Taking Stock 19 December 2018

SO the glamour business entrepreneur Eric Watson, remembered as the owner of the Hanover Group, and Britain’s Power Group, as well as Pacific Retail Finance, has now advised that his company has insufficient money to repay a debt to the wealthy New Zealand businessman, Owen Glenn.

A UK court had ruled that Glenn was owed around $60 million plus interest costs, as a result of a mismanaged and mis-described joint deal with Watson.

Watson’s lawyers say the debt is beyond the means of Watson’s investment company, Cullen Investments.

Does this mean that without Glenn’s money, Cullen and perhaps Watson have been in deficit for some time?

The only surprised observer of all this must have been the compilers of absurd ‘’rich’’ lists, who have never acknowledged the difference between someone’s view of the value of gross assets, and the cold-blooded reality of nett realisable value. They think Watson is ‘’worth’’ hundreds of millions.

Those list compilers attribute unimaginable wealth to people with assets valued at prices untested by daily transactions that establish real values.

If one owns government bonds, bank deposits, even corporate bonds or listed equities, one can make a meaningful stab at their real value.

It is still only a guess, as a holder of large numbers of shares must find liquid buyers. Such necessary people or institutions drift in and out of markets.

A person with 100,000 shares in a company whose shares are lightly traded has more certainty of their real value on any particular day than someone with 10 million shares where a one-day sale might drown liquidity and cause massive price falls.

People like Watson, who buy real assets like land, property or businesses, never want to be forced sellers, least of all to meet an unexpected debt, like a court order.

Rarely do these people hold cash or even care about liquidity. They care about their ability to service loans.

I once heard an arrogant fool describe how cash was irrelevant. All one needed was the ability to service debt, he claimed.

His theory gets tested when the lender wants the capital repaid and no one wants to buy his asset (building etc) at anything like the ‘’valuation’’ price.

Watson now is facing a tax claim of tens of millions, an interim payment to Glenn of tens of millions, and very likely a further payment to Glenn of another $100 million or more.

If he is fortunate, his bankers will lend him all this money. He would be unwise to assume this.

If banks themselves worried about making illiquid loans, then the chances of borrowing huge sums, when one is stressed, diminish.

It is exactly these unpropitious circumstances that lead to forced sales, at bonfire prices, or bankruptcies.

All of this explains my derision when I read of the wealth attributed to people with huge levels of debt.

A genuinely wealthy person can write a cheque without conferring with his bank manager.

Most on the ‘’rich’’ list whose wealth is assessed by the ’’value’’ of an illiquid asset are at the constant mercy of their bankers.

Wise bankers know their first duty is to preserve the money belonging to their depositors.

The sight of a stressed ‘’rich lister’’ arriving at the door when the banks themselves are exercising caution is an omen of unwanted news.

Watson is challenging the two awards made against him, or his companies.

Glenn and the IRD will be jostling with each other if Watson’s appeals should fail.

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WATSON and Glenn will both know that the omens for 2019 are not encouraging.

Global financial markets have handed back the gains of the first nine months of 2018 and now appear to be in a dark mood, looking for reasons to fall.

It may be correct to observe that in New Zealand we have many essential companies reaping sustainable profits and paying attractive dividends.

We also have many companies striving to achieve revenue gains so that profits one day might emerge.

The latter group is vulnerable, always, but even the former group will be sold down if foreign money is repatriated unexpectedly.

Foreign markets are currently hyper-sensitive to the never-ending conundrums of trade wars, currency wars, territorial wars and bad banking practices.

One senses that large institutions are almost searching for an opportunity to be ahead of the pack, downsizing their risk portfolios for the certain values of cash.

Asset allocation changes have been noticeable.

New Zealand is in a much less vulnerable spot than most of our trading partners but if problems offshore lead to the repatriation of foreign money, our own savings pool would not underwrite our current values.

The result of a slowdown would be more difficulty in renewing bank loans (more margin, tougher covenants), tighter attitudes of bond investors (more margin required for bond investors), and a distinct unwillingness to feed money into rights issues.

The likes of Pacific Edge was wise to make a wholesale placement recently. Its retail offer will be watched with caution.

The Seeka rights issue will have reminded the market of the need to price rights issues, and underwriting services correctly. Underwriters and sub-underwriters are needed in tough times, and well worth their fees. The discounted price for the Seeka placement was large, ensuring the transaction succeeded.

My guess is that 2019 will be a testing time for global investors and may well lead to a glum year for short-term investors here.

The signal to focus on will be bank lending.

We still rely heavily on the savings of other countries which may need their own savings in 2019.

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MY book on the destruction of value after South Canterbury Finance collapsed regrettably will not improve morale when it is published in April, 2019.

The book has been a long time in incubation.

It examines the collapse of SCF, the four huge mistakes made by the late Allan Hubbard, the failures of the structures intended to mitigate errors, the people failures, the failure of the laws to protect investors and the utterly awful bonfire contrived by the rescue parties. Their behaviour was unforgiveable.

The book also traces the pathway to compensation, littered as it was with obstacles left by Crown agencies, Key’s government, and inadequate law.

The purpose of the book is to generate a rethink of the laws and protocols that absolutely must be changed before the arrival of the next iteration of non-bank deposit takers and non-bank lenders.

A central point is how we disincentivise greedy, cowardly, or illegal behaviour.

Ideally our moral base would guide behaviour.

If that fails, the ignominy of disgrace should mitigate dreadful behaviour.

The final sanction should be the law.

However when none of these are effective, we need a new form of sanction.

My solution for those whose behaviour is illegal or immoral is a non-discretionary outcome.

I suggest jail and banishment from the highly privileged world of capital markets, where the huge rewards should be matched by value-add and commitment to laws and morality.

Whether it be a lawyer harassing his female staff, a moneylender accepting bribes, an adviser putting his fees ahead of the client’s needs, an executive ignoring his legal commitments, or a director failing in his duties, the law must offer an effective sanction.

Not three strikes, not two, one strike. Sanction – jail and expulsion from the highly-paid capital markets.

The book ‘’The Billion Dollar Bonfire’’ outlines how so many parties failed to perform to a fair standard.

The money burnt was far in excess of what was unavoidable.

The title is accurate.

The book is now written, being prepared for publication by a group that specialise in non-fiction NZ books.

My ambition is to spark debate and bring about reviews of 13 laws and protocols.

We never again would want a repeat of the chicanery and lawlessness of the finance company behaviour seen between 2006 and 2010.

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FOLLOWING the publishing of the book next year I will revert to a shorter week, offset by the arrival of my son, Johnny, at our office.

Johnny has had a career in securities trading, having recently left ANZ, where he headed the equity desk for ANZ Securities.

He will join our team of five advisers, and will assist with city visits, as well as sharing the task of writing the weekly Taking Stock newsletters.

I will have a little more time to focus on grandchildren but will continue to visit clients in other cities and be in our Paraparaumu office on Mondays and Tuesdays. There is no rest even for those who are not wicked!

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OUR office is now closed. It reopens on Monday, January 7.

We wish clients and readers a joyful holiday season, and a healthy, fun-laden 2019.

Chris Lee

Managing Director

Chris Lee & Partners Limited


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.

 _ _ _ _ _ _ _ _ _ _ _ _

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.

 _ _ _ _ _ _ _ _ _ _ _ _

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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TRAVEL

 

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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