Market News – 15 April 2019

General warning.

This note started after hearing the updates about how much money New Zealanders are scammed out of.

If you are ‘approached’ (phone, email, in person), meaning you did not initiate a request for service, and the communication is trying to draw you into an action that you did not intend, then you should back away.

At the very least, think it through with a very cynical eye and ask someone else for an opinion on the matter.

Some of you may have experienced the many businesses that try to convince you to open online trading accounts in financial markets. Often these businesses are based outside NZ and thus do not need to meet as many of our local regulatory consumer protections.

On a recent online advertisement for such online trading businesses I saw in a footnote, demanded by Australia’s regulator ASIC, the following words: ‘84% of accounts trading in derivatives lose money’.

If I remove the professional traders who hold accounts from this data then I speculate (pun intended) that it is nearly 100% of retail investors losing money when trying to trade derivatives through these online accounts.

Don’t be drawn into this either.

INVESTMENT OPINION

Selling Future Cash Flows – Businesses, and people, are discovering different future cash flows to sell to investors and extract large sums of money today, for use on different spending/investment purposes.

Actually, I hope it is a different investment purpose because selling one’s future cash flows implies introducing a cost to that money (just like debt).

Last week Sky City Casino advised the market that it had sold 29 years worth of revenue from its Auckland car parking for $220 million. (we knew we were paying too much for commercial car parking – Ed).

This SKC transaction discloses various things but one is how the recognition of low interest rates has sunk in with investors and how investment managers (Macquarie in this case) are hunting for assets with cash flow certainty to discount at a yield a little above current interest rates and then present it to investors as an opportunity, which it is.

The reality is that Macquarie will probably place this new asset immediately into client portfolios (pass the car park risks to the investor) and begin earning their annual fee so don’t expect it to be re-offered to retail investors via public offer.

I say this as if Macquarie has done something bad; they have not. They, and SKC management, have discovered another reliable cash flow that can be sold to investors who crave regular cash flow with a reasonable return.

Armed with data about the probable cash flow from the car park SKC has agreed a yield to offer to investors who wish to buy that cash flow, thus determining the purchase price today.

I originally thought that yield might be 5% or 6%, but subsequent information implies they gained a yield closer to 8.00%, which seems a little high to me (a loss of opportunity for SKC).

I think you can be sure that the yield offered will be lower than SKC’s cost of capital (the money they use to own their car park) so passing the car movement and cash flow risks to someone else, at a yield below their cost of capital (money to run the business) is a good way to raise $220 million and reduce debts or invest in more rewarding business activities.

I ponder why SKC and other business do not begin to offer such investments to the public directly; annuities with yields dependent on the revenues collected in the car park.

Macquarie is a wholesale buyer, which means the return sought would be higher than a business might achieve if they sell the asset directly to retail investors.

If SKC had offered this investment to retail investors, some of whom might be attracted to an annuity, they might have been able to temporarily sell the asset at, say, a 5.00% implied return.

The cash flows from a car park for 20 years would provide a nice annuity product to investors without the need for an investment manager, and thus avoid the impost of annual management fees which damage returns so deeply in today’s low return market.

If other businesses aren’t so keen on this idea maybe council or government controlled operations could sell off some of their most reliable cash flows to retired investors?

I’m thinking city council parking buildings where they can isolate the actual performance, as opposed to street parking with its vagueries (and desire to push lower with bike use – Ed), or parking fines, which might be a novel one.

In an even more interesting twist on this theme I read an article in the US that described how some students are selling a proportion of their future earnings to raise capital to finance their way through college!

The subtle difference between borrowing money and repaying, or selling future cash flows, is who carries the risk.

If you borrow money, you carry the risk and you must repay the debt obilgation (capital and interest).

If you sell a future cash flow, without guaranteeing the scale of that cash flow, the person who buys it from you carries the risk relating to interest and capital return.

You can see why the simple loan (fixed interest investment) should have the lower interest rate, and why the sale of a future cash flow should at least offer a higher potential return against the additional risk accepted.

I hope some other businesses follow Sky City’s lead and offer amortised cash flows to investors, especially those who are comfortable spending some of their capital in retirement because as a generalisation I would view this as a better option than paying rather hefty fees to the likes of the Lifetime Income Fund to manage capital spending.

I ponder now whether I could sell my National Superannuation payments to my kids, based on an assumption that I’ll live to be 100 years of age?

Business is hard – I saw a headline on Bloomberg last week that was exactly what I had been thinking as I read about the Boeing 737 MAX problems.

The headline was: ‘Anyone who tells you running a business is easy has clearly never tried’.

I don’t want to drift too far in to politics, but politicians would do well to avoid assumptions that private business is a pathway to riches for it places those regulators on their own pathway to the dangers of envy.

Boeing did not set out to have the problems they encountered recently. They are an example of the constant risks faced by businesses and for the most part resolved by those businesses, as they must be, otherwise the business fails.

Of interest to me is the software aspect of the 737 MAX failures.

Boeing make excellent aeroplanes, but as an increased reliance on software is added the business risks have been amplified, not reduced.

Extrapolate this thought to the many businesses using ever more technology and claiming that artificial intelligence will soon replace humans in many fields.

This is something I doubt very much.

Yes, technology and science are helping us along a path of improvement, as one would hope, but computers are not consumers; we need to keep the labour force employed too, otherwise the economy fails.

Relying solely on technology will be a brave move, perhaps too brave, as Boeing is finding out at present.

Believing that business is an assured pathway to excessive riches would be a foolish conclusion for regulators.

Infratil (IFT) – I had one of those Dr Who time warp moments last week when attending Infratil’s annual Investor Day; has it really been 12 months?

As usual, the event was very well organised and informative. IFT has a proud history of good communication with its stakeholders.

The major message was that the portfolio reset (simplification) is largely complete with a couple of items yet to sell.

Interestingly they use similar terms for their portfolio as I do for mine in trying to describe assets as ‘Core’, ‘Core + / Growth’ (‘Supplementary’ for me) and ‘Development’ (‘Explore’ for me).

Whilst they describe all assets as having the potential to be sold, I’ll bet they hear Lloyd’s ghost loud and clear if they ever offer up Trustpower or Wellington Airport for sale. These two businesses provide the water-tight cash flow that all investors crave and thus provide a good proportion of the underwrite for the risks management likes to take in ‘Core+’ and ‘Development’.

The strongest sub-messages were:

Hugely exciting performance by the Canberra Data Centre business, which has now expanded into New South Wales and is wearing running shoes, not loafers, to keep up with customer demand for the service;.

Marko Bogoievski (IFT CEO) speculates that CDC will become IFT’s single biggest asset, soon; and

Very strong performance by Longroad in the US where all original capital has already been returned and the residual business value is $128 million with plenty of new projects underway.

HRL Morrison & Co (MCo) was challenged on the day about their fees after a stellar year of outperformance for IFT and whilst the nominal numbers are indeed large I don’t buy into this argument.

Fees for managing IFT are described ‘on the tin’.

MCo’s fees for outperformance are attractive for them (at 20% of outperformance), but it is 12% per annum that they must outperform which was reasonable when set, relative to the lofty 15-20% targets set up by Lloyd and is surely more reasonable now in a world of collapsing interest rates and relative returns on equity.

Sure, I’d rather own shares in MCo than IFT, but that’s not what was offered on the tin.

I doubt that the financial advice industry will be too vocal about MCo fees because many in our sector charge fees at ratios that have a familiarity when viewed alongside MCo’s (excluding us of course).

What IFT investors do receive is the demonstrably strong management skills of the MCo staff whose performance is far better aligned with IFT shareholders than those tangled up in the recent fee debate surrounding Vital Healthcare Property Trust.

Today IFT shareholders will be rather happy about the recent 30% increase in their share price. If they’d like to understand some of the reasons how this happened they’ll find more detail on the company’s website: https://infratil.com/

INVESTMENT NEWS

Young Business Successes – There was a good article sourced to Callaghan Innovation last week about the growing number of NZ start up businesses that are succeeding, and often doing so on the global stage.

Callaghan highlights the importance of these businesses being able raise new capital, and for founders to be willing to exit their ‘baby’ to reinvest such funds into new ventures (capital recycling) for the ongoing success of the NZ economy.

The NZX would agree with the economic benefits of raising new capital and expanding the register of owners of a business and would undoubtedly welcome all comers to list their businesses on the local exchange.

Callaghan rattles off various successful names such as Xero, A2 Milk, Lanzatech, Rocket Lab, PushPay, Vista, Gentrack and My Food Bag, whilst carefully not dwelling on failed businesses, observing that successful new businesses have added $34 billion of value over the past 15 years.

I noted one Wellington based business that wasn’t recorded in the article, which I have been following (disclosure – I own a few), by the name of Volpara (VHT.ASX). Volpara operates in the health sector (breast cancer screening) and has developed a software application that is effective enough to have already captured 7.1% of all women screened in the US.

You might notice from the code above that Volpara is listed on the Australian stock exchange, but not NZ, which is a problem that the NZX must resolve for NZ investors.

Another article, on a similar subject, confirmed that Sam Stubbs has been able to repay his personal loan of start up funding to Simplicity Kiwisaver because outside investment is now being attracted to support this business.

It would be nice to learn that Sam is considering recycling his own capital into another new business venture, or that he is supporting the ventures of others.

The thrust of the Callaghan story though is that NZ, and NZ entrepreneurs, are becoming much better at trying to build businesses to serve the world and not just our local village.

Here’s hoping that a few of these businesses remain listed on the NZX to provide ‘us’ with direct access to more investment opportunities.

Maybe the NZX could consider launching a Smart Share ETF that focuses on investment in immature businesses that meet certain early stage success criteria?

Global Growth – It’s not great news, but it needs reporting to investors; the International Monetary Fund has again reduced its global economic growth forecasts (3.6% in 2018, expecting 3.3% in 2019).

This is consistent with the sharp fall in interest rates recently, for short and long terms.

AirBNB tax – AirBNB has agreed with Danish law makers to supply data relating to the 39,000 who list their properties in Denmark via the property sharing platform.

For the first two years the data will be manually supplied but by 2021 information flow will be automatic. This sounds as if Danish tax authorities need time to develop their technology to receive the data live.

Denmark has an efficient tax at source economy and it clearly wanted this new revenue development to be captured in the same efficient way. So should all economies.

AirBNB is doing the right thing. They have no role in each different country’s tax or land use regulations so reaching agreements to transfer data to regulators ensures business longevity and shouldn’t have much impact on the financial performance of the business.

Regulators simply want to collect tax based on revenue (and capital it would seem – Ed).

New Zealand is also moving further down the tax at source efficiency model.

Given the scale of tourism in New Zealand our IRD would do well to get on a plane and ask AirBNB for the same agreement for NZ property use.

EVER THE OPTIMIST – You must admire the likes of Sir Stephen Tindall for the financial commitment he, and others, make by investing in multiple young businesses.

These people are often reinvesting money from their own successes and typically offer time free of charge to help these ‘businesses with real potential’ to push further forward.

I see a lot of this happening in the venture capital clubs around NZ.

The item that caught my eye last week related to Sir Stephen providing financing to ‘Simplicity’ Kiwisaver which is an example of him supporting competition that aims to avoid domination of an industry by ‘the few’.

It is very hard for most investors to invest in these evolving businesses, but you should be pleased that there is a lot happening because it is a sign of a healthy financial market populated by enthusiastic business builders.

ETO II – An oblique extract that I took from the Infratil Investor Day was that within many global democracies there are safety valves to dilute the short term impact of ‘incompetent’ leadership.

Some examples were given displaying that whilst central government can charge ahead with strategies that do not have wide support (think President Trump or the Australian Federal government) individual states can make their own decisions about what they will allow locally.

Longroad (Infratil US company) explained how Trump can be anti the Paris Accord and a cheer leader for the coal industry but California has enacted a 100% Clean Electricity Standard and many others are following the same path.

Tilt Renewables are witnessing similar behaviour in Victoria and NSW Australia.

This doesn’t, of course, help where dictators preside (Russia, China, Turkey etc).

INVESTMENT OPPORTUNITIES

Metlifecare – Possible new bond.

Given the directors hints that they may also buyback some of their own shares at current market pricing this new bond offer seems inevitable to me.

Napier Port – The regional council has approved the sale of some shares in the port and now appointed its lead managers to bring the offer to market (in the months ahead).

A new holding company has been formed.

This is an exciting development for investors, and the NZX, and we look forward to this Initial Public Offer reaching the market.

We have a contact list for investors wishing to hear more about participation in the float of Napier Port.

Mercury Energy – Investors holding Mercury’s subordinated bonds (MCY010), which come up against their next Election date on 11 July 2019, should expect a communication from them by early June.

My mix of grey hair and speculation concludes that these investors will be offered an opportunity to either exit their investment or reinvest in a new similar bond for another term.

If a new replacement bond is offered it seems highly likely that new investors will be invited to participate, which helps ensure that the same total amount of funding is retained by the company.

Rabobank – Whilst I am considering complex subordinated bonds, I DO NOT expect Rabobank to offer a new investment to holders of the RCSHA perpetual bonds.

It is our view, based on repayment of the RBOHA and Rabobank statements about these securities, that RCSHA will be repaid on 18 June 2019.

If we are correct you would expect to see an announcement by mid May.

TRAVEL

 

Edward will be in Tauranga 29 April, Blenheim on 15 May.

Kevin will be in Christchurch on 17 April and Ashburton on 9 May.

Mike Warrington