Print this pageTAKING STOCK 31 August 2017
THE excellent results of the retirement village operators, Ryman, Summerset, Metlife and Oceania, were entirely forecastable but the role of these operators still seems to flummox many of the public.
In essence the residents who buy villas or apartments occupy their properties for, on average, eight years. Those who have total care often are in the last year or two of their lives.
The operators do everything possible to ensure all residents have access to the lifestyle they prefer.
As a result, the residents and their families generally have a high respect for the operators.
Healthy residents may want international travel, sporting facilities, visits to shows, in-house entertainment, and help with transport or help when unwell.
Bedridden residents want attentive and accurate care, human kindness, enjoyable food and inclusion in suitable activities.
Everyone wants a beautiful environment, whether it is in luxuriant gardens or sparkling resort-like community facilities.
Resident satisfaction is generally extremely high, so whatever the occasional sneering critic might say, the major providers offer an impressive service for those who have chosen to be residents and can afford the cost.
The secret to the financial model is the deferral of the main charges paid to meet the aspirations of those who own the villages.
The operators collect a hundred thousand or sometimes more when the resident dies and the licence to occupy the premises is sold to someone else.
Usually the operator will return 70-80% of the amount paid by the departing owner for the licence to occupy, and then the licence is resold, often for more than the original price, so the provider of a $400,000 unit repays, say, $300,000, resells for $500,000, and pockets the difference as a ‘’deferred’’ fee for providing the original owner with their lifestyle.
To work out the future profits of a large operator, like Ryman, you simply perform maths.
If Ryman has 12,000 villas and apartments with an average stay in each unit of eight years, then 1500 licences would be resold each year. If the average ‘’deferred’’ charge is $200,000, then your maths show you a cash benefit in that year of 1500 x $200,000, or $300 million. Nice for some!
The profits on the care services provided might historically have been very small but recent rule changes, enabling operators to charge up to $20,000 per annum more for residents in a ‘’premium’’ care room, have meant that Ryman, as an example, might earn tens of extra millions from care.
The other listed operators are smaller than Rymans but the gains are still huge.
Then there are the ‘’revaluation’’ gains, effectively amortising the cash gains made when resales occur.
On top of this you must assess the development margin in a new village.
Villas are built for perhaps $250,000 each but are sold at a price around 75% of the average local house prices.
In, say, Waikanae this average may be $540,000, so 75% of that average would be $405,000. The operator who builds 150 units might make $20 million profit on sales, with which he will have paid for the land, and built some communal services.
If he has enough unused land to build later another 150 units, the next surplus of $20 million would mostly be profit.
Using this generalised formula it is easy to see how Metlife makes a cash profit of $82 million a year, Summerset similar, Ryman much more, and Oceania less but growing.
What is to me astonishing is how little those who have never been to a village actually understand about the retirement village sector.
For example a retirement village is NOT a rest home, it is NOT a ghetto for rich people, unless you classify as rich those people who owned their own home at 75, sold it for $540,000, moved to Ryman for $405,000 and now have $135,000 in the bank as their nest egg. Is that how a young journalist defines the ‘’rich’’?
There are plenty of such couples.
Nor do retirement villages focus on sing-a-longs, jigsaw puzzles, card games and pétanque, though these are all legitimate activities and are enjoyed by some.
Nor do people enter the villages at 55, that age that is often described as ‘’old’’ by the youngsters still working for newspapers, or displaying their wisdom on those ghastly social media forums that allow anonymous people to peddle their unaccountable and usually childish and poorly-based opinions.
Rymans does not accept residents younger than 75, though others have a lower age setting, the lowest usually 65.
Residents have been known to bring in their motorhomes, their fishing boats or even their yachts. Many are very active.
At the Parkwood village, on whose board I have served for 30 years, residents have safaried in Africa, walked some of the Great Wall of China, cruised the Alaskan fiords, jet-boated New Zealand rivers, as well as enjoyed more than 200 events per year, visiting musicals, opera, jazz festivals, sports events etc.
Nearly 20 years ago TV3 ran a programme on life in Parkwood village. It was a fair picture of such a life, but TV3 ruined their reputation with the residents involved by titling their documentary ‘’God’s Waiting Room’’, an insulting title reflecting the insular world of young TV producers and reporters, rather than the active world in which residents live it up to the best of the health and vigour.
You think retirement villages are ‘’God’s Waiting Rooms’’? Try telling that to a raft full of hollering people hurtling down a river (average age 90!).
Retirement villages are more like a property-owning company with thousands of houses, with the village operator having perpetual exclusive rights to sell the ‘’houses’’, at a real estate brokerage fee of 30-50%! Your average real estate company would salivate at that prospect.
A rest home, or the care unit within a village, thrives on the kindness of the staff (often angels), the available resources funded by the real estate, and in the case of the best ones, the attention to details on such things as nursing, care-giving, diet, wine choices, and the invigorating programmes run by specialists, as well as the environment.
Metlife, originally a dreadful outfit, cobbled together by an ambitious Auckland salesman Cliff Cook, is now partly owned by the NZ Government Super Fund and is an organisation unrecognisable from its rather ugly origins.
It now boasts that it employs specialist chefs to dredge up nouvelle cuisine, (though this is a reason for many, like me, to strike Metlife off the list), and its wine choices do not come in cardboard boxes.
Metlife is expensive but it clearly has a dedicated following.
It remains my view that the listed retirement village operators have more sustainable businesses than even the current power generators and retailers.
People will always age, they will always want the best they can make of their final years, and many will always prefer the mix of social contact, communal kindness, physical security, and on-hand help when ill, that the model provides. The government will not offer such facilities and in this era when family homes do not cater for ageing parents, the offspring will support the idea of moving to villages.
The model is here indefinitely.
Disclosure: I chair Parkwood Retirement Village and own shares in Ryman, Metlife, Summerset and Oceania.
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WHILE property ownership, especially commercial property, is often these days in the hands of retirement villages or listed property trusts, there will always be private companies competing for the small stack of well-sited properties.
Indeed, by far the biggest home-owning company in the United States is the giant hedge fund operator BlackRock, which owns tens of billions of dollars’ worth of residential properties, snapped up from banks at heavily discounted prices after the 2008 crash in America.
Leading up to that 2008 crash, five million spec houses were ‘’sold’’ to people with no real deposit, utterly inadequate ability to service a loan, and certainly no ability to service an interest-bearing loan when the 12 month ‘’no-interest’’ incentive expired.
BlackRock, using money provided by pension funds and wealthy punters, kept the finger on the button at every auction and now owns hundreds of thousands of residential homes, collecting market rents from the poor sods who have no alternative but to accept a hedge fund as a landlord.
I guess you could say this is chapter two in how the US housing market is exploited.
Here in New Zealand hundreds of commercial properties, office blocks and industrial properties changed hands after the 1987 crash when our property moguls were seen to comprise wide boys, dreamers, high-risk investors, and a few knaves.
The 2008 crash was not as dramatic, though it chased away some offshore buyers for a while.
Today, with interest rates at low levels, the valuations all seem extraordinarily high and will surely change as businesses adapt their models away from CBD locations to more cost effective locations.
Indeed before the Kaikoura earthquakes, Wellington commercial landlords were rushing around offering free winegums and piped music in bathrooms in search of long leases, even at lower rentals.
The earthquake took out more than a dozen buildings, leaving the power back in the hands of the landlords, for a year or two, before we get the next edict from government or offshore head offices, to make savings in rentals.
When this happens one individual city property owner will still stand head, shoulders and torso above all others.
The 85-year-old German immigrant Mark Dunajtschik owns the pick of the buildings not owned by public companies, his flagship new building near Wellington’s railway station arguably being Wellington’s best building.
Dunajtschik dislikes debt, has borrowings barely a tenth of the level of some of his various publicity-focussed competitors and is almost a bank to some competitors, though for the life of me I cannot imagine why he is so generous to those who banks would regard with deep suspicion.
He is a decent man, now resulting in his nomination for Wellingtonian of the year, following his remarkable generosity in providing $50 million for a children’s hospital in Wellington.
Further to that he has also offered additional help, to ensure the building is completed. Remarkable!
He is the second Wellington commercial property owner and developer this year to win the esteem of the public, after Ian Cassels was named earlier this year as a Wellington icon for his involvement in promoting Wellington, and his vision for developing Wellington property.
You may never see Dunajtschik or Cassels boasting about their assets in public, nor are you likely to read of excessive debt levels, though no doubt they have had their moments when survival was their ambition.
I salute Dunajtschik for his leadership in Wellington property and his decency and generosity as an individual.
For all the bluster one hears in capital markets, very, very few individuals ever have the wherewithal to write a cheque for fifty million to give to a great cause, let alone the social kindness to shed such wealth.
He and his wife deserve the status they hold in property ownership and in benefaction. They are champions.
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CURRENTLY before Parliament is a bill that will define the future of family trusts.
In everyday English it will spell out the requirements of trustees to manage a trust with the same diligence that they would manage other people’s money, recording decisions, explaining decisions and taking into account all stakeholders.
I do hope that this results in two major changes involving trust management:
1. Settlors and families cease to use Trust companies and most definitely do not allow Trustcompanies to manage the assets of a trust (or an estate).
2. Settlors/beneficiaries close immediately all trusts built solely to hide income or assets in the hope of defeating income-tested or asset-tested benefits such as the subsidy for geriatric care.
The first issue is obvious.
Trust companies are not appropriate fund managers. They do not attract the best people and their charges do not reflect added value. Trust companies have been dreadful self-serving fund managers in the past.
Trust companies may be used confidently to design a trust to meet the settlor’s wishes but to allow them also to manage the assets in a trust (or an estate) is simply foolish, in my opinion.
The second issue arises from changes that have occurred in the way the Crown allocates subsidies.
In the 1990s, trusts could hide income to avoid the pension surtax that Bolger and Richardson brought into law, and they could shelter assets, and income from many other Crown subsidies, including those offered to solo parents, the sick, those in need of geriatric care and even the unemployed.
Obviously it was poor legal drafting that allowed people of significant wealth to skew their wealth management in order to maximise tax-payer subsidies.
I personally observed people of immense wealth creating structures that enabled them to collect subsidies from the Crown of what amounted to fob pocket money for the wealthy.
Today the laws are unequivocal and sane.
To achieve such subsidies today would require an ill-advised person to commit perjury.
Many trusts are cynically created solely to produce regular income for paid trustees.
The new law should be the catalyst to kill off such arrangements.
That is not to say that all trusts should be disestablished.
There are legitimate reasons for some trusts, one of them being the avoidance of judicial intervention, a growing trend for courts to intervene on how an estate should be dispersed.
If a parent has a dysfunctional family, a skewed allocation to different beneficiaries is often adjusted by a judge who might have the same picture of the family that grasping beneficiaries have painted in court.
Trusts solve this, as the assets of the trust will continue to be subject to the trust deed, and that does not die when the testator dies.
There have been many dull books written on trusts, often by colourless, self-serving trust practitioners, but they are now outdated and largely irrelevant.
There are competent lawyers who specialise in trust advice and design, and there will be many advisers in the best sharebroking firms or bank wealth divisions who will be experienced in the creation of effective trusts, and the management of the assets.
If fund managers are involved, the very best of them should be appointed.
Beneficiaries and independent, non-corporate trustees should have the power to fire professional trustees for any reason at all, perhaps reviewable by a court if another beneficiary has a different opinion.
In my experience, every husband/wife wants the surviving spouse to be the prime beneficiary, and wants all investment strategies to meet the needs of that person, before the needs of others are even considered.
A good trust deed caters for that.
For example there is nothing to stop a deed stating that until the spouse’s income needs are fully met by projected interest and dividend income, no money is to be invested in assets that do not produce income.
Deeds may also forbid the use of ETFs, managed funds or any particular securities, or trust companies or other fee-charging intermediaries. The deed must be specific. In my view every draft deed should be considered by independent solicitors before being finalised. The cost will be much less than the added value.
Settlors of trusts MUST be savvy when they dictate the rules of the deed.
They simply must rule against the use of trust companies, if their experience of these companies replicates my own encounters with them.
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ANOTHER of the disastrous weaknesses of trust companies was their inability to attract the right people to supervise the trust deeds of corporates, like finance companies and mortgage trusts.
Trustees Executors made a complete hash of representing South Canterbury Finance debenture and bond investors but were saved by the Crown guarantees, and thus were not accountable for their ineptitude.
Perpetual Trust evolved in the years after 2002 into an appalling organisation, weakly led, poorly governed and manned with country mice, disconnected from investors, unfit to perform their duties.
Companies like Lombard, St Laurence, Strategic, Capital + Merchant Finance, Dominion Finance and MFS (Octavius), were allowed to take risks with investors’ money without the trustee ever blowing a whistle.
Covenant was as poor, privately aware in 2006 that Bridgecorp was on the edge of collapse, but never intervening in a useful way, just as Covenant allowed the criminally mis-described and mis-governed Nathan Finance to deceive investors.
NZ Guardian Trust presided over the deed and behaviour of Eric Watson’s Hanover Group, where investor money was used to fund the high-risk personal projects of Watson and his selected co-owner Mark Hotchin, both of whom feature in our Never Again List.
Frankly, it is an appalling indictment on the NZ Securities Commission that not one of these trust companies was prosecuted, their directors and senior staff never made accountable for their role in the loss of a few billion dollars of investor money.
I guess it is fair to say that in rare instances a receiver/liquidator has bullied small sums out of careless trustees but no one has faced the full force of the law.
The latest example is the settlement by the smallest of trust companies, Prince and Partners, resolving their negligence with the bulldust company Viaduct Capital, finally shelling out $4.5 million.
Viaduct Capital was about as genuine as a seven dollar note and fooled only a small handful of happily-duped salesmen into channelling client money into the VC incinerator.
Today trust companies are licensed, so there is now the risk of delicensing. Thank heavens for that. Bad behaviour should be reported. Delicensing should be a standard response to incompetence, arrogance or greed.
How did the governments in the years 2000-2008 ever allow such bonfires to be ignored for so long?
Should those governments have been accountable for neglect?
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Powerhouse Ventures Ltd incubates start-ups. Who will incubate PVL? Its managing director Stephen Hampson has quit, effective immediately, and its controversial CFO, Paul Viney, replaces Hampson.
PVL may become corporate shorthand for Poorly Vetted Listings.
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TRAVEL
Kevin will be in Christchurch on 28 September and in Invercargill on 19 October.
Chris will be in Auckland on 4 September, in Tauranga on 5 September and in Christchurch on September 26 and 27.
Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.
Anyone wanting to make an appointment should contact us.
If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.
Chris Lee
Managing Director
Chris Lee & Partners Limited
TAKING STOCK 24 August 2017
REGULAR readers of Taking Stock may recall that at the beginning of this year there was regular discussion of a new form of corporate security expected to be offered to retail investors.
The new security would offer regular income, a fixed maturity date for return of capital AND a potential capital gain.
I expect Precinct Properties to offer us details of the first example of that security within the next few days.
Its new offer of convertible notes will provide a quarterly interest payment of perhaps 4.8% (certainly somewhere between 4.5% and 5.5%).
The note will have a four-year term at which point Precinct will repay cash or offer discounted shares at a capped price.
If it repays cash, and the share price has reached higher defined levels, some of the price gain might be added to the capital repayment.
Precinct Properties is a most appropriate company to offer this new type of security.
It has a very low level of debt, its property portfolio is significantly better than any other listed office property portfolio, and its tenants and lease terms meet the criteria required by low-risk investors.
The offer of securities totalling $100 million, with $50 million of over-subscriptions, is very likely to appeal to Kiwisaver managers, who will regard this investment as having an adequate yield, genuine upside but no downside.
If the offer is as successful as I envisage, then investors can expect similar offers from other companies, with the balance sheet strength to appeal to institutional and retail investors.
The offer will come at the same time as Heartland Bank’s senior bond, which also seeks $150 million.
Heartland will offer a senior note, ranking equally with deposits, yielding a minimum (and likely) rate of 4.5%, paid quarterly, with a five-year maturity.
As a BBB credit-rated issuer, HBL’s notes are likely to appeal to institutions and fund managers whose mandates often insist on investment grade bonds.
The five year NZX-listed Heartland note will have an advantage over a term deposit in liquidity. Term deposits cannot be broken should a need arise but notes are saleable, if that need arises.
Heartland Bank will pay distributors the brokerage fee, a wise decision that all issuers should follow if they want the retail market to participate.
I expect there to be many such issues over the next two months, given the signal from Rabobank that, as expected, it will repay its annually-reset subordinated shares on October 9.
Rabobank raised $900 million with this issue in 2007, at a time when global debt markets were shaking, as the sub-prime liar loan securities were beginning to undermine confidence in banks, which owned this trash.
No NZ banks owned these securities but by 2007 the first of the failed finance companies, Provincial and Bridgecorp, were surfacing and the trustee companies, like NZ Guardian Trust, were signalling the freezing of their dreadful ’’cash’’ and ‘’mortgage’’ trusts.
Rabobank’s issue was so successful because its banking strength was seen as an AAA safety haven, though later even Rabobank saw its credit rating fall.
In the Past 10 years the Rabobank security sometimes traded as low as 70 cents in the dollar.
The wise people, with experienced advisors, bought more at the discounted price, have had good cash returns and will soon have very satisfactory capital gains, when the $1.00 repayment occurs in six weeks.
Investors should note those trading gains are taxable, the NZ tax laws differentiating gains on shares (often not taxable) from gains on fixed-interest instruments (usually taxable). Please note: we are NOT tax advisers.
I suspect the current round of offers, and those yet to be announced, will be attractive, especially to those whose analysis of equity markets might cause some suspicion that globally, and here, prices look toppish.
Our advised clients will receive a confidential newsletter shortly, outlining our views and our advice on market conditions.
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WHEN markets are ‘’toppish’’, and investors are searching for signals, it can often be a single uncomfortable event that triggers a herd reaction.
Ideally there would be a series of events that gradually provide signals, the first investors to notice the early events being rewarded for their attention.
If one thinks back to the 1980s the first signals of an impending market collapse were probably of simply stupid market practices coming to investors’ attention slowly, because of the dreadful, corrupt practices at the time.
Insider trading was rampant so when company chairmen were flogging off shares, sometimes while publicly claiming they were buying shares, the best informed investors could hear the creaking and groaning of strained markets.
There were literally hundreds of public companies with no credible business models, dozens of new ones listing each year.
Today the signals might be of legal behaviour, like ‘’shorting’’ apparently respectable shares, or using company cashflow to buy back the shares to increase share prices (temporarily), and leverage (permanently).
A large company might divulge undetected losses, or a small company might divulge appalling governance. Other signals might be shareholder in-fighting, or regulator interventions.
Perhaps companies might begin to cut essential long-term spending, or cut back on research, or development, or apprenticeship programmes.
Perhaps banks will slow down lending to corporates. Perhaps retailers will face falling margins and begin to close outlets, or sell out.
Always there will be those who look to piece together signals so they might formulate strategies to escape from major market falls.
In the USA – the daddy of all over-priced markets – data is emerging that the S&P500 is now at prices that are unsustainable.
One chart I saw displayed how many weeks of labour, at the national average wage, are required to buy a notional share in the S&P500.
In 1964 it was 33 hours, in 2001 108 hours, in 2009 65 hours and today back at 109 hours, the highest ever figure.
Another chart showed household indebtedness in the USA, now totalling the highest ever figure of 13 trillion US dollars. Of interest was the rising percentage relating to student debt and car loans.
Mortgage loans had actually fallen since 2001, though mortgage debt was still nine trillion of the 13 trillion.
American commentators are warning investors to head for other sharemarkets, but not to buy into the US market at current prices. ‘’Say no to the S&P500’’ is a current catch phrase.
Meanwhile European commentary warns of the multiplier effect of Exchange Trade Fund investment in global assets.
ETFs which simply buy everything in an index, have pushed share prices up mindlessly but if markets fell, ETFs, subject to instant withdrawals, would hasten the fall as much as they accelerated the rise. In a falling market, annuity funds also fall into crisis.
Of course volatility in prices does not scare everyone.
Price falls might provide buying opportunities for those with cash or bonds.
Readers may recall how the Royal Bank of Scotland, seeking to be noticed and willing to be wrong, 18 months ago wrote to its clients suggesting they sell everything and revert to cash.
Anyone following that attention-seeking advice would have quit for a dollar what is now worth around $1.20.
Will RBOS go again, with the same advice?
We do live in interesting times. Confucius gets his wish!
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THE disgraceful behaviour of the directors of Powerhouse Ventures Ltd continues to perplex investors.
I can now report that a complaint has been made formally to the Australian financial market regulator ASIC, and that an investigation will proceed into Powerhouse, perhaps over its CropLogic issue as well as HydroWorks.
The HydroWorks complaint relates to the valuation PVL published of its subsidiary, the 23%-owned manufacturing and design company specialising in hydro plant projects.
As explained previously, PVL displayed a 2015 valuation of HydroWorks in the October 2016 prospectus used by PVL to raise money with an issue of shares in PVL.
PVL estimated HydroWorks to be worth $19.3 million, or $57 a share, in October 2016, when it was making large losses and had already abandoned a programme that had assumed high margins and had led to the 2015 valuation, clearly ridiculous by October 2016.
I imagine PVL simply made a mistake in citing this obsolete valuation.
History is a harsh judge. Hindsight is perfect. But the Powerhouse directors clearly made a monumental mistake.
HydroWorks is now being liquidated just 10 months after the October 2016 display of a $19.3 million valuation, and the company wishing to liquidate HW is PVL. PVL’s own shares have fallen 70% in ten months, the credibility of the company seriously damaged.
ASIC will now be investigating the PVL IPO, presumably wanting satisfaction that the valuation process was thorough, contemporary and not misleading.
Curiously, HydroWorks last week came within a few moments of being rescued by a large creditor with access to funds and key credible people, including one of New Zealand’s best chief executives from an earlier era.
Powerhouse must have decided that the appointment as liquidator of its adviser, Deloittes, would lead to the best possible outcome for itself. Other creditors may be unimpressed.
I now expect HW’s intellectual property (clever turbine design) to be sold to a competitor.
The IP was never valued in HydroWorks’ balance sheet but may be its only valuable asset.
The saga affects very few investors, as neither HW nor PVL were of any significant scale, between them having hundreds of shareholders but not thousands.
The relevance of HW’s failure will not be apparent until the ASIC investigation is published.
If PVL’s IPO prospectus is found to meet the required standard, my guess is the acceptable level of governance benchmark must then be moved, to the chagrin of those, like me, who seek to invest based on what auditors, investigative accountants, regulators and directors assess to be full and fair information.
This saga will retain my attention, and that of the market, especially those who monitor governance standards, and want to see standards rise.
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SHAREHOLDERS in Fletcher Building will be paid a final dividend equal to that of last year, despite the disappointing profits achieved in what many had anticipated would be a bumper season.
Construction division losses, and the continuing bleak returns from some poorly-conceived offshore investments, offset the vulgar margins Fletcher Building makes from its retail products.
While there has been much attention given to some poor decisions by Fletchers’ executive management, leading to the exit of the unadmired CEO Mark Adamson, there has been far too little said about Fletchers’ rotten culture, the responsibility now of its board, and perhaps its chairman, Ralph Norris.
Former Fletcher senior staff have talked for years about the deteriorating culture, where entitlement, vanity and self-focus have all been visible.
Given its market dominance and favourable political indulgence, FBU ought to be our flagship public company.
I am now hearing that any new executive team will be likely to pursue Adamson’s path, focussing on share price, quarterly results, headcount and cost reductions, rather than building a great company to exploit its privileged market position.
If that is indeed the ongoing direction then in my view FBU needs a new board as much as it needs a new CEO.
Perhaps the public and the shareholders would be pleased to hear from earlier executives who were in charge during the years of progress.
Might Fletchers approach the founders of Mainfreight to offer some thoughts?
Mainfreight tells shareholders its strategic plan is a 100-year plan.
Fletchers seems to have a 100-day horizon, and sometimes a 100-minute focus.
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AS the election nears, one hears of plans to fix the housing problems.
Perhaps the problems are in two groupings, one being the unavailability in the biggest cities of modest, affordable houses for first-time buyers, the second being the shortage of emergency accommodation for those who live under bridges.
The Housing Corporation, to my certain knowledge, is going at full throttle trying to cater for those who would want to pay affordable rent.
It may need to talk to experienced developers to solve the first-home buyer problem, which is at its most extreme in the four biggest cities.
Recently I met with a successful developer who is adamant that inner city apartments of a good standard could be sold profitably at around $1500 a square metre, meaning a two bedroom 70sqm apartment might retail at around $100,000. That would be affordable!
If the homeless can be accommodated in smaller units, then the Housing Corp might do well to include office building conversions in its plans, and might want to visit Germany where old containers are converted to temporary housing for those who are homeless.
Perhaps the Housing Corp needs a building division, fed by skilled labour surfacing from apprenticeships funded by Housing Corp subsidies.
Technical universities, teaching building, electrical, plumbing and other relevant skills, ought to be a great option for those who want long-term jobs in the new era where many jobs are threatened by technology.
Imagine an education sponsored by Housing Corp, with post graduate employment guarantees.
Good builders today are charging $140 an hour! What a great career!
Will someone join the dots?
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TRAVEL
Kevin will be in Christchurch on 31 August.
Chris will be in Auckland on 4 September and in Tauranga on 5 September and in Christchurch on September 26 and 27.
Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.
Anyone wanting to make an appointment should contact us.
If you wish to be alerted about the next time we visit your region please email us and we will retain it and get back to you once dates are booked.
Chris Lee
Managing Director
Chris Lee & Partners Limited
Taking Stock 17 August 2017
THE concept of incubating a fledgling company, and patiently supporting it to achieve its potential, has come under the spotlight at great cost to a set of investors this week.
Last week we heard from one of New Zealand’s best performing companies on its plan to support companies with debt or equity (or both) to achieve long-term success.
And we also witnessed the probable destruction of a high-potential company, HydroWorks, in large part because its ‘’incubator’’ is itself a ‘’cot case’’ and has failed to offer the required support.
What a contrast these two ‘’incubators’’ demonstrate.
The shining philosophy came from our best investment bank, FNZC, which announced its plans to support great companies by giving them time and resources to achieve their potential.
FNZC opened a division (Principal Investments) stating it had no pre-defined views, no end philosophy and no short-term goals.
It would provide equity and junior debt to enable companies to execute and grow their business, including acquisitions.
It would provide growth capital and assist in succession planning.
It might do no deals in any year, and maybe approve only one deal of every 20 it was offered.
It would not expect any investment to convert to a conclusion in a year.
‘’We should be making almost no money in the first three years. If our time horizon was that short we would be thinking about it the wrong way,’’ FNZC said.
‘’If we think in the very long term, call it 10 years, we should have a network of companies coming in and out being ready to move into private equity hands, or ready to list, ready to carry on and have genuine earnings and growing.’’
The noise readers can hear now is my loud cheering of a philosophy every experienced, successful businessman will support.
Call it ‘’long termism’’. The Swiss, the Germans and the Dutch will understand.
Mainfreight, Auckland Airport, Port of Tauranga, Fisher & Paykel Healthcare, Ebos, Ryman and even Xero will understand.
Now contrast that philosophy with that of Powerhouse Ventures Ltd, which for some years has claimed that it is a patient, supportive incubator of potentially great companies.
It has shareholdings in 24 fledglings, often providing around $100,000 of capital, always claiming to offer governance and capital market expertise.
Last year it revalued upwards by nearly 50% the shares it held in these 24 companies and, based on those revaluations, sold to the public shares in Powerhouses Ventures Ltd at AUD $1.07, raising, with the help of some smoke and mirrors, the minimum sum its offer could accept. Probably those ‘’revaluations’’ also had an implication for executive cash bonuses.
Its biggest investment in value was HydroWorks, an engineering company with genuine capability and undoubted ability to improve the output of hydroelectricity from established plants and to build new hydro stations. HydroWorks is not a disruptive technology company. It is simply a clever designer and builder of hydro schemes.
Trustpower labelled HydroWorks’ clever turbine design as a world-leading product.
Powerhouse Ventures Ltd had a 23% interest in HydroWorks, controlled its board and extolled its future, when talking to capital markets.
Last week, just 11 months after Powerhouse Ventures Ltd revalued HydroWorks to around $20 million, Powerhouse Ventures Ltd declared its investment in HydroWorks was worthless, effectively signalling that it would no longer support HydroWorks, consigning it to receivership.
If we put aside the ‘’incubation’’ promise and the governance promise we must also put aside the written promise to be a ‘’patient’’ investor, or even a competent investor.
HydroWorks had a new partnership with Australian companies that promised a pipeline of hydro plant work, probably at prices that might have converted HydroWorks’s engineering design and skill into significant profits, in coming years.
It now needs a new source of capital if it is to survive.
To be fair, HydroWorks had, under Powerhouse Ventures Ltd.’s governance, made some progress, but PVL had made some serious errors which had left HW with millions of debt, a list of unpaid creditors, and a debt to PVL with a 48% interest rate, becoming 120% if the debt was in default. This loan was crafted by a patient, supportive incubator?
To secure a manufacturing capacity of its unique turbines, HydroWorks, led by Powerhouse Ventures Ltd, had bought a Christchurch manufacturer, Mace Engineering, after what we now can see as childishly poor due diligence by the PVL directors.
Mace Engineering, a mature Christchurch manufacturer, had far more internal problems that PVL seemed to recognise, including an ageing union-dominated work force, with a potential redundancy entitlement of some magnitude, old plant, and a legacy of losses surfacing in its work in progress ledger.
So it had ageing plant, was making losses, and required expensive restructuring, and HW picked up the tab.
Yet PVL and HW published forecasts predicting almost immediate multi-million dollar contributions of cash to HydroWorks from Mace profits!
Mace actually consumed cash, never produced it.
Further, PVL and HW produced forecasts in 2015 that HydroWorks would make millions by selling mini turbines for use in irrigation canals, estimating that activity would produce millions of revenue. They forecast sales of forty units. They sold one.
Interestingly the PVL-dominated board of HydroWorks abandoned that mini turbine strategy before January 2016. Read this again. The timing is relevant.
In 2015 Powerhouse Ventures Ltd employed the corporate valuer Edisons, and later Woodward Partners, to value HydroWorks.
Analysts Moira Daw and Simon Wilson gathered up the information they were supplied, did the arithmetic, and calculated that based on supplied information, the present value in 2015 of HydroWorks’ 339,000 shares was $57 per share in Edison’s opinion.
This assessment assumed spectacular sale of mini turbines, Mace profits, and profits from two major projects in Australia.
Armed with this assessment, HydroWorks raised more capital.
By January 2016, PVL’s directors on the HW Board ought to have been aware that Mace was not profitable and should have accepted that there would be no sales of mini turbines to irrigation canals.
Indeed HW abandoned that mini turbine strategy and was busily restructuring Mace.
Directors would have known that the other source of revenue, completing major hydro projects in Victoria and Queensland, would provide no nett gains, or more likely losses.
Powerhouse Ventures Ltd, by early 2016, realised HW could not be sold to the public through a public offer of listed shares. HydroWorks was making losses; it was unable to pay its creditors on time; indeed it was borrowing from Powerhouse Ventures Ltd a sum that reached $1.4 million just to survive, and was paying Powerhouse Ventures Ltd.’s demanded interest rate of 48%, with a penalty rate of 120%, according to one insider.
HydroWorks needed much more capital to be eligible for proper banking facilities and to provide the bonds required by those who were advertising tenders for multimillion projects in Australia and Asia. (These bonds guarantee project completion).
So HydroWorks in January 2016 was short of capital, short of cash-flow, was unprofitable, and had an expensive problem with Mace to address.
Powerhouse Ventures Ltd needed money to maintain its 24 start-up companies so Powerhouse Ventures Ltd listed its own shares, justifying the A$1.07 by displaying what it called fair value for its various investments which included HydroWorks.
It valued for its IPO in September 2016, the HydroWorks shares at $57 per share, the value Edison had calculated in 2015, when HydroWorks was still expecting Mace to contribute millions of profit and when HydroWorks was hoping to make millions by selling mini turbines for irrigation canals.
PVL had directors on HW’s board during this period, led by the Powerhouse Ventures Ltd managing director (Dr) Stephen Hampson.
Perhaps it might have been wise to re-assess HydroWorks’ ‘’fair value’’ in 2016, before the Powerhouse Ventures Ltd documents for the IPO were printed. Were Powerhouse Ventures Ltd investors misled?
The investigating accountant for PVL’s IPO was BDO Spicers which certified that it knew of no material changes that might deceive or mislead investors in the PVL offer.
The Powerhouse Ventures Ltd IPO displayed a board chaired by one of New Zealand’s well known economists and public company directors (NAB, Comalco as examples) in Kerry McDonald. He resigned three months after the IPO, without explanation.
It also displayed Rick Christie, once a BP Executive but in the last 30 years a public company director, once chairman of Ebos. He remains a Powerhouse Ventures Ltd Director.
Prospective PVL investors might have taken for granted that both of these fellows would have performed extensive due diligence before agreeing to join the Powerhouse Ventures Ltd Board, and before selling PVL shares at A$1.07 to the public.
Powerhouse Ventures Ltd, despite having very little cash and being still in its infancy, paid Hampson $350,000 plus bonuses, for his role as MD. His bonuses are likely to be linked to revaluations of the incubated companies.
PVL simply ought to have seen that HydroWorks was fighting for survival, paying 48% for short term loans, well behind its commitments to creditors and lumbered with a poor decision to buy Mace Engineering.
No one else knew all of this and it was not implied by the revaluation in Powerhouse Ventures Ltd IPO.
The PVL IPO documents were silent on these problems.
I would have guessed that Powerhouse Ventures Ltd.’s obligations after its September 2016 IPO began with a commitment to restore HydroWorks, which it had described as being worth nearly $20 million. It had an obligation, I would have thought, to ensure that HW was given the time to be worth what PVL said HW was worth.
Without that assistance, HydroWorks was clearly at risk of failure.
There was a case for a $5 million placement of HydroWorks shares to Powerhouse Ventures Ltd, which a long term, patient incubating company might have seen as a much better option that allowing HydroWorks to fail, with all the obvious consequences and the obvious questions such a failure, so soon after the Powerhouse Ventures Ltd IPO, would raise.
This did not happen and cannot happen now PVL has disclosed that it regards HW as being worthless.
The consequences will now unfold.
HydroWorks is a candidate for receivership. Creditors would lose money. The convertible note-holders would be wiped out.
Those who crowd funded HydroWorks in 2015 would lose all of the $1.5 million.
The HydroWorks shareholders would lose everything if a new shareholder does not emerge.
The intellectual property, engineering skills and any manufacturing assets would be bought for some sort of a price and with luck, the HydroWorks expertise would be used by the new buyer, who might acquire the asset for even less than a song; perhaps a brief moment of humming.
Will Powerhouse Ventures Ltd continue to be promoted as a patient investor, incubating good ideas? Will it even survive this ugly demonstration of its skills?
Will its sources of new start-ups - the universities - observe the HydroWorks experience and form a judgement on Powerhouse Ventures Ltd.’s ability to help start-ups mature?
If I were the commercial manager at a university and wanted help to incubate a start-up, my first call would be to the HydroWorks executives to ask of their experience with Powerhouse Ventures Ltd as a patient, incubator of new companies.
The Powerhouse Ventures Ltd saga, I fear, is symptomatic of much that is wrong in investment practices.
I have great faith that FNZC, adhering to its philosophy, will show how it should be done. It has an excellent board of directors and its CEO understands his obligations to all stake-holders.
Note: Powerhouse Ventures Ltd.’s shares sold at A$1.07 11 months ago are now traded at less than a third of the figure.
Will the Australian regulators wonder why?
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REGULAR readers of Taking Stock will know of my view of the trustee company Perpetual Guardian Trust, formed by Englishman and ex-Macquarie staffer Andrew Barnes.
Several years ago Barnes and PGC owner George Kerr hatched a deal for Barnes to buy from Kerr Perpetual Trust, then buy NZ Guardian Trust, merge the two companies and then list it on the NZX after creating some one-off cost savings, bolstering profits!
As it transpired the market was less enthusiastic about a listing, so that did not happen.
Any sale deal included a $22m bonus payable to Kerr’s company PGC which had owned Perpetual Trust, once the re-sale took place, or so Kerr believed. He argued the bonus was part of his and Barnes’ deal.
There were some other conditions unknown to me and for a while Kerr and Barnes shadow-boxed, Kerr claiming he would sue Barnes, the English visitor claiming he would counter-sue Kerr. In the end Kerr and Barnes seemed to be in harmony.
Barnes bought one or two other tiny trust companies, failed to sell his new grouping via an IPO, but then announced he had been inundated with offers from private sector buyers.
Eventually he announced he had chosen from the various interested parties a newly-formed company called Trustee Partners, based in Australia. Presumably he saw TP as the best of these buyers. (I wonder what the other interested buyers were like.)
Quite remarkably, the new company Trustee Partners had agreed to pay A$200 million for a newly configured NZ company which, with the help of cost cutting, had announced an inaugural profit of $8.5m.
Whether that $8.5m will be repeated obviously would depend on the various clients of all the amalgamated trust companies agreeing to continue to pay the handsome fees that trust companies charge for managing estates and family trusts.
As noted, my view on this is well known.
Trust companies, I think, should write wills and trust documents but should be engaged to manage the funds of estates and trusts only if there is simply no alternative. Rarely, very rarely, are there not better alternatives.
I have yet to see any trust company with any comparative advantage in managing money for other people.
If I were asked I would urge every trust or estate to replace any trust company manager with an external, proven and competent fund manager, with the best protocols and staff in the market!
I would be emboldened in my view by the large number of examples I have seen of very poor relationships between their clients and the Perpetual and NZ Guardian Trust managers, going back well before Barnes arrived in NZ to do his deal with Kerr.
So when the sale to the tiny new Australian company took place I was amazed at the price Trustee Partners had agreed to pay but was delighted that it was an Australian company that had made what I considered to be such a serious misjudgement of PGT’s long-term value. It was nice to see Australians rating a NZ asset so extravagantly.
Well, we now know the saga is not over.
According to Australian media reports Trustee Partners has not paid Barnes or his company for PGT and so Barnes reverts to being the owner, perhaps holding the TP deposit, if one was paid. The Australian media reports Barnes will now sue TP, which apparently explains its default by arguing about some details of some leasing agreements.
If that means Barnes must return to one of the other companies who had clamoured to buy PGT I imagine we will hear soon, and that Trustee Partners would be sued should the new sale price be less than Barnes thought he was to receive.
For those who are clients of PGT I repeat my view which is that PGT should be well capable of drafting a will or a trust for which effort a solicitor might charge a few hundred dollars. I believe PGT should be capable of drafting such documents.
But the money held in any estate or trust should be managed by people or fund managers who are completely independent from PGT, and who should represent the best available talent in the sector. I would regard this as an urgent matter.
No trustee company in New Zealand’s history, certainly not in the past 25 years, would have achieved a reputation as being amongst the best available talent for managing money. Indeed NZ Guardian Trust was demonstrably among the worst, as we saw in 2008.
I hope another Australian buys PGT from Barnes and that the re-sale prompts all trusts and estates to review who manages their money. I prefer a NZ manager.
Funds management should be separated from will or trust design, in my opinion.
If Barnes decides to retain PGT he might assist, by outsourcing the funds management or by encouraging settlors and testators to manage their funds themselves, without fees.
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THE fines applied to the Commonwealth Bank of Australia for what seems like a refusal to comply with anti-money laundering laws, will total a few million dollars, perhaps quite a few. So it should!
In theory, if the regulators used the maximum fine for each of CBA’s offices, the fine could be in trillions, not billions, as there were multiple offences, and maximum penalties are extreme.
The errors by the CBA are astonishing as even the most casual observers of banking practices would know that no bank, indeed no sharebroker, real estate agent, car dealer, lawyer or accountant, can allow unexplained or uncontrolled cash transactions.
It is unimaginable that CBA was unaware of the new strict protocols that treats every customer as a potential drug lord or terrorist.
The CBA’s chairman, a practical woman, has cancelled executive short-term bonuses, punished the non-executive directors with a fee-cut, and may have to fire those who failed. The CEO is to resign.
Of course it is the CBA shareholders who will pay any hefty penalties, not the dopes that made the errors, or failed to oversee the errant staff and processes.
This is pretty much the same outcome that has been seen in Britain after the absolutely dreadful behaviour of its banks in the lead-up to the global financial crisis in 2008.
All the banks were fined a total of many billions for cynical and often criminal behaviour but the fines were paid by shareholders and the only consequence for bankers that I recall was the loss by one chairman of his right to call himself ‘’Sir’’. I cried when I read of that severe penalty.
Conversely in Iceland and Spain the bankers were sent to jail in quite large numbers, though of course this did not happen in the USA, where the senior bankers simply paid themselves multi-million dollar bonuses, often from money supplied by the taxpayers to bail out the bank.
One imagines that the most nauseating of these banks, Merrill Lynch, is now a name no sensible banker would want to have on his CV, its behaviour even worse than Goldman Sachs.
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THERE is a growing tendency for New Zealand fund managers to seek high ground by boycotting investments in companies whose products are deemed to be morally reprehensible.
Investments in areas like armaments, cigarettes, alcohol, oil, coal or anything that feeds an argument about climate change are increasingly being avoided.
One imagines sugar, fat and Enid Blyton books will be next on the banned list, perhaps accompanied by non-organic rhubarb.
But how do the tracker funds (ETFs etc.) track an index if it has companies within the index that some would regard as purveyors of nasty products?
Would some regard pesticides as a negative, while others saw pesticides as necessary to allow grain to survive so that the starving in Africa or South America could be fed?
Some regard travel, with all its dependence on jet fuel, as having a hefty footprint. Will we screen out investments in airlines and airports?
And might we have to revise our admiration for Warren Buffet who rescued Goldman Sachs and is now a substantial shareholder in that controversial self-focussed company?
I would much prefer that it is someone else, certainly not me, who decides what is and is not, acceptable to the majority in this new age where one can be hissed at, for allowing marmalade to be spread on one’s toast.
(Look at all that sugar that man is putting on his toast!)
Who would dare stay in one of Trump’s hotels, let alone invest in the banks that lend to him?
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Travel
Kevin will be in Christchurch on 31 August.
I will be in Auckland on 4 September and in Tauranga on 5 September.
Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.
Anyone wanting to make an appointment should contact us.
If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.
Chris Lee
Managing Director
Chris Lee & Partners Ltd
Taking Stock – 10 August 2017
IF you let your mind drift back a few years, say to 1970, you will recall that in those days Britain had a high level of relevance to New Zealand.
Its gift to its colonies, like New Zealand, had been its version of democracy, its foresight in promoting the socialisation of health and education, its ambition for a corrupt-free police force and judicial system, and most importantly, its appetite for all the unprocessed food that New Zealand could spare.
Its doors were wide open to young Kiwis, to play golf (five pounds a day) on its best courses, to play cricket/ rugby/ soccer/ squash/ badminton in its best facilities, and to enable ambitious young people to advance their knowledge of capital markets.
I acknowledge all of this, and I remain grateful.
New Zealand would not be the great country it is had we been a colony of Russia or Turkey.
But it is not stretching the imagination to foresee that Britain’s vision for itself, today, is more like a mirage than an achievable target. Its decay seems inevitable and self-ordained.
Having spent more than a few hours last month with Brits and Europeans listening to their various thoughts on Britain’s plan to exit its European Union membership, I now conclude that Britain’s reversion to at best mediocrity is inevitable.
Yet the British voters, by a small margin, imply that Britain’s future has been muddled by incoherent and expensive EU interventions, undermining the virtues of the small island.
They regard the incessant arrivals of immigrants as a drain on their resources, and a threat to employment for the native Brits.
They apportion blame to immigrants for the decay of Britain’s infrastructure, its overcrowding, its failures in education, its crime rate, its bleak living standards in many areas, and its accelerated and unsolvable debt levels.
Hearing these views, I checked some ‘’facts’’ that were quoted to me.
It is true that Britain is overcrowded and that its proud, some might say its pompous and vain, view of its education standards needs revision, that its wages in real terms have fallen over the past decade, and that its definition of ‘’jobs’’ is disguising the limited real employment opportunities for unskilled or semi-skilled workers.
Its class system has always been pretentious and a threat and now looks simply stupid, given the level of classless immigrants in dominant decision-making positions.
Its debt at government levels is extreme, nearly two trillion pounds, say three times the debt per head of ‘’colonies’’ like New Zealand. And debt is growing. Britain indefinitely will run with multi-billion pound fiscal deficits.
Its workforce is stratified. Brits do not want to work in nursing, the care sector generally, in manufacturing and in trades and are losing jobs to smarter ‘’foreigners’’ in fields like science, engineering and technology.
A recent survey showed that youngsters in Britain (16-24) are almost the very least skilled in technology, numeracy or literacy, within the bottom five of the 35 OECD countries measured.
In contrast, the Europeans believe that EU membership has propped up Britain’s living standards rather than diminish them.
Indeed the EU subsidises its poorest regions. In the northern states of the EU, nine of the 10 poorest regions are in Britain, including Lancashire, Cornwall and West Wales.
Of Britain’s exports 44% go to the EU countries, while Britain imports 55% of its total, from the EU.
The UK’s GDP is expected to be 5% lower when (if?) Britain exits the EU.
Even if it gets favourable Free Trade Agreements with the USA, India and Brazil, it would not have replaced even a half of its EU trade.
Worse, London would lose its frankly unearned status as a global financial hub.
I call it ‘’unearned’’ as I challenge the concept that Britain has deserved its reputation of being a capable, transparent, honest leader in capital markets.
The reverse is true, in my opinion. Frankfurt and Amsterdam have higher standards.
Consider the behaviour that led to fines imposed on British financial institutions, behaviour in areas like rate rigging with Libor, foreign exchange, commodities (gold for example), and currently, the cynical mis-selling of insurances to consumers where Lloyds Bank alone has been fined billions of pounds for cheating its customers.
Even its central bank, the Bank of England, would be clearly upgraded if it followed New Zealand’s vanilla central bank procedures, though, to be fair, the Canadian Mark Carney has been more pragmatic than his predecessors.
And Britain’s banks themselves are far from the gold standard, almost unusable, as constipated as its law offices and its stock exchange, according to British surveys.
Global banks and investment banks are not exactly intimidated by the prospect of moving from London to gain efficiency in Frankfurt, as the exit of Britain from the EU now encourages banks to do so.
But it was the household living standard that apparently was the driver of the exit vote.
Every UK household ‘’owes’’ around $110,000 (NZD) of the nation’s debt.
It also owes a similar level of mortgage debt.
It also owes around NZ$25,000 on household, non-mortgage debt (credit cards, car loans).
Indeed if one looks at just household debt to household income throughout the world’s supposedly richer countries and studies say Britain, Belgium, France, Germany and Italy, one will find ratios varying from 150% (high level) to 90% (still too high, in my view) of household debt to income.
Italy, a toxic mess, is the lower figure (90%).
Britain is the 150%.
Credit card mentality thrives in Britain.
Extreme levels of sovereign debt and extreme levels of household debt might not lead to Armageddon if there were plans afoot to attack the problem urgently.
There are none that are noticeable.
The ridiculous inequality in wages distribution satisfies the top 0.01 of one per cent but consigns the nurses, teachers and policemen to a lifestyle that would be unattractive to most New Zealanders. (See the figures I quoted in last week’s Taking Stock).
Sweden and Finland address this nauseating abuse of income distribution by enabling everyone – that is every single person – to view the tax returns of everyone else.
Personal income files are for public inspection.
The Scandinavians see daylight as the disinfectant. In Britain, in many occupations it is a dismissal offence to reveal one’s salary.
To stop the mis-use of tax structures (to reduce tax) the Maltese set your government universal pension based on a percentage of what your filed tax returns reveal as your earned income, on the last four years of your working life. Cheating makes no sense. You would just get a lower pension!
Having listened to Brits and Europeans discuss these issues, I continue to wonder why Britain does not have an ‘’Are You Sure?’’ referendum.
German business lenders to whom I spoke hold the view that the only justification for ‘’Brexit’’ would be based on the opinion that the EU must implode soon, presumably signalling the impracticality of Germany’s underwriting everyone, indefinitely.
An EU implosion is not impossible. If the EU did blow up, the first country out would have been the smartest.
Don’t expect your average British voter to have voted ‘’exit’’ after in-depth analysis of the EU’s future! Some characterise the vote as an extension of the public bar braying of ‘’who won the war?’’
I conclude that dear old Mother England, which helped kick-start my career, is now just imagery, romantic perhaps but not worth re-establishing.
Nice people; good fun but unable to adjust to the modern world, or to put right the results of serious errors in policy, made over the past 45 years; still cursed with a union mentality.
Thank goodness Britain is now a nation with which we trade at very low levels, less than a tenth of the percentage of our trade that it represented in the 1960s and early 70s.
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THERE is no better example of the problems that Britain faces as it seeks to exit Europe than in its auto industry.
This industry employs 800,000 people of whom 170,000 are in manufacturing jobs, produces 1.6 million cars and 100,000 commercial vehicles, and exports 1.375m of these largely to Europe (55%).
Britain imports most of the componentry for these vehicles from Europe, currently on favourable terms.
For example power steering, fuel injectors, the engine block and the torque converter come from Germany. The coolant hoses come from the Czech Republic, the exhaust manifold from Hungary, the shock absorbers from Poland, and France supplies the heating, ventilation, air-conditioning, wiring protection and the front lighting.
If Britain exits Europe without an agreement, a 10.5% tariff would be added to the prices of the cars devastating the economics and thus the competiveness of Britain’s car industry.
Clearly the major auto companies fear this.
In 2015 the global companies invested around NZ$4.5 billion into auto industry innovations in Britain.
In 2016 that figure fell to NZ$2.9 billion.
This year, to date, the investment has collapsed to barely NZ$550 million.
The Land Rover is Britain’s key vehicle, production close to 600,000 with European componentry making up 40% of each vehicle.
Britain has adapted before. When I lived in London in the 1970s Britain’s manufacturing process produced 300,000 tonnes of forged parts for cars.
Today that figure is less than 30,000 tonnes.
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THE European car market is dominated by Germany and France, Germany holding 37%, France 26.5%, Japan 12.6%, South Korea 6.1%, Italy 6% and all others (including Britain) 10.9%.
By far the bestselling brand is Volkswagen (anyone care about diesel omissions?) with 11.5% of the total market. Audi, BMW and Mercedes Benz each have about 6%.
For Britain the industry involvement is largely a privilege of EU membership.
More than 90% of Europe manages without British cars.
The banking sector is another potential catastrophe for Britain.
As the day of Britain’s exit nears, Japan’s biggest bank Mitsubishi (MUFG) has announced a plan to headquarter itself in Amsterdam.
Japan’s other huge banks, Nomura, Daiwa and Sumitomo Mitsui, are all moving to Frankfurt, as are Morgan Stanley, Citigroup and Standard Charter Bank.
Collectively these banks currently employ tens of thousands of very well paid staff in London. That changes soon, well before the date when Britain leaves the EU.
HSBC is going to Paris; Bank of America and Barclays have chosen Dublin.
The choice of MUFG to go to Amsterdam is interesting as Dutch banking laws do not allow bonuses to exceed 20% of the published salary of executives.
By comparison Frankfurt allows 200%, subject to specific shareholder approval.
Piece all of this together and you might understand why those to whom I have listened are so certain that Britain will suffer painful and unavoidable falls in tax revenue and jobs and ultimately in living standards. Night will follow day.
I expect as the day of exit nears, there will be factions of both major political parties discussing an ‘’Are You Sure?’’ referendum. Perhaps the traditional political parties will abandon the ‘’Conservative’’ and ‘’Labour’’ differences and become the ‘’remain ‘’ or the ‘’exit’’ parties.
_ _ _ _ _ _
ONE ongoing, hopefully not waning, strength of Britain is its daily newspaper The Financial Times, where quality journalism still exists in bits on most pages.
The Financial Times has a policy of getting rid of its weaker journalists, perhaps like the Times and the Daily Telegraph, sending their weak links and hotheads off to the colonies, just as in banking Citigroup and others have previously sent off their no-hopers to run a branch in Fiji or even New Zealand.
One feature of The Financial Times that the NZ media would do well to copy is its regular publishing of the level of shares that are being borrowed for short selling purposes. If only we had a business-oriented newspaper in NZ!
If an institution or a hedge fund thinks that Virgin Bank (as an example) is in a mess, it might borrow shares from a shareholder in VB and immediately sell the borrowed shares.
When the owner wants his VB shares back, the borrower then repurchases the shares from the market and returns them along with a fee. That ‘’fee’’ should go into the income passed on to investors, though this does not always happen. (Most “lenders” are fund managers.)
If they were repurchased cheaply, the shares that were ‘’shorted’’ would have made a tidy profit for the short seller, a useful piece of information for all investors.
The Financial Times and a few other papers regularly display to readers which shares, and at what levels, are being shorted.
Given that our media is more able to sell its wares with stories like ‘’Bus driver swore at passenger’’, perhaps the publication in NZ has to be through an NZX daily email.
Years ago the NZX published an excellent weekly summary of news.
Gradually this priced itself into non-existence, and became an electronic diary used primarily by brokers.
Perhaps it was expensive to collate the information and therefore it impacted on the absurd bonus schemes in vogue a decade or more ago. (How did that gifting of NZX wealth ever happen?)
An NZX daily or weekly summary might be saleable even to retail investors, given there is so little capital market news published in our papers.
The average UK stock is usually sold short at levels of 10% of all of its issued shares.
Some are sold short by 20%, a figure suggesting very unwelcome news is afoot.
Would you like to know how much of Fletcher Building stock is being short sold?
I have no figures for New Zealand, or Fletcher Building.
Perhaps I need to ask the Financial Times to publish NZ figures.
_ _ _ _ _
CLIMATE change and its link with human laziness (or madness) is well accepted in Germany. It wants to effect real change.
Observe the behaviour of Karolin Ovune, a young lady who is in charge of production planning and materials management at the huge Coca Cola plant in Genshagen, Germany.
Her plant produces 76,000 bottles an hour, some 250 million a year, if the plant has just one shift per day.
Ovune seeks sustainability, optimising recovery from paper, foil and plastic, virtually eliminating thermal ‘’recycling’’.
She sees recycling by converting reusable materials as the new way of obtaining essential raw materials.
She introduced the reusing of bottles and now cites the bottle reuse as being 95%.
Coca Cola’s other German plants have now accepted her pilot scheme and will replicate the philosophy.
Guess what? A deposit on bottles is part of the philosophy.
Does anyone else remember the fortunes to be had in the 1950s by scooping up discarded Coke and Fanta bottles?
Or returning the crates of Red Band or the flagons?
One wonders why these obvious recycling methods were deemed to be inefficient, rather than being deemed to need a more efficient method of re-usage, a wiser use of the world’s resources than just destroying and discarding the bottles, surely.
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Travel:
Kevin will be in Dunedin on 18 August and in Christchurch on 31 August.
Edward will be in Nelson on 22 August and in Blenheim on 23 August.
Edward is also in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.
I intend to be in Christchurch, Auckland and Tauranga in the next four weeks. Anyone wanting to make an appointment should contact us as soon as possible, to enable us to plan.
If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.
Chris Lee
Managing Director
Chris Lee & Partners Ltd
TAKING STOCK 3 August 2017
IF ONE asks business leaders in Europe what occupies their pillow thoughts, the answer will either be the outcome in Europe of Britain’s likely exit from the European Union, or it will be the solution to having emotionally bankrupt people in charge of the nuclear buttons, in at least two countries.
Climate change seems to be regarded as a remote problem.
If you ask workers what concerns them, the answers are likely to be falling pay rates, the threat of robots, pay inequality, immigration and gender inequality in the workforce.
If you ask investors, the virtually unanimous response is the solution to zero interest rates and the related concern of what tracker funds are doing to share prices.
There is no binary answer to the question about Britain’s exit from the EU.
Some believe it will not happen; that the complexities of untangling Britain’s guarantees and its commitments will lead to a new political initiative, resulting in another election, perhaps another referendum.
Clearly Britain wants control of its borders and an end to what it sees as a bottomless purse, feeding European bureaucracy.
The concern about North Korea/Trump seems to be like the concern you hear in New Zealand about the next earthquake, the subject often used to sell newspapers.
One’s imagination can take the subject anywhere it chooses.
Household income is a much easier subject to analyse.
For some years Britain has capped the wages of public servants, the call for austerity being explained as the solution to the global financial crisis that triggered so many problems in Britain and Europe.
To put that in perspective, consider that in 2007 the combined sharemarket wealth of Europe’s leading 500 companies was significantly higher than the US S&P 500.
Since 2007, Europe’s index has underperformed compared to the US, by some 50%. Investment wealth has stalled.
Unemployment has been high, still sits at 9% and, of course, more like 25% for people under 30, with Germany the exception, its rate of workless being less than 4%.
Wage increases have been contained either because of unemployment or because of austerity drives. Germany believes jobs for everyone outweighs the goal of higher wages.
Yet in the private sector there has been precious little evidence of containment of executive incomes, especially in the dominant financial sector in Britain.
The statistics tell the story.
In 1995 the chief executives of British public listed companies making up the FTSE 100 were paid 48 times the average wage, a multiple that most would regard as extreme.
Twenty years later that multiple is 129 times the average wage of their average staff member and 386 times what Britain calls its national living wage.
The figures in the United States are similar - 335 times the minimum adult wage now, yet just 35 years ago that ratio was 40 times.
The concern about the way the cake is cut up is real and is subdued now only because of the diminishing number of real, fulltime jobs, with robots being a small but growing factor.
Real jobs are being threatened by what the Europeans call the ‘’gig economy’’, a nickname referring to the new trend for ‘’self-employment’’, by contracting to take on projects, as required, rather than working for an employer.
An example of the gig economy might be a homecare worker who used to be paid fulltime to provide homecare for the elderly but now is ‘’self-employed’’ and is offered short-term contracts to serve the elderly when required.
Concern about low pay is very real in Britain but it does not apply in all sectors, certainly not in the financial sector. Average wages seem cruelly low, to those who live in New Zealand.
Within the BBC, the researchers, the IT people, the back office staff, and the administration people are paid on average around $45,000 NZ per year.
The frontmen are paid quite absurdly, given that the BBC is funded from the Crown purse and has no real competition, the likes of ITV in the private sector not required, nor able, to provide the breadth of services that only the BBC must provide.
Women presenters seem to be paid much less than men, for no explicable reason, and are now grouping to consider suing the BBC, having found out that their 100,000 pound contracted salaries are less than others, many of whom are men.
I am not sure how you can sign a 100,000 pound employment agreement, presumably quite happily, and then sue the employer because others, of any of the various other genders that abound in this new era, are paid more, but I do not have to address this question.
Meanwhile train drivers are striking, unwilling to accept an offer of around 120,000 (NZD) per year.
The UK Prime Minister is paid around 220,000 (NZD) per year.
Pay rates in Britain are illogical, unsustainable at the top end, and likely to lead to ever more strikes if unresolved. (Teacher strikes contributed the most days lost to strikes last year.) Ferry and air crew are also striking, probably as you read this.
It was interesting to hear one explanation for the absurd executive wages.
That argument was that public companies today were much larger than they were 20 years ago, with much more complex issues to face in areas like accounting, compliance, tax and social policies.
One example cited of how valuable an excellent CEO can be was that of a Prudential CEO who left to join Credit Suisse.
When that news was published, Prudential’s market capitalisation fell by a billion and Credit Suisse’s rose by two billion.
Ipso facto, the CEO demonstrably earned every penny he was paid, or so the argument went.
The contrary argument is supplied by Germany, whose economy far outperforms Britain’s.
Wages in Germany are relatively sane, its chief executives paid far more modestly than Britain’s, yet Britain now runs with sovereign debt at 1.75 trillion pounds, nearly 90% of its GDP, and cannot balance its books.
The average UK household ‘’owes’’ 115,000 NZD through the sovereign debt.
Little New Zealand, so scorned by some UK media (but not by business leaders), has debt levels of around 27% of GDP, the average household ‘’owing’’ around 30,000 NZD.
Britain’s Treasury calculates that should its debt servicing rise by 1%, the cost would be another 4.2 billion pounds of useless expense per year.
Does anyone expect the UK to urge interest rates to rise by any significant amount?
So while business leaders in Britain and Europe consider the big picture events, and the workers try to survive on wages that continue to fall behind, investors, by definition those with surplus capital, worry about capital markets.
Clearly the pitifully low short-term bank rates are still part of the ‘’austerity’’ regime, effectively chiselling fair returns out of those deemed to be able to afford to pay this invisible ‘’tax’’.
So more money than ever looks for a home outside the once trusted bank deposits.
Much of that money ends up in the modern and quite worrying product we would call ‘’tracker funds’’, or exchange traded index funds, which do well in bull markets, dreadfully in bear markets.
These no-look funds that simply ‘’buy everything’’ now are dominating global sharemarkets.
It is said that index funds will soon own half of all available shares in listed companies.
The index funds have been aggressively sold by financial planners who gain their income by charging an annual fee of, say, 1% (sometimes 2%) on the total of each client’s portfolio.
Tracker funds do not rely on research, analysis, or anyone’s judgment, so the financial planner cannot be accountable when in downturns investor money is lost.
Market regulators seem to accept that the average investor is better to track an index than to rely on the skills of an active fund manager (I would say a ‘’real’’ fund manager), or a well informed broker.
The question investors are now asking is what sense there is in a tracker fund buying ever greater amounts of the same shares, irrespective of value.
At what point, when the downturn arrives, will the tracker fund money be recalled by the anxious clients, and what acceleration will that give to the price falls?
Countering that argument is the voice that says that for as long as people hand over their savings every fortnight, to the likes of KiwiSaver, there must be ever greater sums seeking shareholdings, so you almost get perpetual buying pressure.
I have heard this sort of nonsense before, often beginning with the words ‘’this time it is different’’.
I suspect that when the signals are clear enough to frighten investors they will withdraw from tracker funds or ETFs as fast as they can, believing that the ‘’first man out’’ gets the least loss.
The frightened investor then seeks out selected less risky asset types – maybe cash, bonds, property trusts or even precious metals – and if enough do this, creates imbalance elsewhere.
In part the problem in Britain has been caused by the zero rate policy, which eventually destroyed the concept of annuities and unsubsidised savings or pension schemes.
Who wants to pay fees to invest at nil or negative interest rates?
Who would be prepared to allow an annuity manager to buy junk bonds in quest of the sort of yields needed to meet the obligations of the annuity policy or the pension manager?
Indeed last week the European markets acknowledged a rapid growth in junk bond issuance, exploiting the appetite of annuity and pension fund managers.
The question investors ask is what will be the signal that index funds have peaked and will then endure the withdrawals that will let the air out of global share prices? Who will ring the bell?
Obviously lower corporate profits might be such a signal, though there is no audible tinkle at the moment, in fact the reverse is true. Corporate profitability in some sectors is rising.
If I were authorised to advise investors in Europe and Britain, I would have a plan but I am not, so I shall remain silent.
Our advisors have the plan already underway in the land where we can provide advice to clients who have authorised us to do so.
Britain and Europe face problems far more complex than any we face in New Zealand but not every nation there seems to care.
For example last week Mercedes Benz recalled 3 million diesel vehicles to address emission problems, Audi recalled 300,000 and the German Cartel investigator confirmed he was investigating cartel behaviour by German car manufacturers, going back many years.
If each Mercedes or Audi recall costs just 100 Euros to sort out, the combined cost would be 380 million Euros, coincidentally the same sum as Fletcher Building’s latest estimate of its annual profit ($540 million NZ).
And the share price response to the Mercedes and Audi news?
There was no meaningful response. Ho hum.
Indeed Volkswagen, after its dreadful behaviour in cheating with its emission claims, is again selling record volumes of cars, its share price again in the stratosphere.
Pragmatic Germans keep buying VWs because the car seems to be good value for money. It dominates European car sales, as I will discuss in another issue of Taking Stock.
I wonder if the German mindset explains the growth in the savings shovelled into index funds – that is, that contemporary problems get excised by time.
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WHAT will test active fund managers, who perform research and buy and sell shares based on value, will be the imminent availability of Saudi Aramco shares, expected to be co-listed on the London stock exchange, soon.
Saudi Aramco produces 11% of every barrel of oil supplied to the world each day.
It is wholly owned by the Saudis and is the basis of the wealth of their country.
It is owned by Saudi royalty and is estimated to be worth more than US $1 trillion.
The Saudis want to list 5% of the shares on the London exchange but would not apply for the shares to be included in any index.
So the tracker funds would not be buying the shares.
An active fund manager may participate in this IPO but before doing so would need to have formed a view on future oil prices, to have considered the effect on oil price of the new US production, and might also have pondered climate change trends and even electric car numbers.
The active manager would also need to understand Saudi Arabian accounting behaviour, perhaps the Saudi Royal family succession plan, the Saudi attitude towards minority shareholders, and even the veracity of the information provided, especially on reserves.
Active fund manager participation will decide whether Saudi Aramco’s shares will be fully bid, or may languish.
Active fund managers may already own BP and Royal Shell so perhaps Saudi Aramco will share the allocation to oil producers.
I cannot forget a novel I read many years ago about a massive Texan oil producer which conned Wall Street into listing its shares based on concocted valuations and contrived historical accounts.
I do not wish to accuse Saudi Arabia of being inscrutable and indifferent to western expectations so I will watch this listing with an observer’s interest (but not an investor’s interest).
And I will wonder about their gender equality policies.
New issue: An offer of bonds from a new issuer is expected within days. Please contact us if you wish to receive more information.
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TRAVEL
Kevin will be in Dunedin on 18 August and in Christchurch on 31 August.
Edward will be in Nelson on 22 August and in Blenheim on 23 August.
Edward is also in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.
I intend to be in Christchurch, Auckland and Tauranga in the next four weeks. Anyone wanting to make an appointment should contact us as soon as possible, to enable us to plan.
If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.
Chris Lee
Managing Director
Chris Lee & Partners Ltd
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