Market News 19 October 2020

Covid19 and potential vaccines have become outsized stories in the media, alongside a constant barrage of political pieces.

I see even Jacinda is promising 'vaccines by Christmas', which feels like a glaring example of over-promising and …

I decided to spend some time reading all that I could find on the status of Covid19 vaccines; digging deeper was a useful exercise.

I am convinced that the quality of the human brain and the speed of current technology for processing data means that the world will have Covid19 treatment options 'soon' (2021).

There’s no point in my guessing their effectiveness other than to say they will help to restrain the impact of this highly contagious health threat.

The more effective the restraint (control) the more freedom will return to normal movement by the population, which in turn is to the broad benefit of economics.

Thus, from an economics perspective Covid19 is a short duration problem. By short duration I mean 2-3 years, whereas by contrast our economies are very long duration.

You and I need the Port of Tauranga (POT), and many other businesses, for decades so a 2-3 year health problem only has a modest impact on present value, which you can see in the current POT share price.

I read that the world has 211 registered Covid19 vaccines under development and nine have already reached phase 3 trials (last stage prior to wide distribution, if safe).

I don't want to get into the political debate of which nation will 'win' the prestige of delivering effective Covid19 vaccines first, but there will clearly be more than one. Politics is the art of doing and saying things that will attract votes/support (economically valueless!) whereas science is the assessment of evidence and pursuit of facts.

My favourite quote though was iced with politics, emanating from China – '3,000 of our employees and their family members have voluntarily taken the trial vaccine'. (bold highlight is mine)

With respect to the world's health everyone should hug a scientist (and a nurse – Ed) and ignore politicians.

I am certain that the world's scientists will improve the health landscape again and I hope that regulators and insurers don't impose unreasonable restrictions on population movement in future.

INVESTMENT OPINION

Australia vs NZ – For the first time in many years Australia and New Zealand's governments seem to be pursuing quite different economic programmes.

This will surely lead to different economic outcomes and investors should factor this evolving situation into their thinking.

I am certain that if I asked Jacinda Ardern and Scott Morrison the same question  about who will be more successful (jobs, economic growth etc) they would both predict victory 'locally'.

The most polarising item relates to tax:

Australia – tax cuts, accelerated spending, 'push' the economy and hope this delivers the tax revenue and net financial position required by the nation;

New Zealand – tax hikes, hoping debt control and a restored financial position will lead to a better financial outcome.

Both live in hope but they are now separating at the 'fork in the road'.

The 'spend now, worry later' Australian option may not feel right to many conservative households, but my instincts tell me that Australia is likely to enter a period (years) of outperforming NZ economically speaking.

From a patriotic perspective I hope I am wrong.

Maybe this situation is a bob each way, because if Australia does well we are presented with a wealthier customer to sell products and services to? (if the skies and borders are opened – Ed).

It's an interesting development and one I'd like our leaders to keep a close eye on, just in case the local strategy shows signs of frost burn.

Placement Issues – EROAD's share purchase placement (SPP) last week continued the evolution of how businesses raise new money (equity) without doing a pro-rata Rights issue to the current owners (shareholders on the register).

The results of the SPP confirm that an investor's prior shareholding influenced the shares received in the SPP. I know three people who sent in the maximum $50,000 and all received a different allocation of new shares, but in each case the allocation reflected a similar ratio to their original shareholding.

A fair outcome you might say.

Well, maybe, but maybe not.

This proportionate response is indeed progress from the early days of SPP where most applicants received the same number of new shares regardless of the scale of their prior investment with the company.

This disruptive allocation process quite rightly fuelled intense criticism of the businesses.

Imagine if you owned 10% of a widget making company and then you were told by the directors that they had doubled the size of the company through a placement of shares to new investors and that you may access a small handful via an SPP, leaving you now as a 6% shareholder of the business?

Imagine if your prior holding happened to be 51% (i.e. control of the company).

I understand the need for a business to attract new capital and to widen its share register, which was a significant driver for EROAD who wanted to invite Australian investors on to the register as the company became dual listed on the ASX.

This was quite clearly the motivation for ERD because they appointed two Australian share broking firms to manage the overall transaction.

This made sense and ERD directors quite rightly view these developments as adding future value to the business for all shareholders.

However, let me come back to why an SPP may yet not be entirely fair to retail shareholders of a company.

A retail shareholder has no idea how much demand there will be for a SPP offer before they must submit their application for more shares (ERD offer was $8 million, they received $18.46 million of requests from 1,236 shareholders).

If an investor is enthusiastic about gaining additional shares they are likely to send in more money than for the shares actually sought; the people I spoke to sent in the maximum of $50,000.

These investors accept that the company may choose to retain the whole $50,000.

However, what really happens is that as soon as demand exceeds supply (see ERD example above) the company begins to scale back allocations based on a person’s prior shareholding.

The investor has essentially provided the company with a free underwrite (certainty of settlement) for its SPP and underwrites (risk transfer) should not come free, especially if the scale of the financial risk is unknown and thus cannot be factored into the purchase price agreement.

I don't want to pretend that a pro rata Rights issue is the only way a company can raise new equity because this clearly makes it very difficult to encourage significant new investors to support a company within a short time frame, however, board directors need to be very careful about any share price discounting offered when placing new shares and immediately diluting the current share register.

For you, the investor, you'll never know the scaling (reduced allocation) impact until after the offer closes. It's just a risk that you must factor in to your decision making.

Scaling – Extending from above, but changing into the market for Initial Public Offers (IPO) of bonds and shares, one of the most common questions investors ask when participating in a new offer is 'will my request for an allocation be scaled?'

A supplementary question is usually, 'if the risk is 50% scaling shall I double my bid?'

Our answers are always:

There is no way of knowing the impact of scaling until after requests are in. This knowledge rests solely with the decision maker at the company raising money and the lead managers, and even then this knowledge comes after the close off for the deal;

No, you should not increase your bid artificially. Accuracy is always the best information to present;

Any bid presented is irrevocable, we cannot withdraw it from the process after bids are in with the company, so if you ask for double and receive it then payment is required. Please be sure you can tolerate this risk if you ask for a large allocation.

Statistically speaking we are rather proud of the allocations typically received by our clients in bond and share offers presented to the market.

Centralised Crypto Currency – development is not off to a good start.

Seven (egotistical) central banks have met to set a framework for how digital currencies might work in conjunction with paper money.

The report highlights three key elements of the proposal -- cryptocurrency coexisting with cash in a flexible payment system, supporting wider policy objectives and promoting innovation and efficiency.

How exciting (not). I can see the whiteboard, mints and water carafes now.

Wait, here's a few more buzz words: the core features of the digital currencies are that they will be resilient and secure to maintain operational integrity, convenient and available at a low or no cost to end-users, underpinned by appropriate standards and a clear legal framework and have an appropriate role for the private sector.

The seven bankers were: Bank of International Settlements, Bank of England, U.S. Federal Reserve, Bank of Canada, Bank of Japan, the European Central Bank, Sveriges Riksbank and the Swiss National Bank.

No Bank of China, a leader in technical developments for crypto currency?

 

No Australia or New Zealand, two other heavily traded currencies in foreign exchange markets. India, Russia, Africa, Latin America?

This elitist approach to internationally linked, countrywide, crypto currencies will have like private providers of crypto currency and alternative methods of instant payments rubbing their hands with glee.

I had hoped that technology (crypto currency) would have enabled real time, trusted, free, payment methods (without cash) for all consumers would have been with us during the 2020’s but it is looking a lot less likely based on the minority trying to dictate how it should work.

 

EVER THE OPTIMIST

Credit card debt in Australia has dropped by 23% over the past six months to $20.6 billion, its lowest level since 2004.

Some will have been replaced via the new laybuy finance schemes but it appears that the penny has dropped for consumers; repay the ludicrously expensive debt and build up some financial reserves to cope with the next financial pressure point.

ETO II

The NZX deserves to feel a little relief after learning that even the mighty Japanese stock exchange was forced to close due to technology issues a couple of weeks ago.

Apparently they don't even stop for natural disasters, so it was clearly a serious matter and would have involved a lot of bowing.

Investment Opportunities

TWC Quantum is proposing to issue shares in a recently renovated building in Wellington, which is currently being converted into residential apartments. A long term lease will be put in place to give investors certainty of income.

The projected income, after expenses, will allow for quarterly dividends, at a rate of 7.50% per annum.

It is proposed that the building will be funded by 50% equity and 50% debt.

It is proposed that there will be a minimum investment size of between $10,000 & $25,000. This will be detailed in the offer document once completed (likely in November).

Argosy – ARG completed its $125 million 7-year bond offer last week, with an interest rate of 2.20%.

Thank you to all who participated in this bond offer through Chris Lee & Partners Ltd.

TRAVEL

Kevin will be in Timaru on 3 and 4 November to meet with clients (and to reminisce).

David Colman will be in New Plymouth on 3 November and in Wanganui on 4 November to meet clients.

Edward will be in Auckland on 20 November and will see clients in the CBD.

Please let us know now if you would like an appointment in your town or if you would like us to visit your area.

 

Thank you.

Mike Warrington