Taking Stock 13 December 2018


AS most of us seek to clean up unfinished tasks before Christmas, many investors have two weighty decisions to make.

They must decide whether to accept Orion Health’s buy-back offer, cementing an 80% loss if they were original investors, and they must decide whether to file a disputatious vote against the Vital Healthcare Property board.

The Orion buy-back follows four years of disappointment after the listing of Ian McCrae’s software company at the hefty share price of $5.70.

This price was not something he or his brokers conjured out of magic.  Its pricing followed consultation where institutions like the ACC, and brokers, disclosed a price at which they would subscribe.

The lead brokers were First NZ Capital and Craigs.  They described its pricing as problematical.  It was priced on promise rather than maths.

Within days of listing, Orion’s share price was closing in on $6.50, but within months it was slipping, and by earlier this year had reached 60 cents, a figure that forlornly acknowledged that McCrae had lost the support of capital markets, having failed to monetise his ambitions.

McCrae is not a capital markets fellow.  He is a bright mathematician and clever software designer but almost a naïve financial markets man.  He is not your standard entrepreneur who always has a Plan B to cope with failure.

McCrae has five offspring, lives in a nice house, and has virtually all of his wealth tied to Orion Health, in which his holding has been around 50%.

His aspirations were clear from day one.

The Rhapsody product was his cash cow.  It was a relatively standard piece of software, enabling all health practitioners to access the health records of people who walked in any door, anywhere in the world.

More than two dozen countries subscribed to the software.

Rhapsody has positive cash flow, produces a profit and has been easy to value.

McCrae’s real dream was much more problematical.

He foresees a day when the composition of one’s genomes (DNA) can be analysed and can be used to provide an individual with the information to choose lifestyles that optimise one’s health.

(That is a layman’s version of his ambition.)

In plain terms he could foresee that technology links between genome analysis, medical knowledge and communication hardware (Fitbit watches for example) could enable people to adjust their behaviour based on their current health and their preferred lifestyle.

An athlete might be told that his heartbeat was reaching a dangerous level given his personal health issues.

A laggard might be told to lay off the grog or to get some oxygen into his system by exercising.

Predictive analysis was McCrae’s dream.

He employed more than a thousand brilliant mathematicians and software people to develop his idea and sell it.

He believes pre-emptive behavioural changes would reverse the unaffordable increases in health budgets, here and everywhere.

His is a lofty ambition. Failure to achieve such an ambition brings no shame on him.

Capital markets require binary answers and have a short-term focus.

The brutal truth is that McCrae did not understand the need to monetise his ideas in a defined term. He could not revert to capital-raising every time he endured delays.

In hindsight, his work probably needed to be funded by people with much longer time frames than stock exchange investors, sharebrokers and fund managers would allow.

In hindsight, he should have attracted only those investors prepared to wait indefinitely for breakthrough progress.

Orion Health is now selling 75% of its cash cow Rhapsody to fund more years of its Project Blue Sky, as McCrae pursues his dream.

My guess is that virtually every Orion investor will accept the share buy-back offer of $1.22, generated by the proceeds of the sale of 75% of Rhapsody.

Such an outcome will mean there is less cash available to pursue his dream.

I admire McCrae and his ambition but I hope he does not mortgage his house to pursue his dream.

Investors must this week decide whether to take the $1.22 on all, some, or none of their shares.

The decision on Vital Healthcare is not a make or break decision and is much more to do with a corporate practice that few will find tolerable.

Vital is a listed property trust, funding buildings used by medical, dental and veterinarian businesses in Australia and New Zealand.

Its security of rental income is high, its dividends are lean but reliable and its business strategy seems credible.

However it is yet another business being ruined by an absurd agreement with an external fund manager that runs the company.

The agreement is ridiculous in that it puts far too much unbridled power into the manager, over-rewards the manager, and grossly over-incentivises the manager to grow the size of the business, but not necessarily the nett profit.

I had hoped we had seen off the era when such nonsensical contracts allowed the management company to reward itself based on gross assets, gross revenue or gross profit. That formula should never be sanctioned by directors or shareholders.

The only meaningful benchmark should be nett profit.

Perhaps, at a squeeze, you might allow a contract to share a tiny fraction of any revaluation gain, but to allow the fee and the incentives to be based on gross figures simply sprays manure on logic.

How well we ‘’elderly’’ all recall management contracts that encouraged debt-fuelled purchases that simply destroyed companies when asset prices fell.

Vital is asking investors to vote for a director put up by the manager of the assets.  Remarkably, the manager has the power of veto for any director.

Various institutions have put up another option for the director’s role and want to force changes in the management contract.

Sensing some discontent Vital’s manager has employed a lobbyist to call shareholders and urge them to vote for the manager’s preference. We doubt this will go well as every investor who has contacted us has been offended by the caller’s tone and intentions.

My opinion is that the directors who ever agreed to allow such an absurd contract should be prosecuted for not performing their directors’ obligations properly.

Those who sold the contract (ANZ) should be accountable for the damage done to shareholders, the contract holder milking tens of millions in incentive payments for strategies that were of little benefit to shareholders.

New Zealand has seen far too many examples of sycophantic directors allowing absurd contracts.

We see it with the ridiculous termination payments to exiting executives, no better example being the $10 million payment by AMP to George Trumbull after AMP had been badly damaged during his one-year tenure.

We saw it with the nonsensical $5 million payment to a ubiquitous TV announcer after a few days of work.

We saw it with a multi-million payment to the Fletcher Building CEO, Mark Adamson, after a brief tenure characterised by childish rants and poor decisions.

Surely the directors of a company must be accountable for contracts they award?

If they must pay ‘’incentives’’ surely they should be accumulated over many years, and be reversible at a pre-determined rate, when time passes to allow accurate judgement.  Long-term losses should not have been rewarded by short-term bonuses.

The chief executive decision that seems to improve profits in year one might be seen to undermine profits in year six.  If he has been paid a ‘’bonus’’ in year two, and resigned in year three, the shareholders have been diddled.  My grandchildren would understand the illogic in the proposition.

The NZX would understand this problem as well.

The Christmas period is renowned for being a time of giving.

In the case of the Vital decision, my ‘’giving’’ would be the ‘’giving’’ of a stern message to Vital’s fund manager.  I would be ‘’giving’’ him the boot, if such an outcome could be organised.

If you are not attending the meeting to vote we encourage you to re-read this week’s Market News on our website for guidance on appointing proxies from the fund management community to act on your behalf.

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THE period after Xmas will also be crucial for many Brits, including its Prime Minister.

The parliamentary vote on Britain’s plans to exit Europe will provide a crucial signal for the prospects of global stability in 2019, and perhaps thereafter.

As often expressed here the prospects for New Zealand’s ongoing successes are based on our domestic stability but also on the state of our trading partners.

We expect the US to be a challenge.

We observe great demand and co-operation from Asia, but we do need Europe.

The underlying issues in Europe are problematical.

Britain’s relationship with Europe is unlikely to be stable again, for many years.

Just as worrying is Italy, where its banks are struggling to raise money from other countries and, accordingly, are lending less, creating a squeeze on business.

France is not enjoying the tensions between immigrants, city dwellers and its rural areas.  Tourism will suffer.

Germany has a fear of a Trump-led attack on Europe’s motor vehicle industry.  The auto industry drives Europe’s fortunes.

Germany also has a fear that its flagship bank, Deutschebank, is troubled, not just by poor performance but more so by poor behaviour, its money laundering involvement likely to be extremely expensive and damaging to its right to operate in other jurisdictions.

Germany also faces political change, as Angela Merkel, after 18 years, prepares to retire.

Illegal immigration to Europe remains an unsolved problem.

In 2019 Europe will have to handle many grim problems.

Global analysts have long focussed on China with its debt problem hidden in its shadow banking sector.

China, of course, also faces barriers to trading with America.

Most years one could discuss these sorts of potential obstacles to the trading nations, like New Zealand.

My guess is that Europe will be the cause of most concern in coming months.

A collapse of the Italian banks would really test the strength of the German banks and would undermine the European central bank, which has spent hundreds of billions buying Italian and other bonds not offering a proper return for risk.

The bright ending to these worries is that many, including me, will be out of reach during the holiday season, rarely on-line, and mostly on grandfather duties!

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NEXT week will be the final version of Taking Stock for 2018, published on Wednesday, not Thursday, as our office closes on Wednesday December 19, re-opening on Monday January 7.

In the final Taking Stock for 2018 I will provide a synopsis of The Billion Dollar Bonfire, the book I have written for publication in the first week of April 2019.

We hope to retain enough copies to meet any demand. Our list for reserving a copy is now open by emailing Penelope@chrislee.co.nz

Season’s greetings.  May 2019 be a cracker!

Chris Lee

Managing Director

Chris Lee & Partners Limited

Taking Stock 6 December 2018


SOMETIMES investors cannot get the real picture unless they can join the dots.

Those bombarded with the musings of media commentators may need to bring some additional dots together to make sense of recent offerings, so I will try to help.

Firstly let it be said that most wise men of a certain age, let’s call it pensionable age, know that the fount of all wisdom emerges from women of a similar age, and it’s always the case if there is a marital or familial connection.

We of pensionable age know that by popular definition we are ‘’elderly’’, so our wives are likely to be in that same category.

We know we are ‘’elderly’’ because local newspapers describe dog attacks on a 56-year-old man as being canine savagery of the ‘’elderly’’.

We know that sometimes the media presents us with ‘’advice’’ from commentators which, for balance, includes women of ‘’elderly’’ vintage, the modern version of the Aunt Daisy model of the 1950s.

By joining these dots we must conclude that their well-woven words of wisdom cannot be jettisoned as pompous platitudinous piffle, irrespective of the contrary views of younger people who know financial markets and do not partake of newspaper or non-music radio channels, least of all paying attention to today’s Aunt Daisys.

The print media often serves up contributions from the following women - Mary Holm, Liz Koh and Janine Starks - who, in order, focus on KiwiSaver advice to youngsters, budgeting and home science, and matters of insurance, each somewhat of a specialist in their subjects.

So I join the dots and expect that these three, all ‘’elderly’’ by unfair media definition, are all performing a public service by discussing subjects that are important to the age group they address, presumably youngsters.

However, where the dots fell apart for me was in last week’s Wellington newspaper.  On Saturday Starks wrote an advice item on retirement planning, perhaps an unwise departure from the insurance subject in which she seems to be well informed.

She told us that people in her situation need to save two million dollars to maintain the lifestyle to which she aspires, after retirement.

It was at this point that I figured there was a need to challenge such a dotty notion.

Approximately 1% of all New Zealanders, and 0.5% of all living on planet Earth, will ever achieve a seven-figure savings sum if one excludes the value of one’s house, and one talks NZ dollars, not Zimbabwean dollars.

Far less than 1% of the Wellington newspaper audience will be nurturing such an aspiration.

The argument to support her thesis was specious, far more likely to encourage scorn than to inspire readers to read on.

We know that the last published census tells us the mean (50th percentile) household retired in 2013 with around $30,000 of savings (and a debt-free home).

KiwiSaver and other programmes, including the improvement of financial literacy, will lift that figure in the decades to come.  I would be pleased to live long enough, say another 10 years, to see that figure reach $100,000.

The savings figure of $2,000,000 to 99% of New Zealanders is as irrelevant as the aspiration to get young men not to have a cold beer after a game of rugby.

Putting that silly discussion aside there are other modern factors that need to be recorded, for all those seeking to plan the funding of their retirement.

Here are four concrete facts that should appear in every such newspaper article:

1. There is no law requiring retired people to buy new Land Cruiser SUVs each year, with which to drive into mountains for an afternoon of cross-country skiing followed by après-ski, indulging in cheeky little reds from crystal glasses.

Lesson: Most people have a very fine retirement without expensive lifestyles.

2. There is no law requiring retired people to save their capital to pass on to future generations. One’s savings are aimed at funding one’s own retirement, not one’s offspring’s retirement. Providing one’s capital is not plucked by fee-charging advisers, and poked into sub investment grade annuities, the owner of the money can spend the interest and dividend income, and some capital, at a prudent rate.  High fees must be avoided.  The owner of the capital can begin the exclusion list by striking out any annuities with a credit rating the same as, or worse than, Hanover Finance’s rating was three months before it collapsed.  The collapse of annuity providers is always a real risk.  Annuities are, in my view, for the uninformed or for those unable to obtain worthwhile financial advice.

Lesson: If necessary, eat your own savings, don’t let others chew them first.

3. Most people are still part of a functional family, thank heavens.  Generally as one reaches one’s mid 60s, one must accept that one’s parents are perishable.  Because of today’s housing prices, the size of estates is higher than ever.  Providing estates are not chewed up by rapacious fees of trust companies, most people will inherit more than ever before as they approach retirement age. Even retirement village units have value for estates.

Lesson: Inheritances are relevant to one’s financial planning. Equity can move between generations.

4. Because house prices have risen so much, those without enough ready cash can now easily tap into Home Equity Mortgages, enabling the retired to draw an extra 10-30,000 per year, paid monthly.  This ‘’annuity’’ does make sense for many.

Lesson: You can eat your house, if need be.

So should anyone take any heed of the advice of any commentator, male or female, old or young, citing the need to store millions to support a desired lifestyle?

My view remains constant.  One rarely gets useful advice by reading newspapers, talking to cab drivers or listening to salesmen.

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THE Financial Markets Authority, after a credible investigation, has decided Wynyard’s directors did not mislead investors in any culpable way.

The directors erred.  They erred seriously, by assuming Middle Eastern buying interest in Wynyard software would convert to sales revenue and would then justify the extreme cash-burn involved in wooing the Middle Eastern people (Saudi Arabia and Kuwait, I think).

However, the FMA saw errors, not illegalities.

This seems a credible finding.  I expect directors to be informed, inquisitive and intelligent.  I expect them to demonstrate candour, vigour and rigour, but I stop short of expecting infallibility, omniscience or prescience.

However, I do expect them to communicate.  As we all know, our market regulations demand immediate disclosure of all material matters, to ensure investors have symmetry of information and can make buy/sell/hold decisions with a knowledge base equal to all others considering such decisions.

We all know how pathetically weakly these regulations were enforced by the old Securities Commission, led so miserably by Jane Diplock in the era of the finance company implosion.

If we do not recall how poorly the regulators enforced the disclosure laws in that period, we soon will know. A book will be published in March or April that will discuss the costs of this failure.

We will also learn the puny role of John Key’s cabinet in overseeing these matters and the failure to apply available sanctions to a wide range of the parties involved with South Canterbury Finance.

New Zealand, to my knowledge, has yet to be led by an admirable leader with a wide knowledge of commerce, business strategies and business ethics.

Sir John Anderson would have been such a leader.

The FMA is now displaying signs of interest in the Continuous Disclosure Obligations, announcing it may pursue the subject with Wynyard’s directors.

I hope it does.

The New Zealand financial markets are much better policed than they were a decade ago but the observation of disclosure obligations is still a major weakness.

Perhaps we ought to adopt a new protocol.

If anyone or any party learns of an event that is material to a listed security, he, she or it should be required to advise the Board of Directors of that event.

If the Board then secretes the event, wilfully or inadvertently, the sanction should be jail, and a ban from participation in capital markets, unfit and improper for any role.  Binary.  Disclose or sanction.

Then we might have symmetry of information or in other language, a level playing field.

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LAST week’s item about the Belfast aquifer brought a helpful response from a Christchurch correspondent.

He pointed out that aquifers cannot be ‘’sold’’, the word I had used.

One can obtain a consent to extract a defined amount of water.  Trading in these ‘’consents’’ can occur, but the land above the aquifer is not necessarily affected and the aquifer itself continues to belong to the public authorities.

My view on this is not especially relevant but if I had to adjudicate on the bottling of aquifer water for on-sale overseas, I would expect the bottler to be an indigenous company, if only to ensure that its recognition of our laws, and its ability to appear in court if required, would be much improved by its home-town status.

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ONE of New Zealand’s problems is our lack of scale, as inevitable consequence of a small population, comfortingly located miles from anywhere.

It is a strength to have vast oceans between us and potential invaders or illegal immigrants.

It is a weakness that a small market in a large land mass is expensive to service, transport being an obvious problem.

So how should the increasingly activist Commerce Commission react when a company wants scale, by buying a competitor?

If rumour is right, the Steel and Tube response to Fletcher Building’s takeover proposal was, at very least, mindful of the potential cost of dealing with an offer that our Commerce Commission would disallow.

Why pay lawyers and investment bankers multi-millions to work on a deal that could be arbitrarily kiboshed by a bunch of policy wonks?

How much courage was needed by those who have spent time and money finding a Danish buyer for PGG Wrightson’s seeds division?

The Commerce Commission looks to be hunting around for a reason to turn down that takeover.

How did the Commerce Commission ever allow Z Energy to buy Caltex, or the ANZ to buy the National Bank AND Postbank, or Westpac buy Trustbank, and National Australia Bank buy the BNZ?

How did it allow Kiri to buy Lion, or Fonterra to buy KIWI?

At what point should we seek scale, efficiency and cost savings, and simply use the law to prevent exploitative pricing?

Does anyone believe Z Energy’s petrol stations compete with Caltex?

Does anyone believe that the 1960s control of petrol price margins was efficient?

Yet the petrol stations competed on location, and with their food offerings, even if the margin on petrol prices was controlled.

Under this new government, the loudest commercial voice seems to be David Parker’s, the man who wanted to regulate electricity prices.

One imagines that if, as expected, Ardern’s leadership is here for more than one term, there will be ample time for revisiting the concept of price controls in the interest of scale and efficiency.

The Commerce Commission’s initial response to the Danish offer for PGW’s seed division suggest we might be moving to an era of activism.

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Our city visits have ended for 2018.

A new schedule of visits will appear on our website in 2019.

Seasons greetings to all our clients and readers.

Chris Lee

Managing Director

Chris Lee & Partners Limited

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