Taking Stock  30 April 2020

CRAZY investment and market behaviour precedes every market collapse, as all of us with the remnants of a memory will testify.

I recall reading that in the years leading to the world crash in the late 1920s, America had banks and broking firms lending money to speculators in the shares of all manner of improbable companies.  Banks fell over like aerosoled flies when prices collapsed, their loan books in disarray.

Before the 1987 global property and share market collapse, brainless behaviour abounded, banks lending to people who thought they could guarantee future share prices, property values hydraulicked by crooked valuers, new companies seeking public money for such improbable ideas as breeding opossums for their fur and as dog food.

Prior to 2008 we had such appalling regulator focus that finance companies were allowed to falsify their liquidity charts, lie about the nature of their lending and pay their owners huge dividends with borrowed money, their displayed profits depending on future loan collections that never transpired.

From all these versions of chaos I foresee two certainties that all investors should regard with alarm.

The claimed valuations of properties will again be seen as based on the most vulnerable of models.

Swathes of valuable assets will be given away by process-driven, unthinking receivers and liquidators, ungoverned by any meaningful supervision.

These two outcomes are certainties.

Sadly, our recent governments of both hues, and our public sector, have not had the knowledge, experience, energy, motivation or wit to prevent yet more examples of bonfires of other people's money.

The history of our markets over the past five decades display the relationship between high-flying markets, greed and those who fuelled the bonfires - the banks, the valuers, and the market regulators (not to mention crooked directors).  The politicians enabled all of this.

In the times leading up to the 1987 property market crash there were any number of examples of valuers feeding the market with garbage.

My most vivid memory is of a valuer who enabled Registered Securities Ltd to dupe the most innocent of investors, including the best friend of my grandmother, who was visited at her home by a local RSL salesman, offering her a 24% return at a time when the Rural Bank was lending on first mortgages at 24%, and the government stock rate had recently hit 17.5%.

The RSL salesman offered a toxic contributory mortgage scheme, run by dishonest  lawyers in Auckland, and overseen, at the ultimate cost of their demise in New Zealand, by the accounting firm Arthur Young & Co.

RSL promised to lend no more than two thirds on the ''value'' of any property calculated by a registered valuer.

This is how they conspired to cheat.

RSL bought for $23,000 a small house in Foxton.  It then created a company with capital of $100 which agreed to lease the property for an annual rental of $25,000.

The cheats found a valuer whose valuation model used a multiple of the promised lease payment.

If there was a lease agreement of $25,000 per annum, the house must be worth $150,000, enabling RSL to raise two-thirds of that within its first mortgage lending guidelines.  Investors found $100,000 of their money put into the ''first'' mortgage of a house that RSL had just bought for $23,000. 

The dummy company never paid the lease, surprise, surprise.

The mortgage fell into arrears.  The house was sold.  The investor recovered 20 cents in the dollar.  The valuer was not asked to repay his fee.  The supervisor, Arthur Young, was ultimately required to meet the shortfall and in doing so was forced to abandon its accounting brand, ruined by the impost of a $38 million subsidy to investors cheated in part because of Arthur Young's negligence.

This may seem an extreme example of deceptive valuation practices but such deception recurs every time markets become over-heated, if these days in a more subtle form than RSL selected.

In the years leading up to the 2008 crash the serial Christchurch defaulter David Henderson gave us another splendid example of how valuers mislead innocent investors.

He ''bought'' land owned by a Maori group in my home town, Paraparaumu, convincing the owners to leave in vendor finance and accept an unregistered mortgage.  The deal was for around $3 million for a few acres of gorse-covered swamp land.

A crooked valuer was flown into town to value the land on the basis that it would be re-zoned.  In the final iteration of the various valuations he assessed the land was worth $35 million.

Unbelievably, the ASB and BNZ, and more believably Hanover Finance and Dominion Finance, lent a total exceeding $20 million on this miraculously revalued land.

Readers may be perplexed that none of First Step, St Laurence or Bridgecorp had lent on the same land.

The only credible explanation for this may be that they were never told of this wonderful opportunity to lend at 25% to a serial defaulter on land absurdly over-valued.

Of course Henderson's borrowing entity did not repay and the land was sold as you might guess for a figure of less than a fifth of what the ''valuer'' had assessed.  One wonders what he was paid for his work.

Last week we learned from Asset Plus that its valuations have fallen from the heights estimated by presumably sincere valuers, pre-Covid.  Kiwi Property Group has had the same experience.  Property is not worth what valuers had assessed.

Some shareholder wealth has vanished.

Goodman, Property For Industry, Argosy, Stride, Investore and Precinct will presumably have the same adjustments to make at some stage.

Then we will hear from the retirement villages, where again the old valuations will be revealed as ''changed''.

Yet it is not these valuations that I sense will cause the most havoc.

More interesting will be how bankers react to unlisted property companies and private investors who use much higher leverage, some even borrowing up to 70% of valuations, supporting their applications for bank debt with ''personal guarantees'', themselves valued at estimates of wealth generated from dubious property valuations, as the banks will soon discover.

Will the banks react as they did in the 1980s and a decade ago, enforcing debt reduction, leading to sales in what might be an illiquid market?  Banks need more capital for loans that become high risk. They are not likely to regard such borrowers as deserving leniency.

One has to hope that the unlisted mortgage trusts, which have no capital at all, will have used the most conservative valuers.

Property valuations are at best a fickle source of wealth estimations.  They are based on recent, historic data and assume that if one buyer paid a sum for a like building, there will be another buyer itching to purchase another at a similar sum. Only a fool claims wealth based on a valuer’s report.

Investors will display wisdom by becoming familiar with which valuers are discredited in the next round of commercial property price falls.

Never Again lists may appear on this website.

_ _ _ _ _ _ _ _ _ _ _

VALUERS prosper in frothy markets, where deals are chased by inexperienced or incompetent people who view the acquisition of wealth as being part of a 100 metre sprint, rather than the outcome of a long period of achievement and excellence.

In contrast, receivers and liquidators prosper when the foam has dissolved, revealing dirty, cold water and corporate corpses in many business districts.

The insolvency practitioners are unsupervised, basically charge as much per hour as they like, and can file their time sheets knowing they will rarely be challenged. They can engage and pay others in their network whatever they wish to charge.

They live in an unfettered world where bills are paid with Other People's Money.

There is no better example of appalling destruction of Other People's Money than was displayed in the fire sales of South Canterbury Finance where the receiver, McGrath Nicol, produced the worst receivership outcome I have ever seen.

This story is chronicled in a chapter of my book The Billion Dollar Bonfire.  The chapter should be used in every university course that discusses the subject.  I have made the book available electronically, at minimal cost, to make it accessible by universities and students.  Put politely, McGrath Nicol simply destroyed value on a massive scale.

To re-cap, the assets of SCF belonged to the tax-payer of New Zealand after the Crown bought out investors by repaying the investors and taking over the first charge on SCF's assets, an action the Crown had promised, under its Deposit Guarantee Scheme, created by Clark’s Labour government.

Treasury sought guidance on how the receivership should proceed and was told by the private sector (PWC, itself with a large receivership division) that hundreds of millions would be destroyed if a receiver was allowed to sell assets quickly, in the distressed markets that prevailed.

PWC advised that the receiver should patiently manage the receivership over four to six years.

Treasury went further and in advising its Minister, Bill English, recommended that the receiver be supervised by an independent panel over that four to six-year period.  English agreed in public!

Unbelievably, the John Key National Cabinet decided the receiver could do what he liked, as quickly as he liked, without supervision or even Crown guidance.

In reaching this appalling decision, Key's Cabinet presumably were just revealing their collective lack of business acumen, judgement and intelligence, rather than displaying a fiduciary disconnect or a preference for the political advantage of blaming the previous Labour government for its errors with its SCF guarantee.

Perhaps the Key Cabinet was just asserting that ''a hundred million is chump change'', as Key himself had stupidly asserted in March 2011.

Perhaps the Cabinet wanted no focus on a series of cover-ups of related Crown errors.

Whatever, the receiver flogged off real assets at giveaway prices, perhaps emboldened by advice from lawyers and others whose extreme pricing of their advice bore no relationship to the minimal wisdom, knowledge and market understanding they were revealing.

At least a billion dollars of Other People's Money was dusted.  No one was accountable.  Random passers-by became instant multi-millionaires when they bought the discounted assets. The book provides examples of this.

That disaster demands a legal response.  We need new law, requiring receivers/liquidators to be overseen by a panel representing secured and unsecured creditors.

Furthermore we need receivers/liquidators to be personally accountable for their decisions and behaviours; financially accountable. We need this accountability to be decided by a cost-effective process ultimately providing rapid, cheap access to the High Court.

So far, nothing has changed.  Politicians do not care. They pretend not to notice the stench.

Lamentably, the mountain of work shortly to pass into the hands of receivers and liquidators will be conducted at whatever cost they wish to charge, with as little regard for the unsecured creditors as they choose, and with little regard for the hapless owners of the businesses that Covid-19 has helped to destroy.

If the future is like the past, there will be no supervision, no accountability, no maximization of returns, and no justice for incompetent insolvency practitioners. The Minister of Commerce, Kris Faafoi, will be otherwise occupied.

The buyers of assets forcibly sold will collect windfall gains; families will be destroyed because of greed, laziness, incompetence and a visible preference for Old Boys Networks and the status quo. 

As we face thousands of receiverships and liquidators we have a choice.

We can do nothing; or we can raise merry hell, embarrassing our politicians forcing them to rip into the Minister of Business, Innovation and Employment, and demand new laws.

Supervision, transparency and accountability must be enforced by a court system accessible to those without pockets deep enough to buy legal representation.

Do we care enough to act now? Faafoi's mail address is Faafoi, Private Bag, Parliament, Wellington.

_ _ _ _ _ _ _ _ _ _ 

AS the results of the various fund managers and KiwiSaver managers arrive on investors' screens, one conclusion is undeniable.

The active managers did not, perhaps could not, reposition their portfolios early enough to escape major damage in the first quarter of this year.

The index funds and Exchange Traded Funds did as they were designed to do - reflect an index beginning its fall, after a market-changing event.

Though I am no fan of the bonus-loaded funds management sector I have some sympathy for the active managers, who seek to use research to avoid poor-performing companies in preference to companies they expect to shine.

Lack of market liquidity denies any scaled fund the opportunity to sell everything on any given day.

There is one other important factor.

No active fund manager likes to abandon hope so the decision to sell, even the decision to discard leading stocks, is always compromised by a fear that short-term under-performance would lead to investor or mandate withdrawals.

Indeed it was only a few months ago that two fund managers in New Zealand wrote to their investors apologising for being too risk-averse, as their lower-risk portfolio returned less than their more aggressive competitors.

Active fund managers simply find it too risky to make a decision to eliminate sectors and market leaders from their portfolio. They prefer to under-weight, in case their analysis is wrong, or mis-timed.

Index funds and ETFs have a different problem.

One index fund executive contacted me, in essence criticising my habit of regarding all passive fund managers as having the same shortfalls.

He was right.  Index managers are not the same as listed ETFs, though both share common traits.

They do not invest in research.

They invest by a rule book, by rote.

They do not focus on value (but on weightings).

They market themselves for the cheap fees, rather than their skills.  Cheap is said to be better.

They all seek a share of the money collected by pension funds, sovereign funds and those funds that attract individual contributions from people who save.

Because they meet their promise to obey their rule book rather than promise to research and apply skill, the passive managers can never be criticised for poor results.

Their clients get what the markets deliver, every time.

New Zealand is overcrowded with niche fund managers, having wisely grown up from the days when ludicrously expense-ridden, poorly-managed funds like AMP, Prudential, National Mutual, Tower and the banks had the market to themselves.

The current market, which has trembled but not collapsed, will provide the research-based managers with an opportunity to prove that skill and knowledge has a value.

The April reporting season does not endorse that yet.  One suspects that we are in the early days of an environment that will test the theories.

_ _ _ _ _ _ _ _ _ _ _

Johnny Lee writes:

THE sharemarket continues to show its resilience as April draws to a close, with the index closing up for the month as the Government begins to unwind restrictions on freedom of movement.

Amidst the stories of collapse from within our hospitality industry, our listed companies are winding back expenditure and shoring up balance sheets, showing the full benefit of having a diverse range of shareholders and access to capital.

Investore, one of the smaller property trusts listed on our exchange, is the latest to pass around a hat, asking shareholders for $15 million to supplement the $85 million raised from institutional shareholders earlier in the week. The offer includes a variable pricing mechanism, meaning that if the share price falls to certain levels in the lead-up to the offer closing, subscribers to the offer will pay a reduced price.

At the same time, National Australia Bank, one of Australia's ''big four'' banks, has announced a much larger capital raising, raising $3.5 billion, of which $3 billion has already been raised at $14.15 a share from institutional and overseas investors. Retail investors will make up the remaining $500 million in an offer to follow shortly.

National Australia Bank, like most banks, is expecting a huge spike in bad debts in the wake of the Coronavirus, as businesses fail and unemployment spikes. Unfortunately, many of the major banks have found themselves unprepared for the severity of shock, having spent profits on share buybacks and dividends during the stronger years. 

National Australia Bank is also slashing its dividend. One can expect most businesses will be making similar changes, as they hoard cash to see themselves through the anticipated downturn. I note that ANZ Bank has cancelled its dividend in response to the crisis.

Kathmandu and Auckland Airport have both completed their respective capital raisings, with differing levels of success. 

Kathmandu was unable to raise the full amount from shareholders, relying on its underwriters to make up the shortfall. Underwriters are rarely long-term investors, especially in an environment where capital is urgently sought after. 

The failure to entice retail shareholders is unfortunate, and perhaps justifies the tendency of some companies to rely on larger institutional clients for capital injections. Despite the hefty discount, retail investors were either unwilling or unable to participate.

Auckland Airport's offer of new shares, by comparison, closed well oversubscribed. Scaling will occur, with reference to shareholders’ original amounts. Shareholders of 100 shares, applying for $50,000 worth, may find themselves out of luck.

Auckland Airport now has significant reserves, giving it flexibility to endure what it considers its ''worst case'' scenario. Although earnings and dividends may be lean for some time, survival is assured for now.

We expect more capital raisings in the weeks ahead, and clients are welcome to contact us to discuss.

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

THE NZX has recorded a leap in revenue, showing the value of its diversified approach and its efforts to encourage greater participation in capital markets, especially from the younger generation.

Funds under management is growing strongly, courtesy of its Smartshares product. This avenue is becoming a major source of revenue growth for the company. Its willingness to take chances in offering unique products appears to be paying off, providing retail investors with the ability to diversify into sectors and countries that are otherwise unaffordable or inaccessible.

Trading volume, the number of individual transactions occurring on the market, leapt almost 200%, although the average volume has not matched this pace. Far more smaller trades are occurring.

This is largely a global trend, as more and more younger investors take the plunge into sharemarkets for the first time. Retail brokers in the United States are reporting huge growth in young people buying small numbers of share for the first time, especially in stocks that are popular among young people, like Tesla and Apple. In New Zealand, companies such as Cannasouth attract huge numbers of buyers, sometimes only for a few dollars' worth of shares.

A large driver of this has been low interest rates, while others have been attracted to the idea of buying shares and holding them long-term while the market has fallen.

NZX shareholders can be pleased with its progress, especially during difficult times, as its long-term strategy begins to pay dividends.

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

THE dispute between Metlifecare and APVG appears to be escalating, with both sides engaging in a preliminary legal dispute over the terms of the takeover, released to the stock exchange this week.

The market continues to price the shares well below the $7 takeover price, perhaps reflecting the level of confidence shared with the board. 

The issue is complex and seems destined for independent adjudication. I would be amazed (and delighted) if the conclusion resulted in the offer proceeding. I would be extremely disappointed if it concluded with millions wasted in legal fees chasing an improbable outcome.

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

Travel

Under level three Covid-19 conditions we will continue to operate from our home bases, as directed by the government.

We understand that until we reach Level One we will not be allowed to visit other cities, meet with clients or hold seminars.

Be assured that when the path is clear, we will be visiting cities and holding seminars to discuss what we are learning.

Chris Lee

Managing Director

Chris Lee & Partners


Taking Stock 23 April 2020

THE partnership now being forged between the Reserve Bank of New Zealand and the four major Australian banks can be regarded as a major achievement by Reserve Bank Governor Adrian Orr.

Equally it could be regarded as capitulation by the Australian banks at a time when they risked public opprobrium, following the stunning revelations of dishonesty and corruption during the Australian Commission of enquiry last year, and news of an imminent set of European court cases that will allege worldwide banking corruption in previous years.

The Covid-19 threat has deferred, but probably not cancelled, Orr’s focus on bank reform.

Pragmatism has led to Orr agreeing to allow banks time to cleanse their balance sheets and reverse their self-focused practices, in return for transparent bank community efforts to minimise the damage to New Zealand’s business and household bank customers during this health-based economic crisis.

Banks have agreed to support struggling businesses and to tolerate household debt defaults, and to make new loans to small businesses, sharing, somewhat lopsidedly, the risks of the new loans with the Crown.

My expectation is that these new loans will be enforceably underwritten by the Crown (to 80%), leaving enough bank risk to ensure that the Crown is not gamed. The guarantee fee should be real.

Once we are certain the country is in recovery mode there is likely to be a ‘’wash-up’’ to separate again the role of the public sector from private sector activities. Potentially the Crown could become shareholders in the banks, if the circumstances required this.

My guess is that the four Australian banks will then have an obligation to review their governors.

It is hard to imagine that there will not be an intense search for more appropriate governors than the traditional mix of politicians and lawyers, a mix that has rarely served the country well, though it has to be said that an even more bizarre era occurred in the 1980s when the likes of punters such as Brierley and Fay were governing the BNZ, which lent to the most scatter-brained projects.

If the banks retire from their 21st Century focus on their related goals of exponential growth in gross assets and executive bonuses, there may be less emphasis by the Reserve Bank on a clean-out of the unimpressive governors who collectively have allowed banks to pervert the banking rules and to seek to bluff their way through exposed misbehaviour.

But no amount of forelock-tugging sycophancy from guilty bankers will atone for the fallout that seems certain to come out of some European court cases which shortly will hear government allegations of banking theft.

The banks at the centre of the allegations include the NZ-registered but Australian-headquartered bank Macquarie, Merrill Lynch and, of course, Goldman Sachs, and takes aim at some bank executives in London during the previous decade, specifically between 2005 and 2011.

The governments of France and Germany will allege that the likes of Macquarie stole tens of billions from government tax collectors by falsely claiming tax credits.

The alleged heist has been dubbed the Cum-Ex Theft as the refunds claimed and paid out were for tax credits on dividends. (We would know this in New Zealand as an imputation credit.)

The allegedly corrupt bankers knew that whether a stock is trading cum dividend, or ex dividend, determines who is entitled to the dividend and the tax credit.

Multiple trades of the same shares, say on the same day, might make a claim valid at one moment but invalid at another.  Confusion reigns.  Exploitation of the confusion becomes possible.

Tax departments in Europe paid out tax credits/refunds based on evidence that was, they allege, falsely presented.

The amounts stolen exceeded $60 billion and may have been hundreds of billions.

The payout by the European tax collectors resulted in extreme, unearned profits for the many banks which exploited this opportunity.

To where do you think those profits were allocated?

Have a look at the executive bonus sums paid out to senior executives in the likes of Macquarie. (Sixty Macquarie executives are named as defendants, including a chief executive of that era.)

To date at least one group of defendants has accepted the charges and the consequences of their illegal behaviour.  Early confession led to lenience.  Other defendants claim that no law was broken; the law was unclear, they argue.

To me the relevance of all these shenanigans was the effect it had on literally thousands of bank executives who accepted the crazy bonuses of the time, Merrill Lynch being alongside Goldman Sachs as the most extravagant at bonus time, their largesse converting people of unremarkable talent into feudal lords, arming them with tens of millions, with which to escape to new occupations in other countries.

They arrived in the new countries, like New Zealand, and were regarded by some, especially the media, as corporate titans, endorsed by the size of the pile they had built from pillaged governments.

Having interacted with such people a few times, but not understanding how such profits were achieved that led to the multi-million bonuses, I simply observed that there was no link between visible ability, achievement and social intelligence, and the receiving of revolting bonuses.  What baffled me was how mediocrity was so excessively rewarded.

The Cum-Ex case might explain much.  If it is found that $60 billion or more was simply stolen from tax collectors and ended up making hundreds of bankers into multi-millionaires, I would need no further explanations.

If the court establishes this, banks, including Macquarie, would have even more reason to nod their head when our Reserve Bank ‘’suggests’’ how the banks should alter their behaviour.  They would want to minimise any future discussion on their past behaviour.

It is tragic if it takes the discovery of dishonesty to ignite a behavioural cleansing - where is morality?- but I guess the outcome is what we wanted.

We can be grateful to the European governments which have doggedly pursued this for the past decade.

It is easy to imagine the obstructions they have encountered.

Banking executives who are multi-millionaires should be rarities, known for their brilliance and social achievements, not for collecting bonuses sourced from money stolen from anyone, let alone a government treasury.

Surely the days of executive bonuses will pass soon. So too, one hopes, will be respect being based on someone’s pile of loot. How, not how much, should be the real determinant of respect and admiration.

_ _ _ _ _ _ _ _ _

EARLIER this week the modern media outlet, The Spinoff, called, wondering why the behaviour of the NZX 50 index did not reflect the real economy.

How was it that the index was rising when all the economic portents were negative?

The question, of course, assumes that the sharemarket index is intended to reflect the real economy.  The index makes no such pretentious claim.  The index is simply a measurement of the share prices of listed companies and reflects nothing other than the actual prices achieved by matching sellers and buyers, weighted by their number of liquid shares.

If there are more buyers than sellers, prices rise.

But there are distortions that make the index even less relevant to the real economy, as Johnny discussed in last week’s Taking Stock.

The index weights the size of the companies (share price versus number of shares on offer), meaning the daily price change of a large company’s shares affects the index more than the price change of a small company.

Currently A2Milk, Fisher and Paykel Healthcare, and Spark make up around 40% of the NZX50 index.

If those three stocks rise in one day by six per cent, which they often do, then the rest of that NZX50 index (the other 47 companies) would need to fall by four per cent for the index to remain unchanged. Forty seven fall.  Three rise. Index unchanged.

Those wanting to link the real economy to sharemarkets must not look at the index, but at the number of companies whose price falls.

And there is another distorting factor.

One modern way of investing is via index funds, an option which absolves financial advisers and fund managers from accountability for real research or judgement, thus removing advisers from risk but, as an aside, posing the question of the value-add.

The index funds are marketed as being a mirror of the performance of all shares in an index weighted by size and sometimes by liquidity (free float).

But the index funds are often, by their own rules, not anything like a true reflection of the index.  Many funds have an internal rule restricting any stock to a maximum of 5% of a chosen index.  And many index funds rebalance infrequently.

In the case of the NZX50 such a fund could not continue to buy A2Milk, Fisher & Paykel Healthcare or Spark if they became more than 5% of an index.  Yet the real combined weighting of those stocks might each be far more than 5% per stock.

So such an index fund would have to reduce the holdings of such shares and not buy them again unless they fell below the 5% weighting.

The logic is that diversity of holdings is more important than a true mirror image.

The problem with this is that if the three stocks named rose by 6%, and all other stocks fell 4%, their ‘’index’’ fund would fall by 2.5%, whereas as explained, the index itself, measuring the greater importance of the big three, would have finished flat.

So not only are sharemarket indices NOT a reflection of the real economy, they often are NOT a reflection of so-called Index Fund performance.

Any investor today who wanted a portfolio representing our ‘’best’’ companies would most certainly think carefully before buying shares in areas like travel, tourism, property, hospitality, or retail.

Yet an index fund would buy into all of those sectors, obedient to its trust deed, written in indelible ink when the fund was founded.

My opinion is that those deeds need to be rewritten now, better still yesterday. The changes will need to win the consent of investors.

If any managed fund, or index fund, is still investing on the basis of a 2019 manual it should expect mass withdrawals, as its contributors observe changes that no manual could have forecast.

As one obvious example, people beyond 65 years who had not extracted their Kiwisaver money, believing the fees would be justified by fund returns, would surely be observing that their bank deposits, subject to no fees, outperformed every Kiwisaver fund from the day Covid-19 arrived in the world.

A decision not to withdraw would presumably imply that the investor expects a rapid correction of the Kiwisaver under-performance.

Yet if the trust deed has not been changed the Kiwisaver manager is manacled to a manual of misery.

There is no rocket science in this.  The real economy is the guideline.

_ _ _ _ _ _ _ _ _ _

THOSE wanting a preview of what New Zealand will look like without tourists should dial in to life in Queenstown and Wanaka.

For some years their tourism numbers have fed town development that led to high property values as the moneyed bought property to cash in on the tourists’ wealth.

Airbnb rentals supported high-margin property development; cheap foreign casual labour paid rentals that supported high property values; tourists paid absurd hotel rates, and just as absurd prices for a steak or a local pinot noir ($600 in one Queenstown restaurant I visited).

Pubs, cafes, restaurants, motels, hotels, rental car companies and the airport itself could barely cater for demand. Worse, the local mayor wanted Wanaka to build its own international airport, despite Wanaka’s lack of the infrastructure needed to provide quality experiences.

These are quintessential, beautiful NZ towns.

Ask the residents now whether tourism has, or has not, added value to their lives in these chocolate box towns.

The answer is that a handful of speculators/developers have built, sold and banked the gains while a bigger handful are now addressing their problems, post tourism. Those who have sold early and left town are the only winners.

Airbnb owners, so often based in other places, will now wait out time, hoping the change is cyclical rather than structural.

Those residents who have contacted me say they will be delighted to regain freedom of movement, find car parks in town, and watch prices revert to an affordable level.

They will accept empty pubs, cafes and restaurants as the cost of an experiment that will no doubt be tried again one day but not any time soon.

New Zealand has geared itself for an activity that will probably not recur, certainly not tomorrow.

Not all the results of the de-gearing will be viewed with dismay by the local population.

Have the councils filled their coffers during the vibrant days?

_ _ _ _ _ _ _ _ _ _ _

Johnny Lee writes:

THE Metlifecare saga continued this week, with the board confirming the company intends to appoint a Queens Counsel in its efforts to push ahead with the takeover of Metlifecare by Asian Pacific Village Group, a company created by Swedish giant EQT Fund Management

The takeover was to take place at $7 a share, before APVG announced it intended to withdraw from the takeover, citing a material adverse change in the prospects of Metlifecare and a breach of some conditions for the takeover allegedly made by Metlifecare.

The share price is now trading below $5. The market does not believe the actions of Metlifecare will result in the original offer being honoured.

The board is walking something of a tightrope with these actions. It will need to balance the likelihood of the action being successful, as well as the consequence if it is, against the cost and time dedicated to such a course. 

Undoubtedly, the board will view the takeover as the most effective way of delivering value to shareholders. I am sure shareholders would be delighted to be paid $7 for a $5 note. However, the board will need to be careful to maintain a healthy dose of pragmatism and ensure resources are not wasted chasing ghosts.

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

THE recent circulation of headlines regarding ‘’negative oil prices’’ should not have anyone rushing to their nearest Z Energy station, in the hope of walking away with a bag full of money and a tank full of gas.

The value of a crude oil futures contract dropped into the negatives on Monday, meaning those among us willing to take possession of a thousand barrels, or about 160,000 litres, of crude oil in May would be paid for taking and storing them.

The truth is that very few people were willing to do this. Storage facilities and refineries are completely full. Airlines and petrol stations are not buying, for obvious reasons. Those willing to buy are those who are able to safely (and legally) store it, which has led to a sharp increase in the share prices of companies within the tanker industry. These companies effectively lease space aboard massive ships, parking millions of litres of oil at sea, patiently waiting for the oil price to rebound.

Outside of the futures market, the oil price has been falling on the back of a collapse in demand. This is leading to bankruptcies within the industry, which will inevitably lead to debt defaults. Even in New Zealand, Z Energy’s very helpful weekly sale data is giving the public an insight into the fall in demand. We are witnessing falls of over 75% of road petrol consumption, as commuters stay home and people stay within their ‘’bubble’’.

Exacerbating these wild swings are the ETFs, which allow retail investors to actively invest in oil futures, while giving investors none of the obligations around delivery and storage. The growth of these ETFs has left USO, the largest US oil ETF, holding a significant proportion of these contracts. In normal conditions, it could sell them to buy contracts for a later date. These are not normal conditions, forcing them to dump them at a negative price simply to rid themselves of their obligations.

Speculating on commodity prices is brave at the best of times, and 2020 is shaping up to be anything but the best of times.

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

TRAVEL 

We will align ourselves with the preferences of health officials to slow the spread of Covid19 and have suspended our regional visits and closed our offices.

Serving customer needs by phone and email has the same effectiveness and is working well.

If you run into an issue with phone connection please follow it up with an email asking one of us to call you back.

Chris Lee & Partners Ltd


Taking Stock 16 April 2020

Chris Lee writes:-

WE need to look ahead, for the changed world that will emerge.

Some good may emerge.  Might we emerge to find:-

1) More emphasis in New Zealand on food production, food processing and food science leading to more jobs in the provinces, more demand for housing in the rural cities and towns.

2) More respect for the real jobs in life, that fix (plumbing, electricians etc), build (carpenters, engineers) and nurture (teachers, nurses, carers, retail). Perhaps ''sexy'' job will equate with a ''real sustainable job''.

3) De-urbanisation, regenerating the provinces, and easing traffic bottlenecks in places like Queenstown.

4) De-globalisation, as the world recognises the risk of centralising the supply of essential goods.

5) Lower tourism, helping to balance sustainability versus money.

6) Lower demand from tourists and immigrants for housing, enabling prices to stabilise, probably fall in the cities, perhaps less so in places where real jobs are available.

7) Restoration of Departments of Public Works, leading to new processes for bidding at tenders, perhaps measuring quality as well as price and protecting sub-contractors.

8) A return to real banking standards, with no focus on exponential growth, derivative speculations or executive bonuses, leading to community disrespect for extreme greed. Will the government be partners of the NZ banks? Shareholders?

9) Far fewer retail outlets, leading to a return of equilibrium between supply and demand, perhaps, miraculously, even leading to jobs for repairmen rather than ever-increasing waste facilities (tips, as we called them) to absorb fixable equipment.

10) Far more money and effort made to build first-world healthcare, staffed to restore life quality for the over-worked people there.

11) A more tailored tax system – Gareth Morgan might be consulted.

Pardon me. Did I nod off?

__ _ _ _ _ _ _ _ _ _

ALL businesses may apply for the wage subsidy, basing their request on a director's forecast of falling revenue (by a minimum of 30%) in either April, May or June, this year.

If the forecasts are wrong, and revenue falls by only 29%, you immediately return the subsidy.

It is logical, therefore, to accept the subsidy, as it will calm any staff fears and may be needed.

Fund managers like Pathfinder have claimed the subsidy, clearly expecting lower revenue, either from significant client loss, or expecting their investment base to fall to the extent that their fees, a percentage of the money they manage, will suffer because of the falling value of their total investment portfolios.

If a billion of funds were paying a fee of 10 million, withdrawals of $300 million would lead to 30% revenue falls.

If the funds were, say, half invested in cash and half in bonds, the bonds might not fall in value, but if the share portfolio fell by 60% then overall fee revenue would fall by 30%.

If the directors forecast a 60% market fall one hopes they are smart enough to reposition themselves to account for this, selling at-risk shares as soon as market liquidity allows.

Obviously if every fund manager had that view there would not be liquidity to soak up the selling pressure.

It is at that point that people might offer you a $20 note for two fives, as the desperate golf spectator offered Jack Nicklaus when stomach cramps were gripping the spectator.

Another example of such opportunities might be in the motor vehicle sector where brand new rental cars lie asleep on rent-consuming property, used by no one.  The sale of discounted new rental cars is as inevitable as a southerly in Invercargill.

Rental car companies are by far the dominant purchaser of new cars.  The stalling of tourism will have an obvious effect on all new car sales in New Zealand.

The fund managers smart enough to value companies in the new world that will be unveiled in the months and years ahead may indeed be preparing for a large reduction in revenue.

One hopes they are repositioning their various funds to take account of the risk they see.

Current market pricing, at the time of writing, suggests that the repositioning is perhaps planned, but not yet executed.

_ _ _ _ _ _ _ _ _ _

THE business directors may have had a short-term victory in persuading the finance minister Robertson to initiate a (hopefully) short-term easing of the laws that set standards of director behaviour.

The obligation of directors to ensure companies are solvent, continuous disclosure requirements and other reporting obligations have all been waived, temporarily.

It is fair to acknowledge that many companies would now be insolvent if their intangible assets were valued realistically, or if their bankers had not promised support.

Disclosing the extreme distress, or even disclosing directors' plan B, might initiate company failure, or simply hinder any chance of the two- to five-year recovery plans that should be on the table for many, perhaps most, of New Zealand's registered companies.  Some latitude is logical.

But the concession simply must be short-lived, weeks not months.

In three months' time every company should have made the decision that it has, or has not, the capital and a real plan to survive in the very different world that will emerge, once the health crisis is understood.  Shareholders and creditors must then be advised. Companies should not be allowed to seek support from secured creditors unless the directors' plan is credible, detailed and ready to be shared with unsecured creditors.

It would be utterly unfair if the banks, secured by first access to the assets of the company, are fully informed but other creditors, generally unsecured, are left to guess, providing goods and services without payment.

Robertson's acceptance of the ''holiday'' for directors ought to have a time limit.  Someone must explain that to him.

If companies still do not have a clear vision of their survivability by July the state of our business mindset would have an appearance like Dresden in Germany, after the blitz of allied destruction in the vengeful final days of WWII.

Directors have a duty to all stakeholders, including the shareholders, the banks, their staff and their creditors.

_ _ _ _ _ _ _ _ _ _

IT was heartening to hear the chief executive of Infratil, Marco Bogoievski, telling the truth about its most stranded asset, Wellington Airport.

Infratil owns two-thirds of the airport's shares, the other third owned by Wellington City Council.  Infratil supplies the airport with its chairman, Infratil executive Tim Brown, whose eternally cheerful and optimistic demeanour shields a highly commercial instinct.

Bogoievski said there could be no clarity about the airport's future, no way of signalling its prospects.  None of us know what a long period of no tourism will do to the services sector but it will be devastating.

Obviously there will be very few international flights, therefore no duty free shopping, far fewer airport shop transactions, lower car parking receipts, fewer tarmac fees, and probably lower rent receipts from the shops.

Yet the costs of the airport will largely be inelastic.  Any plane that lands must be serviced by those in the control tower.  Staff must unload cargo. Security must be maintained.

To me it sounds like much less revenue, only a little less cost; medium-term result - a reliance on shareholder support, long-term result uncertain.

Infratil says it is easily able to provide support.

Wellington City Council will be more divided on this issue.

For Auckland Airport the dilemma is much greater, as its facilities have been geared to millions of tourists, rather than domestic arrivals.

This will magnify its problems.

Happily, it has discounted its shares and raised enough to survive for its worst-case plan, that being no income for two years.

Those who supplied the capital clearly believe the value of its tarmac and buildings will be restored, making a holiday from any dividend return an acceptable prospect. Its share price will be seen as astonishingly high, by some.

There is no law requiring all of us to reach the same conclusion about the future value of any company.

_ _ _ _ _ _ _ _ _ _

MY comments condemning the previous Key government for its polls-driven behaviour, rather than standard-driven leadership, were not meant as a Red v Blue discussion.

I am an apolitical person.  I simply favour intelligent leadership based on declared strategic planning, and minimum and transparent standards, implemented in a socially-acceptable way.

I wish I had opportunities to applaud, more often.

Blue, red, green or black are not my point.  I use the same criteria when voting for directors of a listed company.

I will never again vote for someone whose goal is power, rather than standards-driven leadership.

If I have offended the whole darned lot of them, I accept my fate.  But I will not be reversing my mindset.

_ _ _ _ _ _ _ _ _

Johnny Lee writes:

READERS of New Zealand media could be forgiven for assuming the New Zealand sharemarket had crashed in the wake of the coronavirus, as small and large scale companies begin failing, with cashflow stalling under the quarantine conditions we are currently enduring.

Instead, the market is down only about 15% from the record high that it set in February, after falling 30% in a four-week period in March. We are now around the same index levels that we saw in July last year, when ''sharemarket reaches new record high'' was a daily, and inane, headline.

A lot of this index strength has come from our two largest stocks, Fisher and Paykel Healthcare, and A2 Milk. Together, these companies make up about a third of our index now, a proportion that is rising as the companies outperform against a weakening market. The ''Portfolio'' index, a measure which caps the weighting of these companies to better represent what a typical retail portfolio may look like, is down further, benefiting less from the relative strength of our two largest stocks.

Overseas, the likes of Italy and France, which have been among the worst hit by the virus, have seen greater drops than the rest of the Western world so far. Nevertheless, even their sharemarkets are rebounding.

The virus and its impact on the economy will not be evenly spread, nor will the sharemarket index necessarily represent the overall health of our economy. Some sectors will be in significantly more danger than others. Our business has attempted to communicate what we view as those sectors that are suddenly exposed to new risks, and if necessary, help clients re-position portfolios away from those areas.

Business failure seems inevitable, however the speed of decline has been surprising to witness and shows how many were on a knife-edge. This week has seen the operator of the Burger King brand in New Zealand fall into receivership. Its shareholders were unwilling to commit further capital to see it through the downturn, leaving the receivers with the unenviable job of locating a buyer for a business that has no short-term future. I imagine the likes of Burger Fuel, a company listed on our exchange, would be facing similar short-term challenges.

The media sector is also struggling at a time when it is most needed. NZME is reporting dramatic falls in advertising revenue, as businesses cut as much expenditure as possible. I fear corporate sponsorship may follow a similar fate unless conditions improve.

Those companies listed on the sharemarket have the advantage of access to capital from thousands of individuals, quickly, by way of rights issues and share purchase plans. The likes of Auckland Airport and Kathmandu have already done this. Smaller companies like Cannasouth and Moa Group are doing the same, but will have a smaller pool of investors to draw upon.

We may see more of our listed companies requesting capital injections from shareholders over the coming weeks. Strong, sustainable companies will find support from its shareholders, even in trying times.

Perhaps more companies will begin to see the prime value of listing on the stock exchange, that being access to capital.

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

THE saga of Metlifecare's takeover by Swedish-owned Asia Pacific Village Group has taken another turn, as the Scandinavian group has indicated it wishes to withdraw from the takeover, citing a Material Adverse Change in the fallout of the Coronavirus. APVG also alleges that Metlifecare breached other terms of its agreement, including consulting it for decisions made in regards to its response to the Government lockdown.

The first point should not take long to resolve. APVG will have to prove that the net tangible assets of the company or the underlying profits of the company have fallen by, or are likely to fall by, a specified amount. One would assume that Metlifecare is the best equipped to evaluate the likelihood of these matters. By choosing to engage with legal advice, Metlifecare will have some confidence in its position. Indeed, it has stated that ''AVPG does not have a lawful basis to terminate the SIA''.

The latter point, the failure to consult, would represent an enormous error on the part of Metlifecare if true. The share price has halved in the past month, representing a fall in value of hundreds of millions of dollars. If this is attributable to an unwillingness to communicate by Metlifecare, then shareholders will be furious. Law suits might follow.

The share price fall itself is telling. The market does not believe Metlifecare will be successful in ''forcing'' AVPG to complete the takeover.

One month ago, an independent company from another country was willing to buy the shares at $7 each. They now trade at around $4.

After the takeover was first proposed, the share price rallied strongly to levels close to $7. Some shareholders chose to sell at levels around $6.90, taking the certainty of a small discount over the risk of the offer falling through. Some Augusta shareholders chose to do the same, with the same logic, during Augusta's takeover talks.

Metlifecare knows that the takeover represents the best value for shareholders in this environment, and will be pursuing this outcome. At the same time, it is battling a virus that seems to be impacting rest home residents to a far greater degree than the general public.

I wish them luck on both fronts.

_ _ _ _ _ _ _ _ _ _

WE continue to urge clients to review their portfolios.  No one has certainty about the environment that will be framed by the virus but it is extraordinary that the signal from the capital markets appears to indicate that our listed companies face a brighter and more certain future than they did 15 months ago.

Since January 2019, the NZX market capitalisation has risen by nearly 20 per cent, even after its recent sell-offs.

It will be fascinating to learn what has happened to justify this increase in confidence in our listed companies.

Clients may email us (info@chrislee.co.nz) or ring us 04 2961023.  Our business is open, our advisers available to help.

Chris Lee

Managing Director

Chris Lee & Partners Ltd


Taking Stock  9th April 2020

When moulds are broken, or clearly deteriorating, the time for real leaders to build new moulds is during the period when the public is stupefied, numbstruck by fear.

Never waste a full blown crisis!

Somewhere in the public service, and in business leadership, there will be people putting together thoughts and plans to build new moulds.

Heavens knows that the evidence of broken moulds was piling up after a period of corporate leadership in the Beehive, conducted, I regret to allege, with neither strategic planning skills, vision, social intelligence or, worst of all, intellectual intelligence.

Rebecca MacFie's excellent book Tragedy at Pike River, The Billion Dollar Bonfire and a needed new book, perhaps called ''Wrecking Our Health Services'' should all be filed in a library under ''The Legacy of Key’s Government 2008-2017''.

We will soon learn that science and medical researchers long ago warned the Key government of the inevitability of a pandemic.  As Trump has done, we preferred tax cuts.  Health budgets came nowhere near providing for first world standards.

Just months ago I learned that in a major hospital prescribed antibiotics were ''not in the budget'' and that a convertible bed could not be fixed because ''There is no money''.  It lay forlornly; broken, unfit for purpose.

We get by on the vow of our doctors and nurses to meet some version of a Hippocratic Oath. Bless them.

The mould created by corporate, image-based leadership needs to head to the Parnell tip and be rebuilt by those who understand that people matter more than tactics to facilitate childish pursuit of personal ambition.

Ardern was absolutely entitled to exclaim that she does not welcome Key's thoughts on solving this health crisis, or, probably, anything.

His PR skills were important during the Christchurch earthquake recovery but are now of no value to Ardern, a grand master in communication, and an empathetic leader.

The first new mould may result from a examination of our health resources and our needs.

The existing mould will not be the only one to be discarded with vehemence.

To his great credit, the ginger-haired Adrian Orr, once referred to most insultingly by the Australians as ''a ginger-haired fool'' (my interpretation of their language) was quick to spot the weakness in our banking system.

He sought to bully the banks into capital-raising, even while some were planning to buy back their own shares, reducing their capital buffer.

He observed crassness and venal behaviour at the ANZ, where the leadership standards were indiscernible.

Now we have a crisis Orr has the unshakeable base from which to force change.

In return for the Reserve Bank's promise to provide the banks with liquidity (but not capital, or, as yet, deposit guarantees) Orr has set about rebuilding the sort of standards that would have been part of banking culture before the arrival of that grimmest of all sins, personal greed.

The RB will provide liquidity and allow flexibility with some of its rules, in, return for:-

- An end to executive bonuses

- A commitment to lower revolting executive salaries

- A commitment to end share buy-backs.

- An agreement not to send capital back to Australia.

- An agreement to lend to viable but struggling New Zealand businesses.

All of the modern weapons of social destruction had thrived in the last two decades. Often unrealized paper profits converted to billions of dollars of bonuses for the most politically competent bankers, or to salaries that make the general public cynical and disrespectful. Share buybacks supported bonuses but undermined bank strength.

Banks like Merril Lynch actually converted tax-payer bail-outs to executive bonuses, by the billions, in 2008.

In the near future I will use Taking Stock to explain how those bonuses came from revenue, in some cases, resulting from what the European Courts are alleging was simple theft of government tax revenue, especially in the period of 2005-2011.

Banks like Merril Lynch and Macquarie, the latter registered and active in New Zealand, allegedly stole billions through their London base and converted that loot to bonuses for people we now observe fleeing to distant parts of the world, including New Zealand, where they seek to be feted for the size of their treasury. Very ordinary people were made into feudal lords by these dubious bonuses.

Orr is using the crisis to smash a mould that a wise government with social and intellectual attributes would have obliterated many years ago.

I have said it before, but will repeat it.  Orr is the right person to be calling these shots.  Ex Westpac, he has witnessed the breeding ground for greed from within the ''tent'' and knows that the ''mould'' has to be re-engineered.

There will be other legacies of Key's government that should be addressed.

Those many parties whose behaviour led to the deaths in Pike River's coalmine, or to the investor and tax-payer losses at South Canterbury Finance, can probably thank the government at the time, for blocking the level of enquiry that would have fingered the worst of the miscreants, and jailed them.

The government's own behaviour would have been displayed had there been such an enquiry, probably ending the ambitions of several politicians.

The mould that created that injustice and amoral behaviour must be broken.

If we emerge from this crisis with a new attitude towards inequality, a new disrespect for those whose leadership is not standards-driven, and a new commitment to allow open examination of poor political behaviour, we will resume our journey towards international respect for our governance and our lack of corruption.

Footnote:- I was loud in applauding Westpac's decision to appoint John McFarlane as its chairman, a man who in his time at ANZ sought to display standards.  His letter to Westpac shareholders is the most encouraging communication I have ever read from a bank chairman.  All the banks' governors should be following his leadership, putting an end to the ghastly displays of greed, vanity and egotism.

Xxxxxxxxxxxxxxxxxxx

The collapse of the ASX-listed NZ finance company F E Investments was approximately as surprising as the presence today of Kapiti Island, off the coast of Paraparaumu Beach.

Only the tiniest number of people would have been dumbfounded.

However the media has entirely missed the point, one reporter blaming the roughly six hundred investors (average nearly $100,000 per person) for failing to do their research, and for not seeing the anomaly between risk and return.

This was the sort of analysis that suggests no link between the reporter's own wealth, and the subject of investing.  The brutal truth is that, since the 2008 crash, far too little has been done to protect investors, who should have no need to check the truthfulness of the documents they are offered.

In the years leading up to the 2008 crash we had useless politicians holding their noses and pretending the air was pure. Not much changed after 2008, as The Billion Dollar Bonfire displays, undeniably.

We had a gormless leader of the main regulator (the Securities Commission) and a leader of the other regulator, Mark Weldon, clueless about the non-bank sector, or his obligations to enforce continuous disclosure rules.

We had trustees who may well have won a ribbon at egg and spoon races but would have been overcharging for their expertise had their weekly remuneration been a sackful of wet pencil shavings.

And we had literally dozens of dishonest and/or complacent/incompetent finance company directors and executives, many of whom escaped criminal trials, inexplicably.

Many of them habitually lied or sought to mislead.

Because few of these issues have been fully addressed since 2008 no investor has had the protection of the law since then.

The only wise response was, and is, to invest in no finance companies other than those owned by an institution, like UDC Finance (ANZ).

Investors cannot conduct the forensic research required to dig out what should be in every trustee and regulator's satchell.

Capital (real monetary back-up) is supposed to cover the difference between debenture interest rates and loan rate-setting.  One would accept 5% from a non-bank  in today's environment if the real capital reserves underwrote risk and if the trustees, regulators and the directors were personally accountable for ensuring that investors were provided with the truth.

When our laws change, placing personal accountability on directors, executives and trustees, then, and only then, will we be likely to use finance companies as a fixed interest option. We will also want to have access to the fit and proper person criteria applied by the regulators.

The media will never be accountable, of course.

For that reason it should never be a source of financial advice.

FE Investments was on a buckled rail line that was certain to cause a derailment.

The readers of the Billion Dollar Bonfire will have expected this crash.

Xxxxxxxxxxxxxxxxxxxxxxxxxxxx

When in pain, there is no comfort in observing others in worse pain but I do find sadness in the problems of South Africa, where, like all former sportsmen, I have friends.

The Covid virus is creating unimaginable hardship.

A few bullet points:-

- The South African dollar is now the worst-performing currency in the world.

- South Africa debt has just been downgraded to CCC, one notch above default, several grades lower than Hanover Finance achieved in its most disgraceful existence.

- Enforcing two-metre separation, the SA police have murdered people.

- South Africa continues to endure cronyism, pocket-lining and outright theft by its public leaders.

- Tens of thousands employed to provide ''security'' for cars owned by the well-off are unemployed during lockdown. (What a third-world job)

- Many live in squalor, quite unable to practise hygiene or two-metre separation.

The end of apartheid was the only possible human response but the beginning of what must now feel like an apocalypse.

XXXXXXXXXXXXXXXXX

Meanwhile in the USA, as you would expect, the poor continue to carry the worst of the pain.

A survey of Americans conducted a few days ago show that wealthier Americans are working from home, being fully paid, while the percentage of the poorly-paid who can work from home is low.

Of the different socio-economic groups these are the percentages working from home, and employed by closed or furloughed companies.

                                 Working        Company

                                 from home    closed

Lowest/Low Middle           7%          17%

Middle                              17%         20%

Upper/Upper Middle         43%         11%

An optimist will assume Trump will target his relief packages to where there is greatest need.

The same optimism may harbor the hope that COVID-19 will disappear with the wave of his little hand.

Xxxxxxxxxxxxxxxxxxx

The Auckland International Airport rights issue was a significant test of fund manager confidence and a good example of company caution.

AIA raised enough cash to survive their worst-case fear, of no revenue at all from its airport for nearly two years.

The fund managers overseas, and with some help here, bombarded the offer, a triumph for the company and its organisers here, Jardens and Citibank. The outcome highlighted that those armed with other people’s money seem certain that air travel will return to previous levels within the next months.  Clearly they have confidence that AIA's worst-case fear is highly unlikely.

It also highlighted the wisdom of acknowledging a potential problem and nuking it.  It is often said, that if you are in trouble and need a hand, ask for six!

And it highlighted one of the risks in New Zealand's tiny capital markets, now no longer with access to the balance sheets of Goldman Sachs or Deutsche Bank.

Only Jardens would have the resources, the access to markets, and perhaps enough of the right people to pull off such a huge deal, overnight.

Goldman Sach is no longer blessed with distribution or capital in New Zealand, its remaining staff simply corporate deal organisers.

Deutsche Bank sold Craigs to the staff, whose combined access to capital would be modest.

Forsyth Barr has looked for, but never found, a partner and Macquarie's presence here, like UBS Warburg, lacks distribution grunt.

New Zealand desperately needs another Jarden.  Perhaps a three-way merger of Forsyth Barr, Craigs and Macquaries would provide an alternative.  Jarden simply does not have the resources to do several of these huge rescue deals simultaneously.

There may be a time soon when there will be more phone calls from needy corporates than phone lines.

Jarden had just the week before raised $100 million for Kathmandu at a hugely discounted price, during a week that may be the first of many, when exuberance mixes with fear, almost alternating daily.

My guess is that those who tap the market for money early on in this Covid period might be rather pleased, as the outcomes of Covid become clear.

One hopes the supportive institutions and any optimistic retail investors have made sound, long-term decisions, correctly guessing the outcomes of this turmoil.

XXXXXXXXXXXXXXXXXX

As the market enters what may be long-term turbulence, one of New Zealand's best fund managers Steven Montgomery has retired from the company he formed, Aspiring Funds Management, based in Christchurch.

Montgomery was one of the platoons of skilled market participants to emerge from the army set up by the late Sir John Anderson, at South Pacific Merchant Finance.

Many of Anderson's army have gone on to make money for themselves, often kicked started by claiming shared pedigree with Anderson.

But Montgomery was a rare one in that he made money for the whole of the country as well as himself, excelling when the Chief Investment Manager at the ACC, over nearly two decades.

Aspiring sought to be an absolute returns fund manager, allocating funds with science, rather than via robotics, making lower but positive returns, by minimising risk.

In the last years its science failed.  Its asset allocation was far too aggressive to cope with the black bird that now looks more like an ugly albatross than a graceful black swan.  Aspiring has reported results that will be regarded with anger.

The only justification for Aspiring's bizarre bonus formula would have been its success in minimising risk, given its bonuses were based on out-performing the cash rate (Virtually nil), while it invested largely in equities, here and globally.

The haemorrhaging of money now will not reflect the undoubted talent of the Aspiring team but it poses serious unanswered questions about how it mixes its aspirations with its bonus scheme.

I would cheer loudly if there were no bonus schemes in any fund manager contract.

Highly-paid people should not need even more money to excel at their job. How can Orr stick his paddle into this?

Nevertheless Montgomery can retire knowing that in his career his talent has produced at different times handsome returns for a huge number of people.

xxxxxx

We have produced a ''what might survive'' analysis for advised clients, visible in that section of our website.  Given the speed of change it may need regular updating.  We have observed a rapid growth in numbers of people switching to our fixed cost advice service.

That make some sense.

We sure are in a period of change, unprecedented for its speed and its breadth.

We will commit to regular communication of what we learn and observe.

Chris Lee


Taking Stock 2 April, 2020

Johnny Lee writes:

AS we begin our second week of isolation at home, including those of us with a heavily pregnant wife and a restless almost-two-year-old, markets continue to display the sort of volatility that has been unseen since the Global Financial Crisis.

Markets are rising 5% on the Monday, falling 6% on Tuesday, before soaring again on the Wednesday. Largely we are following global markets, albeit enjoying smaller swings than those seen in the United States. Our stock market index is dominated by electricity companies, retirement village operators and those companies with exposure to the dairy sector, giving us a slightly more defensive array of major companies than the banking and resource-dominated ASX, or the technology-dominated US.

The cause of the volatility is obvious. A huge unknown has entered society, an unknown that has generated a response that will cause reverberations for many years to come. As politicians and businesspeople scramble to react, markets look to these responses for guidance.

Many companies have simply withdrawn any and all financial forecasts. Companies such as Port of Tauranga or Sky City Entertainment have chosen to suspend guidance, while others retreat to their core operations, entering survival mode for what will surely extend beyond a four-week period. Dividends are being cancelled as discussions instead turn to companies needing to raise capital.

With this retreat comes a closing off of the corporate wallet. Companies are widely electing to forego capital expenditure, a problem that has flow-on effects to other industries. Auckland Airport, for example, has already announced the suspension of its second runway, its nearby hotel and its additional carpark. 

Think of the industries affected by this – glaziers, plumbers, electricians and plasterers – all of whom are suddenly experiencing their own cashflow issues. These sectors are not particularly well known for operating deep cash reserves.

Some companies, such as Telstra in Australia, have chosen the reverse direction, electing to bring forward capital expenditure in a bid to support local industry, while perhaps also taking advantage of the imbalance of market tension. Power and telecommunication companies will not be experiencing the same level of disruption to cashflow as those involved in international trade, and understand that even essential services see reductions in demand when unemployment rises.

And unemployment will rise. The large unknown is not so much by what degree it will rise, but for how long it will take the workforce to re-engage, and indeed whether certain industries will rebound at all. In particular the spotlight must be on those reliant on international tourism, such as convention centres, casinos and hoteliers. Travel bans are more likely to be extended than rescinded.

The extent of this inevitable downturn has many economists scratching their heads, trying to predict the sequence of events that will follow this four-week lockdown.

The Government has already outlined a plan for a ''nation-building programme of infrastructure'', akin to the ''Ministry of Works'' of old, that will presumably seek to re-engage a large part of the construction and engineering workforce. This will certainly result in a large increase in Government borrowing, as it aims to rescue that industry from a private sector pullback, which will be licking its wounds before plotting its own pathway forward. One can assume that other countries will be planning similar injections into their own economies, funded by long-term, cheap debt.

A return to a Ministry of Works-style approach should absolutely include those who lived through its most recent incarnation. It was disestablished in the late 1980s. Many of the politicians making decisions today were children when this occurred, putting us at risk of repeating the mistakes that led to its demise. The next iteration must learn from the mistakes it made, and ensure it is fit for purpose in a globalised world.

A huge increase in Government debt will seek to act as a bridge, allowing our country to avoid falling into the hole in the road. But debts need to be repaid. An increase in debt will eventually necessitate a corresponding response, in either the duration of the debt, asset sales, tax increases or spending cuts. The path that the various Governments of this coming decade choose to take will have an enormous impact on our economy. 

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

THE immediate future, for some companies, will be ensuring they have sufficient capital to see themselves through this crisis.

Many companies on our exchange will have seen a huge drop in demand, perhaps even seeing revenue approach nil, as planes remain grounded and cars remain stationary. Retail shops are closed, and live sport appears to be cancelled for many months to come.

Costs do not simply disappear. Rents must be paid (although I note that some businesses are now in negotiations to suspend rents). Essential staff must still be paid, albeit it at a rate subsidised by the Government. Insurances must be paid.

Which returns us to the necessity for capital and cash reserves. Banks have made it clear that they maintain a willingness to extend funding facilities to well-managed companies. Some companies, such as Port of Tauranga, have been proactive in securing funding from their lenders. 

Other companies will need to approach shareholders instead. The NZX, through its regulatory arm, has been swift to make short-term changes to the listing rules, to allow companies to raise more capital, more quickly.

These changes are significant. The caps that were previously in place included limits on how much a company could raise from each individual shareholder when raising capital using certain mechanisms. This prevented larger, wealthier shareholders from applying for large amounts, diluting smaller shareholders in the process. 

Changes were also made to the timeframe required when raising capital. Some shareholders have expressed to us that the timeframes on recent offers were already too short. However, the urgent need for cash has apparently necessitated this timeframe be shortened even further.

The changes, fortunately, have a fixed duration applied, expiring in October this year unless extended.

With a mechanism now in place for companies to raise significant amounts of capital quickly, the question is which companies will find themselves in need of capital, and the timing of this.

Timing will be important, as the early movers will have the benefit of the greatest pool of cash from the investment community.

As the situation develops, shareholders should continue to be discerning about where they choose to invest, using the new environment as a way of testing the strength of the companies they hold.

Update: Kathmandu has announced it is raising $207 million at 50 cents per share, more than doubling the number of shares on issue. Most of this will be via a fully-underwritten rights issue to existing shareholders.

The offer will be open for 12 days. Retail shareholders can expect documentation to arrive in the coming days.

The cash raised, plus banking facilities now in place, will meet the liquidity needs for the company for at least 12 months.

The offer being fully underwritten is relevant. The offer will almost certainly proceed, giving shareholders confidence that they will not be left owning a company abandoned by the investment community. 

Clearly, this offer can be described as ''high risk, very high-reward''. Kathmandu was priced at around $3 only one month ago. However, the retail sector is quite literally closed for business in some markets, meaning you are buying into a company that cannot open its doors in New Zealand. In some countries, Kathmandu is still allowing online shopping, and in some jurisdictions is still able to keep doors open, although the company expects this situation to change.

Kathmandu's ability to raise capital will also be helpful when contrasted with its privately owned competition, who may not have the same gateway to additional capital. Options give businesses tension when pricing issues like this. 

I would not read too much in to Briscoes' (a large shareholder of Kathmandu) reluctance to participate in the issue. Briscoes will have its own cashflow issues at the moment.

There will almost certainly be more rights issues to come. Companies experiencing large drops in cashflow will be using capital markets as a way to shore up their liquidity positions. As we saw with Genesis Energy's IPO, an early failure can spook both retail and institutional investors, causing them to demand steeper discounts to account for risk. A success can embolden investors, although the pool of cash available is still only limited.

Advised clients who are shareholders of Kathmandu are welcome to contact us for advice on this offer.

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

ECONOMISTS are also grappling with what societal changes, that we are currently accepting out of necessity, will endure once the lockdown is lifted. More countries are choosing to extend their lockdowns, as the effects of what was ultimately an experiment are bearing fruit. 

Will working from home become the norm? As people grow accustomed to ordering groceries online, will they continue this practice beyond the eventual lifting of the lockdown?

Will restaurants and cafes return to normal trading patterns? Gymnasiums? Movie theatres?

Meanwhile, people are clearly becoming more conscious of their hygiene and the way diseases spread. This may have positive ramifications for disease control in the future.

As an example of the lengths people are resorting to, my young son recently dialled in to a virtual, remote playgroup – conference-calling a group of his quarantined friends, no doubt to discuss the harsh conditions they are currently being unfairly subjected to.

Overseas, outdoor movie theatres are seeing a resurgence, while delivery drivers are seeing demand, no doubt enjoying the complete absence of traffic.

The drop in economic activity is seeing changes in the environment, with blue skies returning to cities experiencing their lowest level of air pollution in years. Some people may be seeing the clearest skies they have ever seen.

Investors should prepare for a tumultuous 12 months, and expect a different society to emerge once the lockdown is over.

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

THE Warehouse Group Limited has found itself under scrutiny after making what was ultimately proved to be an inaccurate public statement via a release to the exchange.

Following the Governments decree that only essential businesses would be allowed to operate during the lockdown, the company declared it was considered an essential service and would not be closing. The share price reacted strongly, gaining about 30% in value in within an hour of market open. 

Two days later, it made a subsequent announcement, contradicting the first, sending the share price lower. The store would close for the four-week period.

Concerns were then raised regarding whether The Warehouse Group had deliberately misled the market with an inaccurate disclosure. 

My perspective is that The Warehouse Group felt required to promptly disclose its position to the market, sought legal advice and was a victim itself to the lack of clarity that existed immediately following the Government moves. There was justification in declaring itself an essential service, as a retailer of many products that most New Zealanders would consider essential.

Ultimately, a line was drawn that its operations are not essential to the function and well-being of the country, and it was forced to close.

Those who purchased shares, in good faith that the announcement was accurate, are right to be aggrieved. They were misled, regardless of intention.

However, part of the blame must lie with the information vacuum that existed immediately following the Government's announcement, as well as the interpretation of continuous disclosure obligations, which led to The Warehouse making an announcement that it believed was accurate. 

Update: I note the Warehouse has now been un-excluded, and can operate via its online store, causing a jump in share price.

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

JOHN McFarlane, the recently appointed Chairman of Westpac Banking Group, has made a public statement regarding Westpac's approach to the Coronavirus, and the new strategic direction he intends to take Westpac Bank.

It is mandatory reading for shareholders of Westpac, and those interested in the changing culture of banking within this country.

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

WE are anticipating an imminent update regarding the Tiwai Point Smelter. Regardless of outcome, this will have ramifications for all shareholders of the energy sector.

Rio Tinto had previously advised that a response would be made by the end of March. So far, it has announced it will close a single potline, to ensure staff are able to meet health and safety guidelines in respect to the coronavirus. 

A further announcement, presumably, will be made shortly.

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

WE note the recent announcement from ANZ in regards to its ANBHB bonds. We also note the announcement from Heartland Bank along similar lines.

We will be providing an update to bond holders in due course.

Stay well

Chris Lee & Partners


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 © 2020 by Chris Lee & Partners Ltd. To enquire about copyright clearances contact: copyrightclearance@chrislee.co.nz