December 2017, or for trucks which have an automatic on-board recorder (AOBRD) before December 2019.

ELDs are required to track a driver’s hours of service (HOS) electronically and synchronise with the truck’s engine.

Unlike ELDs, AOBRDs are not required to track location and are not required to be synchronized with the engine’s electronic control module.

ELDs are installed in individual trucks and are synched to the engine’s electronic control module to record distance, time and GPS location data which is sent and stored at a depot where Road User Charges, compliance and other commercial information can be assessed and managed. Driver behaviour such as braking suddenly and high speeds through corners are examples of information that can also be gathered across an entire fleet of trucks.

Benefits of ELD systems include, but are not limited to:

- Tax revenue can be calculated accurately and collected with a high-level of transparency.

- Drivers do less or no paperwork, saving time and reducing human error.

- Companies can accurately monitor their fleet and reduce maintenance and administration costs.

- Authorities can inspect data and oversee compliance.


EROAD

EROAD (ERD) was originally founded in New Zealand in 2000 by economist Brian Michie and it introduced the first nationwide electronic road user charging (RUC) system in New Zealand in 2009.

It listed on the New Zealand Stock Exchange in 2014 and is headquartered in Auckland.  It wants to be part of the solution for America’s third-world highways.

ERD develops, sells, leases and supports systems consisting of a secure ELD (electronic logging device) recorder, payment system and related services.

The cellular systems replace existing paper-based logbooks and automated on-board recorders.

The EROAD systems are either sold or leased to their transport carrier customers.

ERD has been adding to its established markets in New Zealand and Australia with total units increasing by 7,512 to 39,964 in December 2016 (+23%).

EROADs services collect more than 36% of Heavy Vehicle Road User Charges in New Zealand and this market penetration is rising.

Growth in the US market where it has an office in Portland, Oregon has continued with an increase of 1,192 units to 5,693 in December 2016 (+26%).

EROAD has scheduled reports of contracted units on a quarterly basis with the next report due in early April which will be a key measure of their growth in their targeted markets.

EROAD recently announced that they had achieved a US first with the registration of their Electronic Logging Device (ELD) on the Federal Motor Carrier Safety Administration (FMCSA) register.

EROAD is one of 33 companies (as at date of writing) offering a compliant ELD solution on the FMCSA register, with the company the first to offer a permanent in-cab, tethered hardware-based ELD system.

Achieving commercial success in the USA will require a dedicated, skilled sales force due to the extremely competitive market conditions. The New Zealand/Australia business generates sufficient cash-flow to offset EROAD’s US operating losses.  Raising new funds through a placement or rights issue should not be ruled out as a future possibility if there is slower than expected growth in the USA.

EROAD has made progress by working with state governments in Oregon and California. EROAD has been chosen by the California Department of Transport (CalTrans) as its heavy vehicle technology provider for the California Road Charge Pilot which runs from July 2016 to April 2017.

Heavy vehicle participants in the California Road Charge Pilot can take advantage of the full range of EROAD services including electronic IFTA, electronic logbook, Oregon WMT, driver feedback, idle reporting, vehicle maintenance reporting and more for no additional cost.

The potential for growth in the US market is enormous with a nationwide estimate of between 3.5 and 4 million truck drivers working for an estimated 1.2 million companies which are owner-operated by a large majority. Ten percent of US trucking companies have 6 or more trucks but only 3% have 20 trucks or more.

Some of the largest US freight companies are UPS, FedEx, J.B.Hunt, YRC Worldwide and XPO Logistics, each having many thousands of trucks within their fleets.

EROAD continues to be a long-term investment for growth with no dividends to be expected for many years as the company uses profits made in New Zealand and Australia to fund growth in the US.

If EROAD continues its success in Australia and New Zealand where it continues to establish itself and can capture even a small percentage of the sizeable US ELD market it is possible that its shares could offer dividends and be well regarded by investors.

The shares traded at $2.15 at the time of writing and have traded in small volumes, increasing in value by 36% since January 2017 when they traded as low as $1.60.  (The shares were floated at $3.00 in 2014).

The share price is likely to continue to reflect the uncertain future of sales growth in the US and thus the drain on the revenue gained in NZ/Australia.

An investment in EROAD will require patience and a tolerance for risk.

Chris Lee writes:

Of course EROAD is in the spotlight this month for another reason, two of its former staff accused of insider trading, perhaps facing a Financial Market Authority intervention.

The FMA seems to have moved to another gear, after spending years investigating the behaviour of those who led the finance company sector in the years leading to its collapse.

Its second mission was to chase out of the advisory industry those operators who followed the Money Managers, Vestar, Reeves Moses, Broadbase, strategies.  They have all gone, without a crowd appearing at the Wailing Wall.

It is apparent that fund managers, brokers and public companies are now in the spotlight as the FMA tries to achieve the goal of an equally-informed, law-abiding environment for investors.

The goal is not lofty, it is not simply idealistic or unachievable and it is absolutely essential.

New Zealand relies on foreign capital.  No foreign fund manager or sovereign wealth fund is going to allocate increasing (or any) money to a country which allows capital market participants to cheat.

Many will recall how the Japanese sovereign wealth funds reacted to the disgraceful manipulations with the DFC thirty years ago.

When the Japanese discovered the cynical behaviour the result was that NZ was struck off its investment list for several years.

The FMA now has signalled that it will focus on three types of cheating: market manipulation, insider trading and hopefully, front-running.

Market manipulation is best described as the tilting of behaviour to gain unfair advantage for some, at the expenses of others.

In its simplest form, it allows those with power, like brokers or fund managers, to behave in a manner that misleads others and leads to a few making money at the expense of others.

In its most childish form, it is described as window dressing.

Say Rhubarb Funds has a million shares in Manure Corp where there is little turnover and, at month end the final sale price an hour before the month’s trading will end, looks likely to be $1.00.

One minute before the month end Rhubarb offers to buy 10,000 Manure shares at $1.20.  Someone sells.

At month end Rhubarb fund managers value the million shares at $1.20, report to investors a wonderful profitable month, and the manipulating staff member gets a bonus.

In the new environment the fund manager would very likely be prosecuted for market manipulation.

Ideally, month end results should be calculated at the lower of the final sale price, or the average price weighted by volume over the last days of sales, to stop this practice.

Another example of manipulation might follow an alternative course.

Rhubarb wants to sell 100,000 Manure shares at $1.10, knows there is a buyer, so it buys itself a handful of Manure shares at $1.10, conning the buyer into believing he must pay $1.10 to fill his order, as that is the ‘’market price’’.

Capital market players should be smarter than to fall for such a tactic but even in capital markets there will be juniors who are easily out-witted, especially in Tier Three broking firms.

Insider trading is simply theft.

A staff member in Manure Corp may hear from his boss that scorpions are destroying their crop and that Manure Corp plans a news release of how this invasion will damage profits.

If the staff member rushes off to sell his personal shares before the market is informed he is committing theft.

He is selling a defective product to a buyer who cannot know what the seller knows.

The staff member will be sacked, disgraced, maybe fined, maybe jailed and should be seen as unfit and improper for any positions in a sector that relies on honesty and trust.

Even if the staff member tells his Mum to sell her Manure shares, he is guilty of inside trading, and so is she.

Just imagine if Manure’s chief executive went around the country telling investors and fund managers that the company was in great shape when the chief executive knew about the plague of scorpions.

Is it credible that the chief executive would not be pursued by anyone or everyone who cared about the future of our country’s reputation?

The FMA clearly will focus on manipulation and insider trading.  It should also take a good look at front-running, perhaps the highest form of corporate theft.

Front running occurs when a person with information on someone else’s buying or selling plans then uses that information to jump the queue and help himself to money.

Imagine a young researcher at an institution convinces his investment committee to allocate a million dollars to Manure Corp shares.

The committee agrees to buy but the rotten little researcher, knowing the price will rise as his company enters the market, jumps in for himself (or his wife/mother/friend) and buys as many shares as he can afford.

He then sells to his company when they enter the market at the price that has been lifted by the buying order of a million shares.

Those with the greed gene, the weakness gene, the no-self-respect gene, play this game and often make a fortune, before they get caught.

Decades ago they were internally disgraced and quietly sacked, but not prosecuted, a corporate response that allowed some cheats to move on in the same occupation perhaps with a new employer that did not care about faulty genes, or wanted a weak man who would fire the bullets for a company with a rotten philosophy, cowed by his nasty secret.

It will be a breakthrough day when the FMA can prosecute and prove that front running has occurred.

It is not just a capital markets issue, nor even just an issue to prove that symmetry of information is essential.

Regulator prosecution boosted by a court applying an enormous penalty would be a great moment for New Zealand, a great illustration to the world that New Zealand accepts no corruption, and can be trusted.

 _ _ _ _ _ _ _ _ _ _ _ _

NEWS that the Australian listed construction company Downer will buy out Hawkins Construction is good news for a number of different groups, but perhaps not all.

Hawkins has had a patchy record of governance, like all construction companies is known for its use of creditors’ money for prolonged periods and probably over-trades, though not to anywhere near the extent of the appallingly-governed Mainzeal Construction which inevitably collapsed years ago, its directors now facing a civil case that will seek to recover enormous sums for creditors.

Along with Fletchers, Fulton Hogan, Downers and more recently the European giant Vinci, Hawkins has profited greatly from the bloated contracts coming out of Christchurch.

Experts believe our Crown and our insurers have paid billions more than was necessary to the main contractors though the accusations have never been itemised, nor have the beneficiaries been named.  And clearly, as Fletchers has just revealed, not every tender for a contract is carefully prepared.  (Next week I will discuss the errors Fletchers made).

Suffice to say that the main contractors have been able to cover stretched balance sheets because of the generous levels of ‘’fat’’ in many contracts.  Tax payers have been poorly served by those awarding contractors, it seems.

Vinci is French-owned and arrived here by first buying half of the family-owned contractor March Construction in Christchurch.  It is a huge company, many times the size of Fletchers or any of our Australasian contracting businesses.  It is threatening our existing contracting companies because of its grunt.

It has now exercised its option to buy 100% of March Construction and also owns Heb, the head contractor appointed to build Transmission Gully, a multi-billion dollar exercise near Wellington.

Hawkins, with its limited capital, is facing increasing powerful competition so a Downer takeover makes sense for both sets of shareholders.

Downer will need to come up with cash.

Logically it should stop buying back its own capital with its spare cash, a strategy I dislike.  (No business ever fails because of too much capital).

A much safer option would be to fund the purchase not with a senior debt issue but with a capital note issue that might realistically be converted to shares upon maturity.

Were Downers to offer a coupon, say 6%, and a conversion at the investors’ option to shares, at a fixed price only slightly more that today’s share price, Downers might raise enough money to help finance the purchase of Hawkins AND repay its expensive perpetual annual re-set notes.

Such a strategy would be welcomed by new investors though the holders of the perpetuals might rue the loss of a relatively high-yielding security.

If the government were going to help to rebuild our infrastructure, it would be addressing several problems that result from population growth, and greater numbers of tourists.

These may include:

- Auckland’s drainage problem;

- Traffic congestion;

- Barriers to divide traffic in areas with high tourist flows;

- Airport x-ray queues (i.e. Wellington);

- Poor road surfaces (everywhere);

- Public transport;

- Earthquake-related repair work;

- Water storage and distribution;

- Polluted rivers.

The construction companies may well be salivating at the prospect of public works contracts being spread around a small number of contractors with the capital, the staff, the expertise and the gear to take on major projects.

Most do not have the capital, the staff, the expertise or the gear so mergers and changes are inevitable.

If such a programme of rebuilding infrastructure does occur, we may need more contractors to be bidding for tenders at margins that are contested in a real way.

We might also hope that the process excludes corruption, so rampant in Christchurch, as expert analysts confirm.

The Hawkins sale to Downers just might be the signal that other bigger overseas-owned contractors can see a pipeline of lucrative projects on the horizon, or it might be a signal that there is more hurt in the sector than any outsider knows.

_ _ _ _ _ _

TRAVEL

I will be in Nelson on April 20.

Michael will be in Tauranga on 18 April (morning).

Kevin will be available in Christchurch on 30 March.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

David is Palmerston North and Whanganui on 29 March and New Plymouth on 30 March.

Anyone wanting to make an appointment please contact us.

Chris Lee
Managing Director
Chris Lee & Partners Limited

COPYRIGHT
This emailed client newsletter is confidential and is sent only to those clients who have requested it. In requesting it, you have accepted that it will not be reproduced in part, or in total, without the expressed permission of Chris Lee & Partners Ltd. The email, as a client newsletter, has some legal privileges because it is a client newsletter.
 
Any member of the media receiving this newsletter is agreeing to the specific terms of it, that is not to copy, publish or distribute these pages or the content of it, without permission from the copyright owner. This work is Copyright © 2010 by Chris Lee & Partners Ltd. To enquire about copyright clearances contact: copyrightclearance@chrislee.co.nz

TAKING STOCK 16 March 2017

PERHAPS it is of interest only to older New Zealanders; perhaps the media simply does not recognise its audience is older, but what is clear to me is that our audience comes to attention when data is released showing New Zealand in a comparison with other countries.

It is a mystery as to why so rarely is research published in the media, when so clearly very few people have an appreciation of their good fortune to live in New Zealand and so many appreciate such research rather than media gossip.

At some recent seminars we held, we displayed one stark statistic that captured attention.

The world’s murder rate measures people intentionally killed in each country, displaying the rate per 100,000 of population.

By continent, America’s rate is 16.3 people per 100,000.

Africa’s rate is 12.5, the world rate is 6.2, Europe, Oceania and Asia is 3.0. In some states of the USA (St Louis, Chicago, Detroit) murder rates are high; respectively 50, 42, 22 per 100,000.

The most dangerous countries are El Salvador 64 and Venezuela 62, South Africa is 33, Russia 9, USA 4. Iceland, Japan, Switzerland, Norway, Poland, China, NZ, Sweden, UK and Germany are less than one person per 100,000.

The latter list (the fewest murders) is, not unexpectedly, pretty much a list of the best countries when it comes to access to health, education and social services, and when it comes to absence of absolute poverty, though China might not be so well rated on this score.

Now observe the countries with the least inequality, the lowest inequality listed first.

Iceland, Norway, Finland, Austria, Czech Republic, Slovenia, Denmark, Belgium, Slovakia and Sweden all rank at lower levels of inequality than New Zealand, which is 23rd on that list, Australia 24th, and the likes of China, Russia and the USA near the bottom.

Interestingly, inequality is measured by quite a variety of methods, the research done by various bodies.

On one measurement Denmark has great inequality, on another measurement it has very little.

Inequality can be measured by the difference between what the richest and poorest own, by the difference in their incomes, or the difference in their access to services, health and education.

When it comes to relative poverty, Iceland, Denmark, Czech Republic, Finland, Norway, France, Luxembourg, Holland, Slovakia and Switzerland have the least.

NZ is 15 spots below Iceland, Australia five spots behind New Zealand, 30th on the list.

The world’s wealth is in the hands of a tiny fraction of the globe.

Of the world’s 7.5 billion, approximately 25 million people (0.33%) have nett assets exceeding a million US dollars, if you believe the research.

In New Zealand, many thousands of houses are worth more than US$1million.

Owning assets between 1 and 5 million US dollars, there are 23 million people on this planet. Nearly two million people own between five and thirty million of wealth.

Those owning more than US$30 million comprise just 0.004% of the world, perhaps 30,000 people, of whom maybe 1,000 live in New Zealand.

Remarkably, more than half of all New Zealand adults are in the top 10% of the world’s wealthiest people.

In the US the median of the wealthiest 5% own 90 times the wealth of the median family. In the Netherlands that multiple is 42, in Australia it is 10.

The average wealth of the wealthiest 1% in the USA (3.2 million people) is US$15m, whereas the same figure for the UK is $5.7m, for Australia $4.7m.

In US dollar terms, there are only seven countries where the minimum adult hourly wage exceeds US $10.

They are Australia US$13.3, Luxembourg $13, UK $11, Netherlands, NZ, Ireland and Belgium all more than US$10.

The minimum adult hourly wage in the major states of the USA is $7.25, Japan $5.9, Hong Kong $4.1, Saudi Arabia $3.85, Kuwait $0.96, Macau $0.58 and Venezuela $0.17.

In terms of corruption, Denmark and New Zealand, closely followed by Finland, Sweden, Switzerland and Norway are the least corrupt, all with factors between 86 and 100, the highest figure being the perfect mark.

Australia’s rating is 79, USA 74, Japan 72, Italy 47, China 40, Russia 29 and Venezuela 16.

Of the world’s countries which produce significant renewable energy (30,000 GWH or more), Paraguay and Norway produce the highest percentage of their consumed energy from renewable sources, Paraguay 99%, Norway 90%.

On that list NZ is sixth (72%).

Canada produces 64%, Sweden 60%, Germany 32%, China 24%, USA 14% and Australia 13%.

Those who measure countries by their human development rate Norway highest with a score of 94, ahead (in order) of Australia, Switzerland, Denmark, Netherlands, Germany, Ireland and USA, Canada and New Zealand are equal ninth.

Others on that list are Sweden and UK (14th equal), Japan 20th, Russia 50th, Malaysia 62nd, China 90th, South Africa 116th, India 130th, Cambodia 143rd and Pakistan 147th.

In terms of unemployment, Norway has the least followed by Korea and Switzerland.

New Zealand is 11 spots behind Norway.

Some 203 countries are measured.

The NZ Census shows us that there is not a single New Zealander living on less than US$2.00 a day, but 42% of the world, that is 3.1 billion people, live on this level of income.

Relative poverty here must be addressed, but no one should insult less-endowed countries by claiming that relative poverty and absolute poverty are comparable.

Our last census showed that a retired NZ household with tax-paid income exceeding NZ$72,000 per annum is in the top three percent of all retired households in New Zealand, top 1% of the world.

The median retired household has bank deposits, shares, bonds or other non-household assets totalling in value around NZ$30,000.

Of course every person on retirement at 65 currently receives a government guaranteed pension that might have a capital value of around $300,000, thanks to our universal NZ pension.

Those who own shares, bonds, bank deposits or rental properties collectively worth $300,000 are in a tiny minority of NZ retired households, certainly the top five percent in New Zealand and most certainly the top ONE percent of the world.

Any New Zealander who earns more than US$28,000 (NZ$40,000) is in the top 10% of salaried earners globally.

New Zealand exports 11 times as much food as it consumes, making it one of the highest food exporters in the world, and it has a temperate band judged by science as being amongst the three best in the world, for the comfort of people and plants.

Barely a handful of countries drink their tap water let alone wash their cars with drinking water.

We have one of the largest areas of protected fishing zones, we are nearly 50% self-sufficient in transport fuel, and would be self-sufficient should our transport system be fuelled by electricity from renewable resources.

Much of the above randomly-selected information was regarded as ‘’news’’ by many who attended our investor seminars, if the reaction from investors was sincere.

Why is the information not shared widely?

Our seminar theme was that investing in New Zealand is the logical option for investors who live and spend here, certainly until the interest and dividend returns ensure income exceeds spending. We see no logic in currency speculation. Investors in NZ have a tangible benefit in transparency.

We styled our meetings with John Clark/Fred Dagg’s memorable 1970s theme: ‘’You don’t know how lucky you are’’.

(For those who prefer the half-empty approach, we recommend some travel pretty well anywhere you like in South America, the US midlands, Eastern Europe, the Middle East, the Far East, Asia or Africa, a combined territory comprising nearly 99% of the globe.)

_ _ _ _ _ _ _ _ _ _ _ _

WHILST it is easy to draw attention to how lucky are those born in NZ (or Australia or Canada), one must acknowledge that the global trade on which we rely is at threat.

Life would be different if we were isolated and unable to export or import.

Being free of protectionism, a condition Trump wants to renegotiate, does not mean we are free from some of the globe’s rotten practices.

My age group may have a different view from that of today’s admirable young people but many strongly dislike the intrusion that has arrived with the development of digital technology.

Last week I had clients of my age complaining bitterly about the abusive Google practice of using Facebook to bombard people with spam, advertising anything that salesmen are willing to sell.

Their calls centred on advertisements for so-called ‘’seminars’’ (real words ‘’selling seminars’’) for a new annuity product, targeting widows and unadvised retired people, as far as I can see.

The intrusive Facebook advertisement offered free refreshments to those who would attend these selling sessions in the next few days.

The lead figure for the selling was a website reporter, not an authorised adviser, not a financial markets participant.

Presumably for a fee, he would promote the annuity at a seminar.

Quite wrongly, the law now allows unqualified, inexperienced newspaper reporters, newspaper columnists, or website ‘’journalists’’ to dispense financial advice or, as in this case, to ‘’sell’’ financial products.

I find this extraordinary and unacceptable.

I have no disrespect for the reporter involved, who might or might not have useful knowledge, but it seems ludicrous to me that someone with no capital market experience, no involvement at any level in wealth management, and governed by no rules, can head up a selling seminar for a financial product.

Put bluntly, the law is an ass, in this area.

To go further, there is nothing to stop a journalist becoming a shareholder in an annuity provider and then selling it at seminars, without any constraint, though that does not seem to be the case this time.

To assert that the journalist is an appropriate authority at an investment sales function would require a good deal of cynicism about the value of the laws regarding financial advice, and the importance of knowledge, experience and accountability.

My respect for the product provider, its governance and management, is hardly likely to be enhanced by using the anomaly in the law regarding financial product selling.

I cannot provide any advice on the product myself but I can suggest the following to anyone tempted to attend the selling sessions:

1. Ask about its credit rating.

2. Ask how many people have invested in it during two years of concentrated selling.

3. Ask for a list of the owners of the product.

4. Ask about its fees.

5. Ask about the capital it has to support its ability to pay out, over many decades.

In my view, the Financial Markets Authority should be attending these sessions and then contemplating the law, to see if it needs amending. I contend that our law does need revision.

Global technology has enhanced our life in New Zealand but, as I heard from clients last week, the intrusion of spam in personal devices like iPhones is not something my age group welcomes.

Perhaps the selling group is not analysing the cleanest way of accessing its target market.

_ _ _ _ _ _ _ _ _ _ _ _

VERY few New Zealand superannuitants would invest their capital in an annuity, for very valid reasons.

An annuity might begin with a widow, widower or retired person assigning his/her wealth to an annuity fund manager who promises to pay out an amount each month, or some other interval, until the investor dies.

Let us say the investor, at age 65, hands over $200,000 in return for a payment of $1,000 per month, till death.

Traditionally the investor might ‘’win’’ if he lived for 30 years, but if he died after, say, 10 years, the fund manager would ‘’win’’, ending any payments on death. The estate loses the capital.

The early-to-die subsidise extreme longevity.

Some annuity managers had conditions that enabled the investor’s estate to be part-refunded with some of the residual amount, sharing the manager’s ‘’win’’.

In New Zealand there are no tax advantages, so in effect the investor could ’’win’’ only by extreme longevity.

What the investor gets might be certainty, providing the annuity provider does not go ‘’broke’’ and default. Default is a real risk. Worldwide, annuity managers are failing to earn the returns to meet their long-term promises.

The provider gets a fee, perhaps varying from 0.3% per annum to 2.3%, from which it might pay its expenses and its salesmen’s commission (and seminar fees). A fee of 2.3% sounds absurdly high.

Now consider a simple bank deposit, where the $200,000 investor sets up, say, 60 investments of $1,000, one maturing each month for five years.

The return on these deposits might be 3.5%, there would be no fees, the banks have billions of capital, all the residual money goes to the estate if the investor dies, and there would be no salesmen’s fees, annual or otherwise.

Imagine the remaining $140,000, after 60 $1,000 deposits have been made, is invested, perhaps with good advice gathered first, in long bonds, property trusts and shares in public listed companies, like Auckland Airport, Port of Tauranga, Spark, Mercury, ANZ Bank, etc.

No annual fees result; no ‘’sharing’’ if death occurs; no risk of default by any annuity provider.

No additional risk occurs.

The annuity provider invests in bonds, shares, property and cash, so the risk is not increased by an investor using the same strategy.

But over 20 years a 2.3% per annum fee on $200,000 equates with a mere $92,000, taken from the investor.

And even paying that sum does not diminish the risk of default, a risk that would be reduced only if the annuity provider had the substance, the experience and the credibility to earn a robust credit rating.

If AMP was the provider its credit rating would be A or A minus. That should be a minimum rating for any insurer. Any provider with a credit rating below investment grade (BBB) should be barred from selling annuity funds management, in my opinion.

What might be needed to make annuities attractive would be a unique tax advantage; perhaps the earnings of the fund might be tax-free, or even subsidised, as an incentive to help people be self-sufficient.

Evidence of fund management skill would also be essential.

There are no tax advantages in New Zealand.

If there were any merit at all in the annuity concept here, it might be that an annuity might be better than poor self-management of one’s money.

My view remains that the banks alone can provide a solution that avoids poor management.

Usage of annuities in New Zealand is so small as to be statistically irrelevant. Those wanting to profit from managing annuity money with a BB minus credit rating are surely not going to win support from investors, or from the financial advice industry that focusses on risk.

_ _ _ _ _ _ _ _ _ _ _ _

TRAVEL

I will be in Christchurch on Thursday March 23 and Friday March 24, and in Nelson on Thursday April 20.

Michael Warrington will be in Tauranga on 18 April (morning).

Kevin Gloag will be available in Christchurch on 30 March.

Edward Lee is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

David Colman is in Palmerston North and Whanganui on 29 March and in New Plymouth on 30 March.
Anyone wanting to make an appointment please contact us.

Chris Lee
Managing Director
Chris Lee & Partners Limited


COPYRIGHT
This emailed client newsletter is confidential and is sent only to those clients who have requested it. In requesting it, you have accepted that it will not be reproduced in part, or in total, without the expressed permission of Chris Lee & Partners Ltd. The email, as a client newsletter, has some legal privileges because it is a client newsletter.
 
Any member of the media receiving this newsletter is agreeing to the specific terms of it, that is not to copy, publish or distribute these pages or the content of it, without permission from the copyright owner. This work is Copyright © 2010 by Chris Lee & Partners Ltd. To enquire about copyright clearances contact: copyrightclearance@chrislee.co.nz

TAKING STOCK 9 March 2017
 
IF THERE had been just one homily to deliver after meeting last week with venture capital/angel investor Powerhouse Ventures, life would be easy.

One obvious message is to remind investors who allocate small sums to venture capital funds that they need to be extremely patient.

My meeting with Powerhouse managing director Steve Hampson, CFO Paul Viney and the company’s Australian investor relations consultant Greg Slade, suggested there would be far more caveats to raise with Powerhouse investors, of whom my family is one.

Patience is certainly the message Powerhouse would promote but Powerhouse has already made serious errors which need discussing, and ultimately correcting.

To recap, Powerhouse is an investment company that many years ago was founded by a few individuals who invested an initial modest sum, less than a million, in various ideas incubated at New Zealand’s universities.

The goal was to commercialise great ideas, feeding in capital to develop the ideas and adding corporate expertise to fast forward laboratory inventions.

With this sort of ambition, Powerhouse would have had the option of selecting one great idea, and throwing at it all the modest wealth of the Powerhouse directors, backing themselves to identify one great prospect.

Such an approach would have in mind very high returns, with the obvious risk that if the concept failed, all would be lost.

The alternative approach was to reduce the potential of high returns by spreading the limited resources so that many ideas were supported, each receiving a little bit of the money.

The odd winner might pay for the failures.

In theory this diversification reduces risk (and reduces returns), the directors no longer having to pick the best idea and go for it.

Powerhouse Ventures now has 23 incubated companies that it is trying to support with money and capital market expertise, and a 24th prospect in sight.

That spread of investments should reduce risk; unhappily it may in fact increase risk, because Powerhouse may have neither the money nor the skills to develop fully those 24 separate ideas, and may spread their resources too thinly to meet the needs of any.

So the second homily after patience might rest on the apparently lean financial capability, and expertise, of the directors to provide sufficient support.

Powerhouse, recognising the need for more money, then decided to list the company, trying to raise $20 million to enable it to fund the 23 ideas it had captured.  It sought to keep as much of the company as possible in the hands of the directors.

It went around New Zealand but could not enthuse even our third tier brokers, despite Powerhouse having a South Island base that might have resonated with a South Island broker.

Its alternative plan was to list in Australia where again it failed to interest third tier brokers, and finally found support with a tiny capital market broker, with limited credentials in those corridors where wealth decisions are made.

The result was that Powerhouse raised just $10 million, a coin or two more perhaps, a most inefficient sum given the fees paid to raise the money.

The $10 million released barely $5 million for the 23 companies, after all the disbursements and loan repayments.

So investors might now say that they need not only patience but they need evidence that the directors themselves have significant personal wealth, and that they have support in the corridors of power in capital markets.

The evidence to date is that Powerhouse lacks grunt in these areas.

Listening to the managing director and CFO and observing their responses was not comfortable for me, nor did I find what I hoped to discover, that being ‘’Plan C’’.

If Plan A was to find an early winner, cash up, validate the model, and generate cash for other potential winners, then Plan B was to give up some upside by reaching out to investors, with such a good offer that the capital for incubated companies would roll in.

Powerhouse messed up Plan B by offering too little to those whose money it needed.

It failed because it commissioned valuations of its 23 companies that in the obvious cases produced valuers’ figures that relied too heavily on a perfect outcome.

As so often happens the valuers used methodology that was not accepted by those whose money was being wooed.  The valuations, in a word, were high.

As an aside I have observed over many decades the fallacy of calculating wealth by accepting valuers’ opinions, none more memorably moronic than the opinion offered by a real estate valuer eleven years ago on the value of leasehold land in Albany.

That valuer will never again be regarded seriously by me.

And in company valuations, I have often noted the accommodating methodology used by valuers wanting to support the ambition of those paying their bills.

When some village idiot claims he is rich because some highly-geared assets have been given high valuations by what may have been a bribed valuer, my response is to step away.

I do not allege Powerhouse bribed village idiots but it is clear to me that its valuer did not achieve much credibility with capital markets.

Investors might regard lesson three as being wary of prices not supported by buyers, but by estimates, optimistic perhaps, of what buyers might pay on a good day.

A rider to this error was that Powerhouse’s directors might have defused critics by discounting the claimed valuations and leaving some serious surplus for those who were going to fund the directors’ chosen ventures.

Perhaps all of these errors were compounded by the over-enthusiastic selling of Powerhouse’s concept, for several years, by its selling force.

The phrase ‘’under promise, over deliver’’ might not have been known to the salesmen.

I guess another area of discontent is over Powerhouse’s salaries and fixed costs, which seem rather generous for a company in its infancy.

If Powerhouse’s directors were of modest wealth, had a great idea (to commercialise university research) that might bring them wealth, and needed time and other people’s money to get to their goal, they might have decided to pay themselves modestly, harbouring their coins to reach their long-term goals.

The Powerhouse model seems to have been less frugal than I would regard as ideal.

All of the above is the bad news.

In summary, Powerhouse made a lot of errors and is in danger of ruining what remains a great idea, and of at least extending the time it will need to produce returns for its founders and investors.

It has 23, soon, I believe to increase to 24, ideas that it believes can be commercialised and can produce streams of dividends or capital gains to any patient investors not put off by all the fundamental errors.

Its share price now A$.80c, just weeks after listing at A$1.07, is supported by very little buying interest.

Those who bought the shares presumably had long-term goals, so would not naturally be sellers, unless they have lost faith in the Powerhouse board and concept.

The irony is that despite all its bumbling, further blighted by very poor communication, share registry errors and a non-existent investor relations focus, Powerhouse has still an outside chance of rewarding its investors, if it can survive the incubation years.

It has three of its 23 companies making progress that might yet validate its model.

The most obvious is Hydroworks, a Canterbury-based company which has genuine competitive advantage, is slowly building a reputation in a sector that is growing, and is beginning to reach break-even cash flow.

Hydroworks is taking longer to achieve its ambitious targets but it is a real company and it may be gaining credibility in Australia.

Its brilliant engineering and design team have found a way of maximising turbine efficiency from water flow, enabling Hydroworks to increase electricity output by some two or three percent, by introducing its turbines.  Trustpower in New Zealand endorses the turbines effusively.

Hydroworks refurbishes hydro plants of which there are 300 in Australasia, some eight plants needing refurbishment every year.

Its turbines can also produce power from city water storage and it has mini turbines that can produce power from irrigation canals.

It has manufacturing as well as design capacity, having bought the Christchurch company Mace Engineering, which invested in Hydroworks.

Its turnover is now more than $10 million, heading slowly towards $20 million.  It must buy performance bonds when it wins large contracts so still needs Powerhouse capital, but its potential is real.

Then there is a vertical robot company, a clever Christchurch idea which allows robots to climb non-magnetic surfaces and inspect, then report on, structural decay and also analyse the goods stored in vats.

For example the robot can clamber all over a carbon fibre (non-magnetic) aircraft after a lightning strike, which prompts an immediate inspection by aviation law.

It can climb dairy vats, and inspect the stainless steel fabric, or measure the qualities of the content.

It may also have an application in petro-chemical storage.

All of these activities eliminate danger to people, are quicker, cheaper and more expert, and enable data to be stored instantly, meaning a robot might compare a surface imperfection to see if it is deteriorating, relative to its state last week.

A third incubated company is CropLogic, which has developed software that measures the optimal time to water (and fertilise) plant roots to produce the best possible crop yields.

The database measures conditions like soil moisture and temperature to ensure water is not wasted, nor denied to plants when needed.

Powerhouse has 20 other incubated companies, in areas like medicine, healthcare, agriculture, technology and manufacturing, that its managing director Hampson forcibly insists have a bright future.

Investors will hope he is right.

Time, he insists, is what is needed.

Time he will not have unless Powerhouse can provide funds, or use such leverage devices as guaranteeing bank loans, a strategy that obviously needs first to enthuse bankers.

The best hope is that one of these good ideas succeeds in validating the methodology of the valuers who publish their view on the market value of each individual company.

If the valuers claim Hydroworks is worth $57.00 per share (as they do) and some company either bids for Hydroworks at that price or higher, or someone underwrites a public issue at that price, then, and only then, will Powerhouse earn credibility for its valuation process.

Even then, one piece of evidence may not be enough.

My family bought shares in Hydroworks and in Powerhouse, as a small part of the 10% of our portfolio we allocate to high risk new ventures.

We have not sold but we are paying attention and want to see better decisions and evidence of commercial success.

I will be urging Powerhouse to re-think its model.

It may need to dilute its ownership in the interests of faster progress.

Until it has the alternative of meeting the needs of its subsidiaries itself, it should be prepared to offer investors a more generous entry point than it has to date.

I perceive that the directors lack the resources to meet the financial needs of 24 companies.

Powerhouse needs to impress and then connect with a capital market participant that endorses the Powerhouse model, and can access wealthy investment companies or individuals able to provide venture capital.

The NZ Venture Investment Fund has supported several of Powerhouse’s incubated companies, a relatively easy door to open, given that NZVIF is investing other people’s money, albeit with good processes and intentions.

Powerhouse’s future hangs in the balance.  It will not last 10 years, in my opinion, unless it gets its model validated before it runs out of money and credibility.

Note: none of this is financial advice.  Readers must obtain their own financial advice specific to their own circumstances.

 _ _ _ _ _ _ _ _ _ _ _ _

THE former Goldman Sachs, Hanover Finance, Tower Corp executive Sam Stubbs, has had a charmed ride with his new venture, a KiwiSaver provider and now fund manager, Simplicity.

He has benefitted from the support of a journalist, Rob Stock, who seems to specialise in household budgeting advice, preaching that low costs enables surpluses to grow.  Stock, for example, may say he rides a bike to work and if he drinks coffee, may do so from a Thermos.  He sets a good example while preaching thrift.

He has now written many articles quoting or promoting Stubbs, who is certainly confident and charming, and has a great bedside manner with journalists.  Stock approves of Stubbs’ low management costs.

Stubbs promotes his KiwiSaver provider by using only zero or low-cost index-funds like Vanguard, and by committing to be charitable with his new company’s profits, as Vanguard itself does.  I am unsure that there will be much profit to distribute.

What executive remuneration gets paid out before any profit is distributable is not ever going to be set immutably, so the charitable concept may not be too relevant, and should be monitored by those who choose Simplicity because of this charitable intent.

Stubbs is highly-focussed on fees, rightly observing that fees would make KiwiSaver redundant were it not for employer and tax department subsidies.  (The same is true of all retirement savings products.)

The sequential logic is that only a very poorly-advised investor would pay a KiwiSaver manager his fees once the subsidies end at age 65.  When the subsidies end, the canny investor extracts his money.

At age 65 the sanguine investor can obtain the same risk/return profile without the fees by replicating the investments held, or similar returns, but without fees, by following the same asset allocation.  Bank deposit rates will usually be better than nett returns from low-risk retirement savings products that are not subsidised.

Only our smartest fund managers, of whom there are a few who deserve this sobriquet, will justify any fees at all.

I observed that Harbour Asset management, run by Andrew Bascand and 76% owned by our leading investment bank First NZ Capital, won yet another award as Fund Manager of the Year recently, a title granted after assessing process as well as risk/return results.

HAM, as well as the likes of Salt, Mint, Aspiring and Milford, consistently demonstrate an advantage for investors that other managers fail to replicate, either because of fees, failure to attract talent, or poor process, hefty management expense ratios or absurd manager bonuses when modest benchmarks are reached.

Stubbs himself is not a fund manager.  He pursues the non-management role of fee-light index-hugging, which works satisfactorily when markets are fairly priced, but which is dangerously slow to respond to building storms, when markets are at perilously high levels.  Index-huggers just go with the flow, mindlessly.

That is not to suggest that I, or anyone, can identify the timing of the next storm, though it is fairly obvious that there is danger when investors value the likes of Uber at 50 billion dollars, when it has yet to make a profit, and under its current product offering would need to double its taxi tariffs to make a profit, a change that would destroy its competitive advantage.  There are some weird visible signals.

No one knows the future but skilled, experienced fund managers and analysts often have an advantage over the unskilled or unthinking, or the robotic, having access to capital market data that others do not.

As an obvious example those who have access to the brand volumes and margins of transport fuel providers have a much better chance of calculating which operators are winning, than those who just buy shares in all the operators (not that all of them have listed shares).

Stubbs is now hoping people will put more into their KiwiSaver accounts than is required to earn the highest levels of subsidy, and that the excess amount will be accessible on demand.

This might be good idea if a fund itself, unsubsidised, had better than average prospects.  Few, if any, have better than average prospects.

And I am just unsure that anyone could ever describe an index fund as having better than average prospects.

As is the case with Powerhouse, so intent on diversity that it sacrifices higher returns, index funds are promising nothing other than the average.

I much prefer Harbour Asset Management’s strategy of employing talent and using analysis and process to achieve better than average returns.

It has won its award three times in four years, a fine achievement.

Morningstar, the global company making this award, is itself, certainly in New Zealand, nowhere near star quality as a securities market researcher, but its methodology for assessing fund managers is rather more holistic than these foreign magazines who dish out awards after badgering companies like ours to advertise in their various organs.

The Morningstar award seems to value process, risk and return and is not just an award that recognises which fund had the highest return last year, a selection process that ignores risk.

 _ _ _ _ _ _ _ _ _ _ _ _

TRAVEL


Michael plans to be in Tauranga on 18 April.

Chris will be in Auckland on March 20, flexible about where he can meet investors.

Kevin will be available in Christchurch on 30 March.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

David is in Palmerston North and Whanganui on 29 March and in New Plymouth on 30 March.
                                                                                                                   
Anyone wanting to make an appointment please contact us.


Chris Lee
Managing Director
Chris Lee & Partners Limited


COPYRIGHT
This emailed client newsletter is confidential and is sent only to those clients who have requested it. In requesting it, you have accepted that it will not be reproduced in part, or in total, without the expressed permission of Chris Lee & Partners Ltd. The email, as a client newsletter, has some legal privileges because it is a client newsletter.
 
Any member of the media receiving this newsletter is agreeing to the specific terms of it, that is not to copy, publish or distribute these pages or the content of it, without permission from the copyright owner. This work is Copyright © 2010 by Chris Lee & Partners Ltd. To enquire about copyright clearances contact: copyrightclearance@chrislee.co.nz

TAKING STOCK 2 March 2017
 
CORPORATE boardrooms in New Zealand are not generally bugged, the cleaners do not sell the contents of the rubbish bin, and generally speaking, sensitive private corporate matters are not usually casually disclosed to the general public, via the media.
 
In some countries, espionage and mischief is more prevalent but in my experience NZ has a pretty clean slate.
 
I know for certain that when price-sensitive information is shared by public companies, the brokers, bankers, lawyers and regulators are subject to heavily enforced rules, and simply cannot breach confidentiality without very severe sanctions.  Front running cannot exist in a respectable or sustainable organisation.
 
So what on earth are we to assume has happened with publication of highly sensitive material involving the investment chairman of New Zealand’s largest corporate investor, the Accident Compensation Corporation?
 
That chairman is Trevor Janes.
 
For disclosure purposes let me reveal that I have previously published my view that Janes should never have been put into this position at ACC.  It was not fair on him and was inappropriate.
 
My view was, and is, that Janes was put there by unwise politicians, his background not what I would look for if appointing an ACC director and, especially, an investment committee chairman.
 
Janes is a friend of National Party Minister Murray McCully, and perhaps was seen by the National Cabinet as a suitable man to link the government with a highly important, and generally independent, investment institution.
 
Were Janes a long-time capital markets specialist with a long record of governance skills, this political connection might be irrelevant.
 
He is not such an obviously-credentialled fellow for the job, as far as I can see.
 
I am unaware of his insightfulness, his investment or governance skills or his capital market expertise or experience.
 
I also know that markets have not been unanimously taken with his role as chairman of Abano Healthcare, where his shareholders are factionalised, but this sort of divided opinion is not evidence of incompetence.  Rather it may simply be subjective. 
 
I do know that Janes chaired the worst finance company in New Zealand during the 2005-2006 period when it (Capital + Merchant Finance) was making appalling decisions and providing utterly unsatisfactory commentary on its progress.  The company was a disgrace, perhaps NZ’s worst governed company.  Chairmen must be accountable, even if failures were caused by others.
 
In this period CMF had real capital of around one million dollars and what I would call pretend capital of another $6m approx – pretend capital because it was repayable at the board’s whim – and it grew its dreadful lending book to around $200 million, making it geared, in effect at 200 to one in real terms.
 
The loans made were dreadful and uninsurable in virtually every case, though its appalling chief executive Owen Tallentire believed the loans were partly insured by Lloyds.
 
Several directors of the company during this period later went to jail for criminal offences (breaches of the Securities Act).
 
Its CEO, Tallentire, a man used to dealing Steptoe-like in second-hand furniture or the like, was the most clueless CEO I have ever met, and for that title he had some pretty hot competition.
 
Janes was the chairman.  He signed off the prospectus (for example in August 2006) but he was not included in the list of directors, targeted, prosecuted and jailed.
 
Perhaps a judgement was made that his signature did not imply understanding or endorsement of Capital + Merchant Finance’s dreadful practices.  (A similar judgement was made over Robert Whale’s involvement with Dominion Finance.  Whale was a specialist lawyer).
 
I have personally published my belief that Janes should not have been considered for what is a key role in the Crown-owned, highly sensitive institution, the Accident Compensation Corporation.
 
Frankly this appointment left me uncomfortable about the judgement of the National Party cabinet.  I am still uncomfortable.
 
For one thing, the ACC is a significant shareholder in the company Abano Healthcare, that Janes chairs, an obvious conflict of interest.
 
The ACC states that Janes will not participate in discussions over this investment – Chinese walls – but very clearly to me, the ACC investment chairman should not be someone who has any such conflict, even if he can avoid conflict by absenting himself.
 
What has brought Janes into focus now was the astonishing revelation last week that Janes believed he had been somewhat sheltered from legal action over his Capital + Merchant Finance role, by an agreement with a litigation funder he once part-owned.
 
According to a media report, Janes and another investor, Paul Lindholm, once part-owned the litigation funder LPF Group, chaired by former Supreme Court judge Bill Wilson, and predominantly owned by former lawyer Phil Newland and shareholder activist/accountant Bruce Sheppard.
 
Perhaps Janes’ one-time ownership was the result of having worked with Newland when Newland was a sharp and uncompromising director of Abano, during its period of impressive growth.  Newland ultimately resigned.
 
Whatever the explanation, Janes and his friend Lindholm became shareholders in LPF.
 
They fell out, according to Newland’s media comments, when LPF was asked to fund a litigation against various Capital + Merchant Finance parties (but NOT Janes himself, as it later transpired).
 
Janes and Lindholm, according to the media report, vociferously objected to funding such an action and eventually sold their shares in LPF, but in agreeing to sell, inserted a confidential clause that sought to stop LPF from funding future litigation over CMF.
 
I have never heard of an equivalent condition imposed on the sale of shares.
 
Ultimately, an Australian litigation funder did fund a case against CMF parties (but not Janes), and LPF apparently helped the Australian company.  When money for CMF investors was clawed back, LPF received a fee for their input.
 
Lindholm is now filing action against LPF, claiming some or all of that fee.  He had absolutely no connection with CMF.  His involvement in demanding a no-go zone for CMF had no obvious motive.
 
This fallout is what has led to publicity and what has caused the exposure of the confidential clause created when he and Janes sold out.  It is the cause of a claim filed against LPF.
 
I am astonished by the no-go clause and even more astonished that Lindholm wants to air such laundry in public.  I would have expected Janes to prevail over his friend Lindholm and argue against the filing.  Perhaps he did.
It was inevitable that the confidential clauses would now be published, debated, perhaps in court, analysed, and judged for its legal status, if a claim was filed.
 
It could hardly be argued the clauses were anti-competitor clauses, designed to enable Lindholm to fund cases against CMF without competition from LPF.  (Lindholm now part-owns another litigation funder).
 
Some other explanation for the inserted clauses would need to surface.
 
Perhaps Janes should now be seeking to stop Lindholm from drawing further attention to what was intended to be a private matter.
 
In my view this highly unusual sequence of events, stemming from an agreement that seems to me most inappropriate, must result in a re-examination of the criteria used by politicians when they appoint people to well-paid positions in government-owned corporations.
 
I repeat my view, that Janes’ chairmanship of CMF should have disqualified him as a candidate for such a key role in a Crown-owned entity.  His appointment set a problematical precedent.
 
Unfairly or not, the truth is that CMF was such an appalling company – investors fleeced, some directors and its CEO jailed – that none of its governors, including Janes, should ever have been considered for a governance role in a Crown organisation, least of all in a huge investment company.
 
Janes should have paid this price for what was either, or both, dreadful due diligence before accepting the role or appalling governance skills.
 
It is a private decision to retain Janes as chairman of Abano Healthcare but it is a public decision to expose him to the inspection required when he becomes chairman of the ACC’s investment committee.
 
That he could display success in his role at the ACC is not the yardstick by which my opposition should be judged.  Indeed he has been nominated by someone as ‘’chairman of the year’’ for his work at ACC, though this nomination was not supported by the panel who chose the winner of the award.
 
In my view the National government has lost significant credibility in capital markets by failing to understand the wider issues.
 
Janes could perhaps relieve some pressure by distancing himself now from the claim Lindholm has brought and by explaining in public the apparently self-protecting shield that the no-go clause appears to have created.
 
 _ _ _ _ _ _ _ _ _ _ _ _
 
OF COURSE, the underbelly of the finance company sector has left many people embarrassed and brought an end to many people’s aspirations.  The collapse was so devastating that collateral damage was inevitable.
 
Many of these who, like Janes, failed miserably in their role of governance, have chosen wisely in my opinion, to accept that they should no longer have a role in governing a company funded by the public.
 
Strategic Finance chairman Denis Thom, a founding director of Robt Jones Investments, a former president of the NZ Law Society, and the senior partner for a while of a medium-sized law firm, moved into full-time governance roles when in his 50s.
 
He became chairman of Wellington International Airport, chairman of Kirkcaldie & Stains, chairman of Urbus Properties (ex Waltus) and, of course, he chaired Strategic Finance, owned by Auckland property entrepreneurs Marc Lindale, Brian Fitzgerald, Wellington solicitor, the late Jock Hobbs, and eventually owned by Australian wide boys, Allco HIT, which itself went broke in 2008.
 
Strategic Finance, under Thom’s chairmanship, abandoned its strategy of short-term bridging lending and made what looked like ever bigger loans to ever riskier propositions, in places like Fiji.
 
It began to lend on greenfield developments but continued to be funded with short-term debenture deposits and like many others appeared to bamboozle itself with the idiotic IFFRS accounting practices that allowed capitalised fees and interest, repayable after many years, to be treated as cash, for the purposes of calculating profit, tax and dividends each year.
 
Inexplicably Thom and his board failed to see the myth of their declared profits, allowing shareholders to extract dividends from profit that never occurred, leaving the company with a huge hole when it went broke.
 
Despite Fitzgerald’s child-like view that Strategic would ‘’repay everyone 100c in the dollar’’, Strategic debenture investors lost about 80% of their money, an appalling outcome for an organisation that boasted about its bank-like credit rating.
 
Perhaps the worst aspect of this was that the company never displayed the amount of capitalised fees and interest that it was claiming as a profit.
 
Perhaps Thom, like lawyer Robert Whale at Dominion Finance, did not understand the misleading aspect of the accounts.  They were, after all, simple lawyers, not accountants.
 
To his credit, when Strategic Finance failed, Thom resigned from his other roles as chairman and seems to have retired, accepting that his use-by date had been revealed.
 
The only positive message I can deliver about Lombard’s pompous and commercially-childish chairman Doug Graham and indeed his fellow politicians and commercial goofs, Bill Jeffries and Hugh Templeton, is that the collapse of Lombard seems to have brought an end to their roles as guardians of investor money, Templeton retiring before the bell rang.
 
Graham was sentenced to community service and home detention for his simply dreadful governance of Lombard.
 
I still hold the pompous, priggish letter he wrote to me after I had written to warn him of the manure in the sack that Lombard was claiming to comprise edible oats.
 
Whale, after his disgraceful role in the deceitfully displayed Dominion Finance, seems to have moved away from governance roles, wisely, in my view.
 
Even the boyish Hanover chairman Greg Muir stepped down from his roles in Auckland sport, after his ineptitude in effective governance was displayed to the world.
 
Lawyer Bruce Davidson, who governed the liars and cheats at Bridgecorp, retired from future governance roles.
 
Entrepreneur Roger Moses, most improbably promoted as a governor of public investment, chaired Nathan Finance, whose behaviour bore no resemblance to its claimed behaviour.
 
Moses went to jail for his failings.
 
Wisely he has retired and no doubt regrets that his successful career as a salesman ever lured him into believing that he had the right ingredients to govern a business handling public money.
 
For all of the above – Thom, Graham, Whale, Davidson, Muir and Moses - I can find the kind words of saying that at least they now accept that they were not cut out for governance roles.
 
Perhaps it is fair to say that until one’s weaknesses are discovered, one might not know the weakness exists.
 
This may be true of Janes.
 
Capital + Merchant Finance lent money on highly speculative propositions, at very high rates, with often little or certainly inadequate security, and often with no or weak guarantees.
 
They kidded themselves that Lloyds of London would insure such idiotic loans for a tiny fee, as though Lloyds would put at risk hundreds of millions, lent by dopey colonials, for a reward of a few coins.
 
Capital + Merchant Finance published accounts that were an appalling representation of reality, misleading investors and even misleading the ASB bank, whose investment advisers allowed clients to put large sums into CMF.
 
Janes will not have been the only person fooled by all of this chicanery, much of which was perpetrated by the shareholders, of whom Janes was not one.
 
But a chairman is supposed to represent and protect all parties and very clearly Janes did not perform competent due diligence on the knaves who were cheating, nor did he see through the misleading narrative and the accounts.
 
Indeed he signed off the August 2006 prospectus, an act that by definition confirmed that its contents were in Janes’ opinion true, correct and not misleading.
 
Those errors were of such magnitude, and so easy to see, that they were defining of his governance.
 
For example, even a cursory thought about the insurance should have led to intense enquiry, and legally documented evidence that the insurer could be seen as the equivalent of real capital, of which the company had threepences and sixpences, but not even shillings.
 
Thom, Muir, Graham, Davidson, Whale and Moses have displayed the right response to such governance failure.
 
The other question one might ask, after the revelation of the private no-go zone was displayed in Lindholm’s filed legal action, was whether there are any more no-go zones restricting the litigation funder, LPF.
 
Clearly Mainzeal, the Crown, David Henderson’s cloak of fine cotton, and its auditors, PricewaterhouseCoopers are not in the no-go zone.
 
We know that LPF is already funding important litigation against them.
 
The publishing of the agreement, during the legal action Lindholm has initiated, will be of some interest, not just in legal circles but also, one imagines, in the Beehive.  So it should be.
 
 _ _ _ _ _ _ _ _ _ _ _ _
 
MERIDIAN Energy has announced a seven-year bond issue, details to be available shortly.
 
It is likely to be for an amount roughly equivalent to the $75m of Meridian bonds maturing in two weeks.
 
We anticipate it will offer a coupon at a similar margin over swap rates to the margin paid by its competitor Contact Energy, implying a Meridian coupon of around 4.75%.
 
Whilst I strongly dislike the growing pattern of corporate debt requiring an investor to access the issue by paying a fee, I cannot see this trend reversing.
 
Corporate treasurers dislike paying more credit margin or more fees than their direct competitors.  They treat this as a game.
 
Contact Energy managed to fill its issue at low margins and without distribution fees.
 
Many investors will find the Meridian bond ‘’appearing’’ in their portfolio, managed under discretion by their brokers.
 
They will then begin paying their broker each year an additional management fee, usually around 1% unless the portfolio is in millions.
 
An annual fee of 1% might reduce the Contact Energy return to 3.6% (before tax), making the purchase of doubtful comparative value, measured against bank rates.
 
In contrast, the one-time distribution fee of 1% equates to 0.14% per annum, so the Contact Energy investors who do not pay these obnoxious and uncommercial annual ‘’management’’ fees will get a return of more like 4.49% per annum.
 
Why any investor allows any organisation, least of all one with modest skills such as a corporate trust company, to charge an annual fee is quite beyond my comprehension.  On a $50,000 investment with Contact Energy, the annual fee-payer is worse off by $430 every single year.
 
Meanwhile investors wanting to buy the Meridian bonds need to get on a distribution list now.
 
It will reward all of its investors unless they are paying an annual fee to own it.
 
TRAVEL
 
I will be in Auckland on Monday 20 March, in in Albany in the mornin,g and Mt Wellington in the afternoon, .
 

David will be in Palmerston North and Wanganui on Wednesday 29 March and New Plymouth on Thursday 30 March. 
 
Michael tentatively plans to make a trip through Hawke’s Bay and Tauranga during the school holidays in April.
 
 
Please contact us if you wish to make an appointment.
 
Chris Lee

Managing Director
Chris Lee & Partners Ltd
 
 
 

 
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