Chris Lee & Partners Ltd

TAKING STOCK 25 January 2018

 

IF you discussed with wise investors their concerns about today’s investment environment, their discussion would focus on the behaviour of directors, auditors, market regulators, bankers, trustee companies, fund managers and financial advisers.

As discussed last week, there is now a reason for optimism that the auditors will perform with much more diligence, as a reaction to the appalling failures of audits in the likes of Wynyard, David Henderson’s Property Ventures Group and Powerhouse Ventures.

Last week Taking Stock discussed the audit malfunctions and the extreme heat now being placed on auditors to lift the standards and value of their work, and to price those services to include the new cost of greater accountability.

We know that from the day Sean Hughes established the Financial Markets Authority that the rigour of the regulator has intensified.

The FMA will never employ the best or wisest people in capital markets, though it will retain external experts in law.  Its budget will always be dictated by politicians.  We can safely say that the FMA is in a higher division than the weak Securities Commission, pitifully led by Jane Diplock during the period when knaves were publishing finance company prospectuses with the Commission and the Justice department’s blessing.

I have some optimism that the FMA today is playing a useful role in lobbying for better regulations, and enforcing them with some vigour and some expertise.  This should help investors.

Banks are currently more focussed than ever on downsizing their operations, and concentrating on the right type of lending, to adjust to the capital ratios demanded by central bankers.  Loose lending, resulting in false asset prices, is no longer as likely, certainly not with mainstream banks.

So the chances of investors being burnt because of idiotic banking policies, fuelled by greed, are much lower than at any time since Muldoon’s days of micro-management.

Indeed the banks are exiting activities such as derivative trading, rather than relying on them to elevate profits, dividends and bonuses.

Trustee companies have consolidated, British character Andrew Barnes the potential beneficiary after he enjoyed arbitraging some trustee company assets, perhaps adding value to his trading activities by rationalising this sector, cutting staff levels, reducing the premises cost, and creating what may be short-term profit increases through cost cutting.

In my view it is a sign of our country’s immaturity that we allow British entrepreneurs to immigrate here to arbitrage assets.  Maths teachers would be far more helpful immigrants.

My view is unimportant.  Changes have occurred.  Trustee companies will be of much less influence in the future and will eventually play no important role, other than to write wills and trust deeds, and perform administrative services, for very low costs.

Whereas the sector once generated tens of millions of profit, it will in the future be of similar relevance to shoe repair shops, which also once played an important role in New Zealand.

I have seen enough ‘’cobblers’’ to be relieved that this sector is likely to shrink to irrelevance.

Investors are increasingly able to distinguish between those investments that benefit from advice or management (sharebrokers or fund managers) and those where there is little to gain from paying intermediation costs that are not offset by greater returns.

Obviously bank deposits, corporate bonds, finance company debentures (UDC, as an example) and property trusts offer little scope for enhanced returns through daily ‘’monitoring’’, with attached fees.

Specialist fund managers, who price their services keenly and do not have absurd bonus incentives, do add value by finding ways to enhance returns.

An obvious enhancement for investors in a fund comes when the managers ‘’lend’’ shares for a fee, another might come from underwriting fees, when managers might get a fee for guaranteeing to take up new issues or placements.

The best fund managers are also canny in trading stocks before rights issues and perhaps obtaining, through relationships with brokers, healthy allocations of new issues, as some may have done, for example, with the government asset sales programme.

And research, performed by experienced people with specialist knowledge, has a high value.

Returns can be improved, but only if the managers’ costs and bonuses are insignificant.

The financial advice industry has been cleansed of many of the sort of spruikers who operated under the radar, in the likes of Reeves Moses, Money Managers, Broadbase and Vestar, prior to the culling of many of these, when advisers were forced by new laws to display competence and good character.

We cannot be too fulsome in our praises, for some of these merchants now operate under the umbrella of apparently reputable brands, perhaps selling insurance products or managed funds.  It helps to trace the work history of salesmen.

However, indisputably the swamp is less murky now than it was a few years ago.

Careful readers of this might observe that I have so far skipped discussion on the most important group of all – the company directors who control company behaviour and company cheque books.

It is in this area where least progress has been made, where accountability has been weak, and where investors are most threatened.

The NZ Shareholders Association, modestly funded and with no statutory rights, has done a fair job in using publicity to disinfect some of the obvious problems but its influence is not the solution.

Very sadly we keep losing access to the solution which would have the most obvious useful influence.

We are regularly observing out-of-court settlements for poor director behaviour, producing some money for the affected investors or creditors, but doing nothing about modernising our understanding of what the law expects of directors, and enforcing higher standards.

Readers might recall my mixed thoughts when the investors in Credit Sails notes achieved a large compensation package after the Commerce Commission threatened to enforce law that included provisions to jail those who had offended.

The cynical behaviours in this transaction were offset by a $61 million ‘’settlement’’ (not a ‘’fine’’ in legal terms) but ultimately we missed an opportunity to display the most effective punishment for such behaviour, career-ending jail sentences.

Most recently many have been hoping that the court would judge the behaviour of the directors of the awful Property Ventures Group, controlled by serial defaulter and corporate misfit David Henderson, arguably New Zealand’s most inappropriate company director.

In this instance the heroic liquidator Robert Walker stalked Henderson and his directors for many years, eventually bullying a settlement from the auditors PricewaterhouseCoopers of some tens of millions.

Walker then sought to prosecute the dreadful performances of the directors, but just last week the directors told the media that their case would not be heard in court after they agreed that, with the help of their insurers, they would ‘’settle’’ the matter.

In effect, another payment, probably of tens of millions, has meant that no High Court judge will be able to hear the evidence, apply the law, and publish his opinion, effectively creating precedent (and case law for future cases).

Many, including me, greatly regret that yet again the court is sidestepped by an insurance-backed payment.

This is a sensitive subject.

Of course the creditors and investors want as much back as they can get, and of course compensation is the wealthy cousin of retribution.

Indeed I might be a hypocrite on the subject.

I act for the SCF preference shareholders, who were stripped of their rights and therefore potentially stripped of money by illegal behaviour from multi parties, beginning with John Key’s government and Treasury.

I would happily have ended my mission had Key and his successor Bill English confronted the rotten behaviour by arranging an appropriate level of compensation, yet I know the right moral outcome is that all of those who behaved corruptly, illegally, or with blatant self-interest, should be subject to the judgement of the law.

I do understand the conflicting pursuits of compensation and real justice.

Having said that, I greatly regret that the Property Ventures Group directors are not going to have the privilege of justifying their governance standards in the austere confines of a High Court.

I would have sat in, as an observer, had that trial occurred.

My fear is that the settlement announced last week may allow all those directors and the unadmired Henderson to produce another version of PVG, some day.

Robert Walker must be exhausted but he deserves our highest accolade for his willingness to endure years of dealing with a disaster whose outcome, to use an analogy, was as predictable as the result of applying matches and kerosene to dried out Australian bush.

PVG will now not be the court case we need, to uncover how the law views the governors of a failed company, but we can retain hope.

There is another possible court case looming.

An equally predictable collapse was that of Mainzeal Construction, which late-paid its creditors for years, over-traded, relied on a foreign controlling shareholder whose wealth was not obvious, and eventually crashed, owing more than $100 million to its creditors, its governors apparently blind to all the obvious signs of an inevitable disaster.

Four years before it collapsed, major players in the contracting sector had told me that they would not work as sub-contractors for Mainzeal because of its appalling exploitation of creditors, an obvious signal of its own lack of capital, inadequate banking support, poor cash flow and feeble governance.

The controlling Asian shareholder, like many Asians, believed that a well-known politician would lift the company’s standing and had appointed the one-time National Party leader and Prime Minister Jenny Shipley as chairman.

Shipley’s political prowess can be admired but her capital market, indeed corporate, skills, and most of all the street wisdom needed in the construction industry were not much better than Helen Clark’s artwork.

Later, the former Brierley trader Paul Collins was recruited.  There will be divided opinion on the value of the appointment of this fellow.

Clearly Shipley was unable either to detect the stench in Mainzeal, or to do anything about it.

I cannot imagine a less appropriate role for a politician than to chair a construction company.

As Fletcher Construction will learn, construction companies are places where fingernails will be chipped, filled indefinitely with grease, and where gumboots are worn on the feet, rather than used as a disrespectful description of poor performing directors.

This year the Mainzeal directors are scheduled to meet in the High Court to allow a judge to determine whether their performance was legally adequate.  Or not.

If this case gets to court it is the case every investor should follow closely.

However, if I were a betting man, I would take the odds on a resolution being achieved before the hearing date.

Mainzeal creditors would expect that the resolution will amount to tens of millions, funded perhaps by insurers, minus the personal contributions (perhaps a million or two each) from those who prefer to settle rather than leave the outcome to a judge.

I hope I am wrong.

If investors are giving me the right agenda of their concerns, covering auditors, trustees, fund managers, regulators, financial advisers, bankers and company directors, then they will know that every problem begins with the directors.

Candour, vigour, integrity, intellect, knowledge and relevant experience are the qualities of every single director.  Please note the words ‘’relevant experience’’.

The sooner we learn of the contemporary standards demanded by those who interpret our law, the sooner will begin the cleansing programme as no-hopers flee, and competent directors recalibrate their personal standards.

 _ _ _ _ _ _ _ _ _ _ _ _

WHEN Fisher & Paykel Finance was sold to an Australian fund manager NZ investors in finance company debentures were left with a realistic menu of one.

The remaining option for those who use tap issues from finance companies was one – UDC Finance.

Then the owner of UDC, the ANZ Bank, announced it had sold UDC to a Chinese conglomerate (HNA), with an airline base.

Then there were none.

However the ANZ/HNA deal was never consummated and UDC now reverts to being at least temporarily available, hopefully until someone, like Heartland Bank, buys the book at a banker’s price, rather than an entrepreneur’s price.

After that there again would be none, if one categorises as ‘’useable’’ only those companies with long histories, strong shareholders and credit ratings (preferably).

As the television shopping channel would say, WAIT, there’s MORE.

Auckland suburban entrepreneur Brent King has been helped by some moneyed friends to buy tiny General Finance, which King hopes to grow beyond its current tiny size (total loans about $10 million, capital nearer $2 million).

I discussed last week in Taking Stock King’s background and the hurdles he will need to jump if he is to find a way of joining his creek to a main stream.

Yet the finance company sector is growing and some smart people are making very tidy sums from moneylending to the second or third tier borrowers, mostly funding from wholesale sources only.

The public can participate by using the P2P lender Harmoney, though I personally would not pursue this opportunity, believing that the basis of P2P lending – the use of a matrix of computer-assessed information on the borrower – is easily gamed and necessarily leads to very high-cost, socially-ugly loans, repaid by the honest people whose high rates subsidise the cheats.

The formula is ugly so for me P2P is not my habitat, as an investor.

There are many other finance companies making high returns from moneylending but none have reverted to funding via a debenture issue, perhaps wisely assuming that the subject is still raw.

King, hardly a top drawer performer, is brave to seek public support.

If I were him, I would seek to persuade his wealthy backers to arrange the funding from wholesale markets, effectively by borrowing from banks or by securitising the loans, meaning bundling them up into million or multi-million lots and selling them off to the banks or institutions, perhaps with a vendor’s guarantee or with a validation from a credit rating agency.

It is this formula which works for three of the great survivors of the sector, the ugly Geneva Finance, the Pasifika ‘’bank’’ Instant Finance Ltd, and the other high-rate second and third tier lender, Avanti.

Geneva Finance has been through the hoops.

Owned in part by former Chase Corporation director Peter Francis, and managed by a belligerent but resilient character, Geneva somehow persuaded its secured debenture-holders to subsidise its unsecured investors, allowing Geneva to operate in a vacuum for some years, recovering if one ignores the time value of money.

To be generous, one can say that the moratorium ‘’worked’’ in that Geneva today continues to be a provider of personal loans to those who are not price sensitive.

Instant Finance found a market niche as a source of emergency loans to Pasifika, funding small loans at high rates, using the banks as its source of funds.

From memory, Westpac lent to Instant Finance at, say, 9%, providing IF the funds to lend at 30%.

Handsome dividends to the shareholders of IF have flowed, perhaps deservedly, as no one else seems able to meet the needs of its market.

A third survivor is Avanti Finance, owned substantially by Glenn Hawkins, the son of Equiticorp’s founder, Allan Hawkins, now an old bloke drained of his energy to stir up markets, as he did in the 1980s.

Allan Hawkins spent years in jail over his role as Managing Director of the failed Equiticorp Group.

I had known Hawkins in the early 1980s, when he was MD of CBA Merchant Finance, a bank-controlled merchant bank.

An entrepreneur, ambitious, and motivated by a thirst for real wealth, Hawkins founded Equiticorp, hired Brian Fitzgerald (later the core figure at Strategic Finance), and set out to create a company that made stable profits from money lending, and windfall profits by leveraging its deposits to enter into large trading positions, such as its huge holding in BHP.

This latter ambition led to losses as well as gains.  Hawkins and his team failed to attract the blue-blooded in capital markets.

Eventually Equiticorp failed, Hawkins went to jail, and the Crown had to pay out $300 million to investors as a punishment for agreeing to an illegal structure when Roger Douglas was conniving to sell NZ Steel to Equiticorp.

($300 million to Equiticorp, $1 billion to South Canterbury Finance.  Treasury.  Join the dots.)

Today Hawkins’ son Glenn owns Avanti Finance which has an operation that delivers to Glenn Hawkins dividends of sufficient tens of millions that he can happily buy into the American-arranged, North Auckland golf resort at Te Arai.  This involves a commitment to spend around $10 million for a house and a willingness to pay a share of the costs of a golf course not likely to be played by other than a few hundred people, ever.

That annual impost might be tens of thousands.  Visitors are not a feature of Te Arai’s links.

Clearly Avanti’s model is a winner for Hawkins.

Clearly the Hawkins genes have moneylending and wealth branded into their mutations.

We can conclude that there still is a demand from second and third-tier borrowers, happy to pay excruciating rates for their money, enabling handsome returns to reach finance company owners.

Central to this model are the banks, and institutions like the ACC, the NZ Super Fund or Kiwisaver fund managers, who buy the bundle of loans, perhaps at a yield of six per cent, leaving the risk and the rest of the lending margin to the finance company owner.

Not interested in this model are those retail investors who are unwilling to forget about their experiences with Hanover, Strategic, St Laurence, Nathans, Bridgecorp, Lombard, First Step, NZ Guardian Mortgage Trust, Canterbury Mortgage Trust etc.

My guess is that investors will again want to participate, seeking a three per cent margin over bank rates when the following stars and planets are aligned.

Those extra-terrestrials might be renamed Capital, Director Competence, Director Morality, Regulatory Integrity, Audit Thoroughness and Accountability, Fund Manager Value for Money, Advisory Excellence, Banking Sobriety, Political Morality, and High Court Rulings.

These new names may sound less exotic than Mars, Saturn or Venus, but every star or planet will be aligned only when the High Court has the right to intervene to stop settlements that ensure the law always prevails.

We need culprits in jail, to deter the next generation of cheats.

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

Travel

I will be in Christchurch on Tuesday 27 February (pm) and Wednesday 28 February (am).

Edward Lee will be in Nelson on 12 February, Blenheim on 13 February and Auckland (on Queen Street) on 28 February.

Kevin Gloag will be in Christchurch on 8 February.

Michael Warrington is planning trips to Auckland, Tauranga and Hamilton shortly, probably later in February and early March.

Any client or investor is welcome to contact our office to arrange a meeting.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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TAKING STOCK 18 JANUARY 2018   

FEW things are certain in capital markets but in New Zealand in 2018 there is one absolute certainty.

This year will be the year when auditors refuse to sign off accounts until they have answers to all the questions that every banker, moneylender, fund manager, sharebroker or investor might imagine that a diligent auditor would ask.

The explanation for this improved diligence requires just two words – Wynyard and PowerHouse.

Wynyard will be remembered with grief by its followers for its seemed to be a credible company, yet it proved worthless.

It seemed to have developed software in the field of security that appeared to be valuable in many sectors – policing an obvious one – and in many countries, at least two of which were sited in the Middle East.

It had an apparently competent and experienced group of directors, a motivated chief executive and it claimed sales that implied revenue and ultimately profits and dividends.

Particularly it claimed sales in the Middle East that would imminently convert to cash, allowing Wynyard to access banking facilities.

Its auditor was satisfied that it was solvent and sustainable, and that its ‘’sales’’ were correctly described.

We all now know that the acclaimed sales were faux sales and that Wynyard had overspent, imagining a growth path that was never discovered.

Banks, fund managers and investors lost everything, despite a capital-raising just months before Wynyard was found to be an empty vessel.

The auditors will not yet have seen off the challenges that resulted.  The whole audit profession came to attention over the consequences of a failed audit inspection.

The result will be far more stringent audit enquiries than previously.

PowerHouse Ventures Group will have added to the pressure on auditors.

Before PowerHouse, via the Australian stock exchange, went into an issue of new shares in 2016, it had to produce a prospectus.

A requirement of the regulators was that an investigating accountant, quite aside from the auditor, had to certify that the presentation to new investors was sound.

The PowerHouse document presented to the market claimed that its most valuable asset, HydroWorks, was in late 2016 worth nearly $20 million.  In 2017 it was worth minus $12 million.

To support the $20m value, the documents cited a valuation from Edison which had been prepared in 2015 and was based on assumptions that various strategies would succeed.

The problem for all those who signed off on HydroWorks’ value in late 2016 was that in 2015 the strategies were failing, the company was achieving virtually no nett revenue, the highest margin products had not sold and the production of them had been abandoned.

So in 2015 HydroWorks had made a decision to abandon those strategies, completely negating the assumptions behind Edison’s rich valuation.

Yet in the last quarter of 2016 the prospectus was presented to investors with the 2015 HydroWorks valuation.

An investigating accountant signed off on this valuation.  The auditors did not demur.

Worse, a bunch of PowerHouse directors signed the prospectus, either displaying complete ignorance about the state of their dominant asset, or displaying indifference to a highly misleading document.

The PowerHouse directors at the time were chaired by Kerry McDonald, a professional director, economist, former chair of Comalco, and former National Bank of Australia director.

McDonald is in his 70s.  Clearly inexperience was not the problem.  His explanation is yet to be published.

Rick Christie, also in his 70s, was a PowerHouse director, once having chaired Ebos, a highly successful NZX-listed company.  He, too, could hardly claim inexperience.

The other PowerHouse directors may all have distinguished records in academia but perhaps might argue no special insight into the world of capital markets or commerce.

Clearly the PowerHouse board will be asked to explain the appalling presentation in the prospectus.

But the real concern as always will be with those who have the deepest pockets – the auditors and the investigating accountant.

Wynyard and PowerHouse collectively cost investors in 2017 hundreds of millions, PowerHouse contributing only tens of millions.

Perhaps in 2018 we will find out whether higher auditing standards in the long term might be seen as a valuable offset to the losses incurred by investors.

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

ANOTHER set of investors who will feel grumpy are those who fell for the unlikely story of Veritas, a back-door NZX listing which was used to release tens of millions to the vendors of the Mad Butcher chain, owned by Peter Leitch and his son-in-law Michael Morton.

Those hapless people who put money into Veritas bought the Mad Butcher chain about four years ago for around $40 million and have just sold it back to Morton for about $8 million.

Someone has done well from this.  It will not be any investor in Veritas.

The Veritas charade replicates the dealings of Mowbray Collectables, which bought a rural stamp trading operation from John Mowbray and finally sold it back to him for a fraction of what it had originally paid to Mowbray.

Neither company was ever a credible, NZX listing, Mowbray’s even less credible than Veritas.

The Mad Butcher was, and is, a business best owned by those who worked at the counter.

Its chances of competing as a meat packer and retailer (it never was a butchering operation) depended on the dedication and hard work of the shop salespeople.

Never was there a hope of such margins that would be needed to ensure growth while feeding staff, managers, the franchising owner and external shareholders.

The idea was daft.

Even more daft was the concept that a group of directors with no special talent could add value by buying into other food or liquor businesses, like Nosh, or a bunch of eclectic Hamilton bars.  Retail investors were dudded.

_ _ _ _ _ _ _ _ _ _ _

I HAVE great respect for the current NZX CEO Mark Peterson, and had similar respect for Tim Bennett, who preceded Peterson.

The previous NZX CEO Mark Weldon left behind messes that required patient, intelligent, socially mature and stable men like Bennett and Peterson to sort out.

I do not expect another ‘’Veritas’’ to gain an NZX listing.

The fund manager lament that the NZX is not attracting new listings is not the prime issue, I hope.

Last year the sole new listing was Oceania Healthcare.  It had to jump through many hoops to gain its listing.

Perhaps as a result it was priced properly, has a credible future, a competent board, a business that looks sustainable, and has prospects of imminent profits and dividends.

Indeed, its maiden dividend will be announced soon, its profit likely to exceed its forecasted profits.

Of course there were many NZX new listings of corporate bonds, most pleasingly new issuers like Summerset.

There were also some well managed and well priced placements and rights issues, none better than those of Heartland Bank and Eroad, both of which companies are committed to credible strategies.

If the NZX were able to attract more listings like A2 Milk, Synlait Milk, Heartland, Eroad, Airworks, Xero, Pushpay, Vista and Gentrack, all of which have appeared in recent years, the investors will have some useful options.

Predominantly the NZX is a ‘’yield’’ story, heavily weighted to listed fixed-interest securities and dividend-bearing functional companies.

It will not compete with the ASX as an exchange targeting new technology companies, nor will it compete with the Toronto exchange, where optimistic and sometimes highly dishonest mining operators find enthusiastic punters.

For all of these reasons I would expect the NZX to hold up better than most if a wave of fear grips world markets.

Technology start-ups and mining penny dreadfuls are far less likely to remain in favour if the world’s fund managers, and exchange traded fund managers, are faced with a flight from risk by retail investors.

The NZX should not be distracted by the self interest of fund managers.

_ _ _ _ ____ _ _ __

IS New Zealand ready to forgive those who drove our finance companies in the period of 2002-2008 when so many owners and executives behaved dreadfully?

I have my doubts about this forgiveness.  Ask again in 10 years!

Obviously the creator of Dorchester Pacific and Viking Capital, Brent King, thinks we are ready for the next iteration.

Funded by an eclectic bunch of supporters, King has bought the tiny finance company General Finance for a modest sum and proposes to crank up its size, believing there is a hungry market for 5% deposit rates and 7% mortgage rates.

General Finance, to the credit of its owners Bill Cairns and James Lockie, survived the 2008 collapse, largely because they sized their operation to a level where their modest personal wealth could provide enough back-up liquidity to deposit-takers.

In the same way, Tony Radisich allowed Broadlands Finance to exit with dignity, using his wealth to maintain liquidity.

In both cases the finance company had declined to perform bare-land property developments and mis-describe such high-risk nonsense as ‘’secured property lending’’ or ‘’mortgage lending’’.

General Finance, of course, has nothing to do with the company General Finance that was founded in 1928, listed on the NZX until 1980, bought then by Todds and the National Bank, and sold to UDC in 1989, abandoning the GF brand.

Bill Cairns was a university graduate who worked for General Finance in the early 1980s and must have grinned when he found he could own that name in the 1990s, by which time he would have developed enough knowledge to run his own company.

King has bought it, displaying intent and energy levels that Cairns and Lockie may have exhausted.  The price of around $3m is modest.

When King had control of Dorchester, that company performed third-tier car loans, property loans and was involved in some interesting transactions, one related to the energy sector.

The company was chaired by Renouf & Co sharebroker Murray Radford, best known for his knowledge of golfing rules, where he is a distinguished referee.

On its board was Bill Birch, a 1970s disciple of Robert Muldoon, an architect of the Think Big campaign, led by Muldoon, that produced the likes of the gas-to-fuel concept in Taranaki.

Like virtually every politician I have met, Birch was a strange and, in my view, poor-performing governor of a listed company.  He will certainly regret his agreement to get involved with King in Viking Capital, which burnt investors’ money on a penny dreadful, ICP Bio.

King’s next venture was to buy into IRG, originally based on a publication which made its money by selling advertising to finance companies and publishing promotional articles for their advertisers in its free magazine.

IRG has morphed into internet publishing, selling financial advice.  It runs one of the dreadful internet chat forums, where anonymous idiots mingle with sharemarket traders, debating matters of the market, with or without knowledge, but certainly without constraint.

King will now be in the ‘’white hair’’ phase of his career but clearly has the need and desire to have another go at succeeding in capital markets.

My guess is that those investors with money for fixed-interest products will continue to want NZX liquidity for their securities more than they will want an extra one per cent from a finance company ‘’security’’, especially if the company is not owned by a well-established institution and has risibly small capital.

I guess King may have noted that investors might have lost two credible finance companies, firstly when Fisher & Paykel Finance was sold to the Australians and reverted to bank debt rather than debenture issuance.

The second to go seemed to be the ANZ-owned UDC Finance, conditionally sold to a Chinese company with an airline as its central asset.

However, this deal collapsed so ANZ remains the owner, albeit reluctantly.

Very obviously, UDC should have been listed on the NZX 20 years ago.

Perhaps it is not too late.

If UDC now makes $60m a year, it might still be worth the thick end of a billion.

Imagine if UDC was paying 5% for 12-month deposits.  The public would swamp it with money, trusting ANZ to be reliable owner.

Would anyone prefer 5% from General Finance?  Or even 6% or 7%?

Perhaps in 2018 we will learn the answer to these questions.

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WHEN long-term Christchurch contractor and itinerant gold miner Sam March died last week of lung cancer, a whole rural town will have grieved.

A real man, a real New Zealander has died.  Sam was the sort of New Zealander for whom those of my generation will always give thanks.

It would not be overstating matters to record that Sam had been one of many who helped create the New Zealand that many of my age celebrate.

With his older brother Buzz, Sam left school as a young teenager, went pretty well straight into partnership with his go-getting brother, and over the past nearly 60 years he did his bit to build New Zealand’s infrastructure and to mine gold, generating perhaps hundreds of millions of dollars as gold sales grew, now our second largest export to Australia.

Sam was the ultimate quiet, hard-working, amiable problem-solver, with special skills in teaching and leading his workers, currently numbering around three dozen at the project he managed at the time of his demise, a gold mine in the Southland rural village of Waikaia.

He had learnt his gold mining skills in the field over nearly four decades, not in any university.

His brilliant, gracious man-management skills were natural to him.  Knowledge was to be shared, dignity was to be maintained.

Had NZ’s school of management needed a personification of good management practices, Sam would have been the model.

Just one of his triumphs sums up Sam.

In the 1980s, the NZ government announced it was building a new hydro plant in Central Otago and would move part of the town of Cromwell to obtain the optimal site.

Cromwell’s dozens of shops, houses and some orchards had to be demolished before the newly-created lake drowned them.

The town had been built on the junction of the Clutha and Kawarau Rivers, a busy joining of rivers that had been a lucrative source of gold more than 150 years ago.  As the miners rushed back to mine the river bed in the late 1800s and early 1900s, the town was built on the shingles beside the river, with churches, pubs, blacksmiths, grocer shops and miners’ huts covering the shingles.

From the river junction, the Lady Ranfurly gold plant set records for daily gold extraction.

Sam and Buzz, with a fellow geologist, the late Ron Bodger, knew the history, so when the plan to flood the town was announced, Sam and Buzz marched down the main street, hammering in white pegs to define their claim to explore for gold.

The TV cameras were there, perhaps believing the pegging was a stunt.

In the years it took to move parts of the town, Sam led a mine that proved nicely profitable, exploring the shingles that no one had imagined would ever be accessible while they were topped by a town centre.

Sam and Buzz also won the contract for March Construction as engineering contractors, to build much of the infrastructure for the new town of Cromwell.

Sam March was no academic.  He left school early and achieved his high levels of knowledge in the field.

He was never a scone-doer, never greedy, never abusive.  He was a small, wiry, strong man, quiet, amiable and old-fashioned.

His sausage casserole was enjoyed by many, his macaroni cheese a weekly highlight and he was a dab hand at roast chicken or grilled chops.

The young high-fliers of today, armed with their MBAs, will do well if they can contribute as much to ‘’real New Zealand’’ as Sam did.

He had five daughters and one son and is survived by his second wife, Maureen.

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Travel

I will be in Christchurch, at the Airport Gateway Motor Lodge, on Tuesday January 23 (pm) and Wednesday 24 (am).

I will be in Albany (Albany Motor Lodge) on Tuesday January 30 (pm) and at Waipuna Lodge, Mt Wellington on Wednesday January 31 (am).

Kevin Gloag will be in Christchurch on 8 February.

Michael Warrington is planning trips to Auckland, Tauranga and Hamilton shortly, probably later in February and early March.

Any client or investor is welcome to contact our office to arrange a meeting.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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TAKING STOCK 11 JANUARY 2018

IF we begin 2018 with New Year optimism, we could start by quoting milestone achievements of mankind, such as the massive global reduction in diseases or sicknesses like cancer and measles.

We could cite the huge global reduction in forced child labour, or the massive increase in the switch to renewable energy.

We need to balance that approach, if only because we could do better.  Corporate behaviour still needs to improve.

So over Christmas, sheltering from the storm on Waiheke on January 5, I read an outstanding account of Volkswagen’s chicanery, written by a resident German, Jack Ewing.

His work is comparable in excellence to New Zealand’s Rebecca Macfie who exposed the corporate louts who ran Pike River Coal.  They, like the British generals at Gallipoli, urged their troops to march into fire.

Ewing exposes the extreme cynicism of Volkswagen, whose senior people relentlessly lied about their ability to use diesel to fuel passenger cars without the exhaust fumes poisoning the population.

The key to Ewing’s story is in the science of burning fuel.

Diesel burns hotter than petrol and has the natural by-product of nitrogen oxide, a poison that has links to respiratory illness.

Volkswagen pretended that it could eliminate this by-product (and also reduce carbon monoxide) with engineering genius, a process not able to be replicated by any competitor.

It targeted ‘’green’’ citizens who were willing to pay more for a car so they could do ‘’their bit’’, reducing climate-changing carbon monoxide, or health-destroying nitrogen oxide.

Volkswagen specifically targeted American ‘’green’’ motorists, displaying television advertising where ‘’Green Police’’ arrested citizens for poor recycling, stopped motorists to check their exhaust fumes, but bowed and waved on Volkswagen diesel-powered passenger cars, saluting the cleanliness of their exhausts.

That was the public story.

The truth was that the German car manufacturer knew that its diesel fumes were toxic, spewing out much more poison than was legal.

They knew that the Americans tested the fumes in a laboratory, rather than on the road.

So they requisitioned software that made the car behave differently when it was being tested in a laboratory, identifying that the wheels were spinning but the steering wheel was unattended and not in use.

The laboratory results verified the sales claim of low nitrogen oxide in the fumes.

But the car in the laboratory was operating in a way that would destroy the engine if it was used like that for many hours.

As soon as the car was on the road it belched poisonous fumes but operated without engine damage.

The German car company knew the fumes were poisonous.  Worse, they knew there were technical solutions but these were costly and reduced margins as well as diminishing the sales story of a passenger car that claimed to use a cheaper fuel, achieve better economy, and travel faster.

(But which poisoned people and created smog.)

The book Faster, Higher and Farther traces the rotten culture that characterised Volkswagen, right back to the days when Adolf Hitler engaged in chicanery when the car company was formed in the 1930s.

Hitler needed to build autobahns and roads for the tanks he proposed to launch in the war he was planning.

Well before he declared war he built those roads, claiming they were to meet the travel plans of hundreds of thousands of ordinary German ‘’folk’’ for whom Hitler’s government, through its ownership of Volkswagen, would provide cars.

Author Ewing traces the corporate games played by the two families who come to control Porsche and Volkswagen and engineered their merger.

He displays the unaddressed rotten culture, where corporate goals, bullying management, cynical political support and ‘’clever’’ tactics allowed Volkswagen to become the world’s second biggest car manufacturer.

Dissenting voices were never tolerated.  Whistle blowers were cowed into silence.

Senior managers bribed union heads and suppliers with cash (millions) for prostitutes.  Emission regulations were ‘’solved’’ by cheating, rather than by science.

At one time, nearly one million people were employed by Volkswagen.  Every town mayor wooed the car company, hoping to generate jobs and rateable (taxable) activities.

Ewing does us all a great service by producing a book that highlights the dark side of the moon – corporate greed, corporate egotism, dishonest marketing, indifference towards the environment, cynical exploitation of weak politicians and exploitation of an industry where no competitors were so pure that they would risk blowing the whistle.

How often when I read this book did it seem analogous with other sectors, like banking, our 2002-2008 finance company sector, our food sector, tobacco and our funds management sector, going back decades.

My suggestion to universities who seek to teach corporate ethics is that they require students to read Tragedy at Pike River Mine, and Faster, Higher, Farther.

These books will display behaviours that should be identified, outlawed and never replicated.

_ _ _ _ _ _ _ _

VOLKSWAGEN was not the first company to introduce software aimed at foiling regulators.

Cadillac paid a fine of US$25 million decades ago for cheating.

The large American truck manufacturers were fined $1 billion 25 years ago for lying about emissions.

For five years, General Motors covered up a faulty ignition switch that led to hundreds of road deaths.

Hyundai paid a huge fine for false claims.

Volkswagen dwarfs them all.  To date, its compensation payments and fines exceed $30 billion.

Many more cases are unresolved.

Ultimately the costs are likely to exceed $50 billion.

There will be just one good result.

As part of its penance, Volkswagen has been required to commit billions to developing electric cars, while it exits its attempt to prove that diesel was the passenger car fuel of the future.

_ _ _ _ _ _ __

DISCLOSURE – honest, full, understandable discussion of all relevant material – is the key requirement in New Zealand of all sharebrokers, financial advisers and financial service providers.

As was seen with VW’s diesel fumes, obfuscation is the opposite of disclosure.

If you ever have wondered why fund managers in New Zealand do not aspire to list their business on the NZX, the answer is likely to be their hatred of the full disclosure a listing would demand.

What fund manager wants to discuss in detail its staff remuneration policies, its executive contracts, its areas of competitive advantage, or even details of the formula by which it calculates its bonuses?

It might be harsh to pick on particular operators like Milford or Fisher Funds, where bonus formulae are illogical, unfair or absurd, as many fund managers use the same illogically self-serving formula.

Just as one example, imagine a fund that pays an extra bonus to the manager (to ‘’align’’ the interest of the manager and the public), based on an arbitrary figure like the Reserve Bank’s Overnight Cash Rate (OCR), or a similar bank deposit benchmark.

Beat the OCR by, say, 2% and then the fund manager shares the extra return, perhaps taking 15% of the surplus.

Might this formula make sense if the fund was restricted to investing only in bank deposits, Treasury notes and A-rated bonds?

But what if 25% of the fund could be invested in listed property trusts or other listed equities, or in bank deposits in India, where rates might be 8%.

The fund simply must earn far more than 2% more than the OCR just to allow for all the greater risk.

The benchmark of an OCR would be absurd.

Why would any of the ‘’surplus’’ achieved by more risky investing go to the fund manager?

Indeed, a fundamental question might be why any fund manager, advertising a service to the public, and charging a set, non-reversible fee for the service, should need incentivising to ‘’align’’ his interest with the client.

Is not the consequential logic that the fund manager would make poor decisions if he were not incentivised to make good decisions?

As for other areas of disclosure, like fund manager nett profits, the less said, the less the fees will be questioned.

To be fair, not all fund managers earn millions for taking investment risks with other people’s money, though many do.

But the subject is one on which more disclosure is required.  Current levels are inadequate.

The same is true of trust companies, where salaries, bonuses and dividends are poorly disclosed as are the details of agreements that are highly material.

Again, to be fair, it has to be acknowledged that the Financial Markets Authority now licenses each trustee and applies a ‘’Fit and Proper Person’’’ matrix to the executives.

Sadly the Fit and Proper Person test is not published so investors must just hope for the best, that the test is not perfunctory and that it would exclude slippery, deceitful people from ever calling the shots with other people’s money (wills, trusts, etc).

The subject is particularly relevant given the speed with which NZ trust companies have changed hands in recent years.

This began when Perpetual Trust somehow wound up in the control of George Kerr.  He mis-used client money and was required to reverse a loan the fund made to him.  Selling PT may have been an obligation.

He sold it to a British character, Andrew Barnes, who had been linked to Kerr during a period when Barnes had acquired a shareholding and the chairman’s role in AWM in Australia.

Barnes must have qualified for NZ citizenship after he resigned from AWM, for he moved out here, bought a spot on Waiheke Island and having acquired control of Perpetual Trust, bought competing trust companies NZ Guardian Trust, Covenant and others, and formed Perpetual Guardian Trust (PGT) with borrowed money.

He borrowed $20 million of senior debt, $60 million of mezzanine debt (usually priced around 18%) and set about finding a buyer, stridently discussing his views of its value in capital markets as he sought to flick the created company.

When it seemed his best sale exit would be by selling it to retail investors via an NZX or ASX listing, he engaged with Goldman Sachs, but eventually he told the media that the timing was wrong and that a trade sale was appropriate.  I doubt retail investors were ever going to buy the narrative.

(I agreed on one point with Barnes – a trade buyer would be a much more suitable and more informed buyer.)

Barnes then announced he had ‘’sold’’ it to two young Australians with absolutely no background in trust companies.  They were in their early 30s and were going to pay an improbable $200m, probably borrowing at high rates.

Who was going to make the ‘’fit and proper person’’ assessment of them?  How could the FMA have properly judged the new buyers?

The sale must have been conditional on FMA approval of these two lads.

Fortunately, this ‘’sale’’ was not a sale, as the deposit had been paid into a trust account and the vendors ultimately withdrew, presumably signalling they really had only an option to buy PGT.

Barnes said he would sue them and reverted to being the owner until along came a credible ‘’buyer’’, Direct Capital, which entered into a contract that made much more sense, and would have been much easier for the FMA to assess.

Although the details have not been disclosed (to my knowledge), it is highly likely that the competent and experienced people at Direct Capital would have agreed to pay a sane price, perhaps $80 million at most, to buy PGT, thus enabling Barnes to clear the debt that one of his companies had borrowed to create PGT.

My guess is that when Direct Capital eventually exits PGT, perhaps with another trade sale, it might share some of any profit it might (or might not) make with the former Macquarie fellow Barnes.

So open about his desire to sell for so long (for obvious reasons), Barnes would gain a reward if Direct Capital could improve PGT, fund it at a low cost, and eventually sell it for more than $80 million.

I raise the subject under the general theme of disclosure because the PGT transaction and the issues it raises are very clearly of great importance to everyone who has granted PGT the right to manage their funds.  They are entitled to know everything about the ownership structure.

And it is relevant to many Kiwisaver investors, as PGT oversees some hundreds of millions or more of Kiwisaver money, managed by Kiwisaver managers.  PGT is the trustee acting for the savers, just as it acted for investors in the finance companies before the 2008 crash.

If PGT oversees, say, a billion of Kiwisaver money and gets a fee of one basis point (0.001%), there may be value for money in the fee because of the independent oversight.  Any more than two basis points would be grossly excessive.

On a billion, a basis point equates to a million, for what in reality is a pretty mundane task.

If I were the market regulator, I would require Direct Capital to disclose the deal it has made with Barnes and I would confirm to the market (all investors) that I was happy to see Direct Capital own the trust company.

To me, Direct Capital looks like a reputable owner.

Full, meaningful disclosure is in the interest of all parties, in my view.

_ _ _ _ _ _ _ _ _

DIRECT Capital, a huge, NZ-based, privately-owned investment company is well regarded in capital markets, its managing director, Ross George, a familiar name with market participants.

In more recent times it bought what is now King Salmon, provided capital, governance and direction, and rebuilt it, eventually selling it via an NZX listing, at $1.12 per share just 15 months ago.

The price of the shares has more than doubled, the company making modest profits, but progressing its plans to expand and to crack more international markets.

Direct Capital might be best known for the role it played in persuading a muppet receiver to sell to a group of investors the apple grower, exporter and cool storage company, Scales Corporation.

The inept receivers, McGrathNicol, had charge of the South Canterbury Finance assets after SCF collapsed, despite its founder Allan Hubbard gifting to SCF his 80% ownership of Scales.

Scales today has a market value of around $670 million.

McGrathNicol’s performance as receiver was the most bumbling of any receivership I have witnessed, its sale of 80% of Scales for $44 million perhaps being an obvious example of its ineptitude.

Direct Capital, the NZ Government Super Fund, and others bought Scales for an amount that was about a fifteenth of its market value today, not to speak of the dividends received.

Perhaps we, as taxpayers can be grateful that the ‘’gifting’’ at such a price has led to the NZSF gaining bonanza returns, a backdoor compensation for the billion dollars lost by the Crown after SCF was liquidated.

Direct Capital will have benefited by a huge sum for its role with Scales.

Its purchase of PGT will have required skill as it must have done the maths and have gained confidence that it can exit PGT for at least the $80m cost, leaving itself only with upside.

But my guess is that PGT, in a sunset sector, will not be a great money winner and Direct Capital will not make much profit to share.

For Barnes, his gain for the risks he took might have to come from any money he could extract from the original would-be purchasers (the two young Australian lads), plus a share of any gain that might come from Direct Capital’s successes as owner.

As Direct Capital has no disclosure obligations, we may never know whether my figures are right or not.

But surely every PGT client is entitled to know these details.

If they do not know the details, they might be best to find another source of help.

_ _ __ _ _ _ _ ___

Travel

I will be in Christchurch, at the Airport Gateway Lodge, on Tuesday January 23 (pm) and Wednesday 24 (am).

I will be in Albany (Albany Motor Lodge) on Tuesday January 30 (pm) and at Waipuna Lodge, Mt Wellington on Wednesday January 31 (pm).

Any client or investor is welcome to contact our office to arrange a meeting.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

Footnote: thanks to a Christmas gift from an old investment banker friend, Brian Kreft, I also read More Paddocks to Plough, an account of the career of Graeme Thompson, who created and then destroyed the meat exporter Fortex in the 1990s.  Thompson was sentenced to four years in jail for misleading investors and his creditors.

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