Chris Lee & Partners Ltd

TAKING STOCK 27 July, 2017

NO regular reader of Taking Stock will have been surprised last week by the news that Fletcher Building has been incurring much worse losses in its construction division than it had discovered in June.

No one will be surprised that the socially shy but privately aggressive CEO, the British fellow Mark Adamson, has departed, a year before his contract ends.

His departure will disqualify him from access to a $35 million bonus pool he might have shared.  He will lose some subsidised shares he might have been given.  His CV has not been enhanced.  And the substantial investment he made in FBU shares will have fallen well short of his expectations.

Frankly, Adamson was a poor choice for FBU nearly five years ago.

Blame Ralph Waters, an earlier FBU CEO, who appointed Adamson when Waters had moved from the executive role to a governance role.

Adamson is a fund manager, not a business leader.  He is share-price driven, rather than value driven.

A chasm separates these two styles.

One can achieve share price successes by focussing on the short-term, for instance by cutting staff levels, cutting out research and development, cutting out apprenticeship programmes, or hoofing out experienced old-timers and buying in youngsters who might be less questioning of executive strategies.

One can use cash flow to buy back shares.

One can use leverage to add more return at the expense of more risk.

One can sell off prime assets at a nice premium, and gain a temporary share price lift.

These are all the standard ploys of hedge fund mentality, pretty much the diametrical opposite of a true company-building mentality, as you might see at Mainfreight.

A real manager will balance the need to reduce risk with the urge to improve returns, forecasting cyclical changes from his experience, knowing that long-term survival, let along long-term glory, matters more than a quarterly profit statement.

Fletchers still has the chance to be New Zealand’s flagship company, representing the gold standard in building and construction, capturing the major contracts because of it status, reputation and performance, rather than because of its political donations or contacts.

Hugh Fletcher in the 1990s presided with paternalistic pomposity over the company, making decisions that were later seen to lack foresight, lack logic and lack commercial nous.

Waters helped restore the company and his successor Jonathan Ling did little apparent damage.

Adamson will be remembered by me as the wrong man for the job, having the wrong sort of approach (short-termism) and, sadly, as being somewhat socially inept.

His comment about being surrounded by ‘’old farts’’ was not so much just vulgar, as grossly arrogant, and his parting shot that FBU needed to be run by women was also inane.

Construction and building contribute only a share of FBU’s revenues but they represent most of the company’s risk, as well as being its flagship division.

Sometime in the next decade there will be women emerging who have scaled the scaffolding, overseen the engineering and construction work, and come through the apprenticeships, the project management, and the senior management roles.

That sort of experience is currently missing.

To choose the executives without acknowledging the need for that experience is a fund manager initiative, not that of a real manager.

Adamson displays his unsuitability for the task in his dismissive description of experienced men as ‘’old farts’’.

Perhaps Ralph Norris will need to be an executive chairman, if his banking background is the right skillset to rebuild FBU.

My view is that the next era of FBU needs to be built on a foundation of excellence, a focus on a shared culture, aspirational, transparent and proud, aiming at long-term market dominance, whatever the short-term inconvenience to the dividend pool.

If dividends were halved for a year or two while the recovery began, the lower dividends would have been long forgotten when excellence had been achieved.

Fund manager mentality is a good part of the balance that great company executives must achieve.

But it surely is not the mentality that must prevail over more balanced approaches.

_ _ _ _ _ _ _ _

POOR corporate behaviour afflicts more than just Fletcher Building or indeed New Zealand investors.

In Europe there have been two careful investigations in the past year, uncovering anti-social and despicable corporate behaviour.

Here in Malta an investigator from its Tax Office has found a recent technique to cheat the taxman, with smart-alec technology being offered to restaurants and bars, based on credit cards.

Foreign technology was developed which enabled those in the hospitality services to cheat by hiding their sales, thus avoiding their equivalent of GST and reducing their tax obligations.  Millions of euros have been hidden.

When customers paid by card, the transaction was processed correctly through the till but if the customer threw away the receipt, probably into a conveniently-placed nearby rubbish bin, the owner could retrieve the receipt.

Each receipt had a secret code that, re-entered into the electronic till, had the effect of deleting the record of the sale, meaning the turnover was understated.

In Britain, its Treasury has found another abusive credit card practice and is preparing legislation to prevent it.

As is the case in New Zealand, the lawmakers intend that extra charges made to customers should simply reflect the cost to the service provider, and should not be a charge that simply is profit-gouging.

In the UK, such giants as Ryanair have a 2% charge for using a credit card (instead of cash) that does not reflect the true cost to Ryanair of card usage.

Even the Queen Mary University of London plays the gouging game, as do many travel agents.

This is commonplace in New Zealand, of course, so won’t be of any surprise to Kiwis.  However, the UK response to this charge might interest our regulators.

It goes without saying that true transparency in life always is the best long-term strategy.

The hidden, furtive profit gouge is yet another inevitable development of those with short-term aspirations only.

_ _ _ _ _ _ _ _ _ _

IF you are concerned that you have been ripped off and want to file a claim, do not go to a British or American law firm.

The most common experience in Britain, according to surveys, will be a discovery of blatant inattention, tardiness or incompetence, at an extreme cost.

And, in the US, according to a survey by the American Bar Association, to whom lawyers pledge obedience, there is a good chance the lawyer you see will be high on hash, opioids, cocaine or ‘’crack’’.

If they are not high, nearly all the encounters will allegedly be with high alcohol users!

The survey of 1200 American lawyers had a section on drug use.

Drug use is illegal in the US, so unsurprisingly, 900 of the 1200 replies declined to respond to the drug usage section.

Of the remaining 300 replies, 60 admitted to regular use of cocaine, around 60 regularly used opioids, 125 used marijuana and 190 used sedatives regularly.

Nearly a quarter of all lawyers admitted to ‘’intermediate’’ concern about their own drug use.

_ _ _ _ _ _ _ _ _ _

WHILE New Zealand’s newest and tiniest KiwiSaver manager is brainlessly calling for NZ listed companies to reduce annual dividends, Britain’s listed companies are on target to pay their highest ever dividends.

Uncertain about the outcome after leaving Europe, and very aware that global assets are extremely expensive (because of zero-cost money), the British listed companies are expected this year to pay out 90 billion pounds in dividends, a figure that is 7% higher than last year.

The oil company, Royal Dutch Shell, the bank HSBC and the cigarette company British American Tobacco, are leading the move to higher dividends.

Of 19 categories of companies, 12 are paying out more of their profits to shareholders than they paid last year.

Notably, not paying out more are those which fit into the airline, IT, healthcare, media and insurance sectors.

US and European companies are also looking to increase dividends.

If the NZ KiwiSaver manager earned his fees by performing research and analysis, and then matched his investment decisions to a group of younger investors who sought the risk of selecting growth companies, the fund manager could buy into UK IT, healthcare, airline, media and insurance companies, then he would be tailoring his investments to the stated philosophy of preferring lower dividend returns.

If the fund manager first passes on all client money to an index fund, his views on growth, dividends, corporate excellence, skilled management, consumer trends, and changing technology would be of as much relevance as his views on the effectiveness of different baking powders.

Presumably he believes everything rises, whatever the formula!

My guess is that most wise companies will be wary about chasing growth strategies and will discount his views as being poorly conceived.

Perhaps they may want to ponder the current state of Fletcher Building, and measure its success at identifying growth strategies.

I am sure that Fletcher shareholders would much rather have been paid in dividends the $10 billion that was burnt during the Hugh Fletcher era (reference the book ‘’Battle of the Titans’’).

_ _ _ _ _ _ _ _ _ _

PERHAPS prompting caution in the corporate world is recent British news from its main trading banks.

The banks report a surge in the number of customers who fail to repay loans, the delinquent number now the highest since 2009.

Specifically, 62% of banks report rising credit card default rates and 65% report rises in default on other consumer loans.

UK households on average owe 14,000 pounds on loans that are not mortgages.

Perhaps the credit card default rate is linked to the insidious banking practice of offering credit cards with ‘’teaser’’ rates of 0%, sometimes for terms of up to two years.

If any merchant who sells to the cardholder is paying a fee to the bank of 8%, as is the case with florists, for example, then the bank is probably getting a true return on its ’’nil’’ per cent loans of nearer five per cent per annum.

Banks are now grizzling that credit card debt has reached a level that may mean many loans are never repaid.  How surprising!

Just to keep cards growing, some banks are now paying retailers in Britain to cease accepting cash or cheques, forcing clients to use credit cards.

The day of a cashless society is not dawning but it certainly is not over the horizon by light years.

_ _ _ _ _ _ _ _ _

IN a world where two billion people are starving, millions are wanting to escape their homelands, idiots have control of nuclear bombs and the planet’s existence as a home to humans is in question, the subject of media salaries ranks lowly.

But the BBC, forced to identify each individual’s pay if it exceeds an arbitrary 150,000 pounds per annum, is the subject of the day, after disclosure of some absurd pay levels for people working in an area where there is decreasing competition.

Be assured that the newspaper journalists who are obsessing over the subject are not in the same pay league.

Even in Britain most journalists are from humble backgrounds.  The profession has a statistically high divorce rate, more than its share of alcoholics, rarely achieves any level of wealth, and as a result attracts mostly those who have little in common with the rich, the powerful or the wise.

I once asked one of New Zealand’s best business writers, a woman, why so many journalists were women.

‘’Because no man would accept the pay,’’ she replied.

The BBC, fed by money from the Crown’s tax collections, believes some male TV presenters are many times as valuable as the UK’s Prime Minister, who is paid 130,000 pounds per year (about half of what New Zealand pays its PM).

In New Zealand, somehow some TV presenters, whose lifetime achievements are measured solely by the numbers attracted to their channel and/or show, are valued at similar levels to our Prime Minister.  Phooey!

One must assume that those setting the salaries are allocating money that does not belong to the allocator.

The real test would be if the TV salaries were reduced to a credible level, the incumbents left in a sulk, and the vacant seats were advertised at the new credible level of pay.

The test would be the number of applications for the same, lower-paid job.

The BBC could get this rolling now.  It could reduce the pay to a credible level.

My guess is that very few incumbents would leave if the pay was cut.

Where else would their ‘’talents’’ be used?

_ _ _ _ _ _ _ _ __ _

Errata: Last week I noted that Joseph Muscat headed the Maltese government as a National Party man.  He is in fact Labour.

My wife also wants me to record the exact date Malta became independent.  It was 1964.  She recalls it clearly, as a 13-year-old at the time.  It became a republic in 1974.

(As a chivalrous man it is better for me to record this than to disclose her venerability).

_ _ _ _ _ _ _ _

Travel

Kevin will be in Dunedin on 18 August and in Christchurch on 31 August.

Edward will be in Nelson on 22 August and in Blenheim on 23 August.

Edward is also in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

Anyone wanting to make an appointment should contact us.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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TAKING STOCK 20 July 2017

 

IF YOU imagine two small islands in a big sea, or ocean, inhabited by people enjoying better than average weather, with low sovereign debt, strong banks, a burgeoning tourist sector, excellent food, virtually no unemployment, and doing business in English, under British-based law, you might feel at home.

Add to this list strong economic growth, a simple tax system, socialised health and education services, roading systems where you drive on the left, a love of the sea (sailing, fishing etc.) and a generous universal pension scheme from age 65.

You could also describe the attraction to global investors of a small, well organised country enabling new ideas to be tested, incubated, if you prefer, for use globally if the testing were successful.

Yes, New Zealand is all of this.

So, too, is Malta, in the Mediterranean Sea, 100 miles south of Sicily, one hour by plane from Rome.

Its huge tourism earnings, nearly 30% of its GDP, will now be facing challenges that mirror those facing the two islands in the Pacific that make up New Zealand.

Malta’s success in tourism is now a major threat to its lifestyle, consuming resources that are precious.

Should we be learning from this?

Its two islands are home to around 450,000 people, of whom an increasing number are foreigners, many from places like Poland, Russia, Britain, Italy and Serbia, attracted by the casual work available to serve the tourists.

From April to October, you do not wear a jersey or long trousers in Malta.

The sun is unwavering in this period, there are rarely any raindrops, the temperature in these months is between 20⁰ and in mid-summer 35⁰, the sea is clean and warm, and a desirable type of tourist is heading there, every day.

Malta, with no drinking culture (unlike Ibiza, Mykonos etc.), few nightclubs and a high presence of impressive Catholic churches (365 in number for 450,000 people), attracts couples and families. One does not see drunks or yobs.

Malta’s main appeal is its weather, its culture, its history (thousands of years of civilisation), its total absence of stress and its combination of ancientness but worldliness, the likes of its broadband speed comparable with any modern place.

Britain governed Malta till the 1970s when Dom Mintoff took it to a republican status.

The church helps govern behaviour.  Malta has the highest proportion of church-going people of any country, at around 90% of the population.

In terms of income distribution it is the second most ‘’equal’’ country of any developed economy.

It has the fastest growing economy in Europe, whose brotherhood it joined about 10 years ago.

It has effectively no unemployment.

Average wages are around NZ$18,000 so prices of most things reflect this.  Groceries are significantly cheaper than New Zealand.

It has more cars per population than all countries in the world bar seven, with a similar ratio to New Zealand.  Its car fleet is of small vehicles, mostly imported from Japan, second-hand.

You can see why it attracts tourists who use the small hours to sleep, rather than to booze.

The problem now is that it attracts too many tourists.

New Zealand’s 4.5 million people live in a land that is approximately 1000 times the size of Malta and attracts nearly 4 million tourists per year.

Malta, with one tenth of the population of NZ, attracts nearly three million tourists per year.

Please imagine an average of 250,000 tourists arriving each month to live in an area the size of Wellington.

Imagine the pressure on accommodation, on the airport, on roads, on sewerage, water, supermarkets, shops, transport, rental cars, customs control, hospitals, dentists and restaurants.

Now imagine there being not twelve months each of 250,000 but six months of 500,000 visitors in Wellington!

And imagine that half the tourists had never driven on the left, as they do in Malta (and New Zealand).

It is greatly to Malta’s credit that the outcome is not absurd chaos.

To date the experience here is not of a rapidly growing number of car accidents, largely because the roads in Malta are suited only to low-speed driving.  There is no road where a sane driver would reach 80kph, and there is no distance to travel, neither island exceeding 40 kilometres in length.

One problem Malta strives to solve is in providing the seasonal work force that can cater for the numbers.

There is no unemployment so Malta allows foreign youngsters to arrive to work in cafes, bars, restaurants, hotels and in the large number of serviced apartments.

However, the basic infrastructure is fully utilised.

The tourists keep coming in greater numbers.

They bring wealth to this tiny nation, but just as New Zealand will discover one day, there will be a limit to the visitors who will want to return, if the numbers eventually overwhelm the available resources, and tourists are left with unsatisfactory holiday memories.

I suspect New Zealand should send some specialists to Malta to form a think-tank to seek solutions.

The similarities of our nations far exceed our British influences.

 _ _ _ _ _ _ _ _ _ _ _ _

MALTA has little arable land so it imports its vegetables and fruit, mostly from Italy, and it imports meat, often from New Zealand, and dairy from Europe.

One drinks imported bottled water, sold at a piffling sum, perhaps NZ 40cents for a litre.

Fish are farmed at sea, trapped by football-field sized nets, extracted to order each day, but mostly exported (to Japan).

Its wealth is based on tourism, including education, which attracts 10,000 European students (12-18 years old) each year, wanting to be educated in English, in a safe country.

More recently wealth has come from its global leadership in the internet gaming sector, which now accounts for 12% of Malta’s tax receipts.

It attracted the global internet gambling providers by offering very generous tax rebates to companies which employ Maltese IT people, and build or occupy premium office space.

Malta’s education system focusses on science, engineering, IT and health providers.  Its international successes in these areas are impressive.

It does not offer university degrees in the art of knucklebones, basketball or tracking the flight path of blowflies.  Maltese students pay no fees if they succeed.

Its sovereign debt is very low, its consumer debt is even lower, but its mortgage-based debt is growing, as house prices increase.

The Maltese are not big users of credit cards or hire purchase.

Foreigners can buy or build expensive houses only, or rent expensive places.  They may not buy for a price less than 350,000 Euros, whereas the standard home is less than half of that figure.

So there is no foreign investment in rental properties, except at the top end where the tenants are other foreigners, renting luxury apartments in premium seaside areas.

Building costs are around NZ $1,800 per square metre.  (In NZ, you can add 50% to that figure).

Malta has had long periods of both Labour and National governments, currently the government by landslide, of National hue, led by Joseph Muscat.

He might be known in some corner of New Zealand for he once had a foreign trust based in Auckland.

A cynic might wonder if the global gaming sector has been generous to politicians.

One imagines that anti-money laundering rules are strictly applied to that sector.

After much thought, and some twenty years of short visits, I now offer to join a New Zealand envoy to discuss solutions to the problems of excessive tourism growth.

My offer is conditional on the agreement that the envoy visits Malta in summer for a long period and requires all meetings to be held in the evenings, at an outside café, on a promenade by the Mediterranean.

_ _ _ _ _ _ _ _ _

REFERENCE in last week’s Taking Stock to the new levels of ‘’activism’’ or ‘’constructivism’’ undertaken by powerful fund managers acknowledged the weight of their votes, representing their clients’ shares.

That power, exercisable not by thousands of individuals but by one fund manager, is a threat to recalcitrant companies, lazy directors or overpaid executives.

Providing the exercise of that power genuinely represents the best interests of the people whose money bought the shares, activism or constructivism has potential to improve performance and behaviour.

In the New Zealand context, the power is now largely with the KiwiSaver providers whose size gives them grunt at the voting table.  I guess the banks and insurers also regularly retain the voting function, and the retail sharebrokers, Craigs and Forsyth Barr, may also have some bicep if a company calls for a vote.

An obviously contentious area is director and executive remuneration.

The responsible fund manager would canvass the views of his savers and vote accordingly.

Perhaps a takeover proposal might also be a relevant subject for a fund manager to consider.

Any fund manager with a billion invested is likely to have hundreds of millions invested in NZX-listed shares.  If the amount were $100 million, the fund is likely to own, say, a million shares in Auckland International Airport.

A million votes is not insignificant.

The views of that fund manager exercising that vote are therefore important, and worthy of discussion, perhaps even in the media, if there is anyone left in the media with the time or interest to discuss issues very relevant to at least 200,000 New Zealanders.

What is not worth more than the most cursory thought is the opinion of a would-be fund manager, with voting power of barely a dozen shares.

Indeed you might ask why that fund exists.

So it was astonishing that last week the media, which so rarely asks powerful people what they think, allowed the tiny fund Simplicity to publish some especially silly, poorly thought-out views on the dividend policies of our NZX-listed companies.

Readers may recall that Simplicity is seeking to attract KiwiSaver clients by offering very low fees to intermediate savers’ money, predominantly tipping it into the hands of the giant American manager Vanguard, which in turn puts the money into exchange traded funds around the world.

The process requires little thought, analysis or skill but simply tosses a cork into the ocean, allowing it to wash up where the waves of market sentiment deliver it.

To date Simplicity has persuaded a few thousand New Zealanders to pursue this path, and may now have around $160m funds under management in the various funds, of which perhaps 10 million is invested in NZX-listed shares.  (Simplicity has attracted about one third of 1% of KiwiSaver money.)

If we assume ten million, then perhaps they could vote on 100,000 Auckland Airport shares.

Hopefully, my point is made.

Simplicity is not a fund manager.  It is an administration system marketed by a pleasant salesman (Sam Stubbs) hoping to achieve perhaps one per cent of the KiwiSaver market.

I repeat it offers little investment analysis, employs no relevant capital market expertise, has no power at any shareholder meeting, and probably has no or minimal contact to establish the views of its KiwiSaver clients on matters of corporate behaviour.

It simply markets a low-fee, no-look system of handing KiwiSaver money to an index investor in America.

Perhaps this disconnect is why Stubbs was so far out of his zone when he suggested last week that NZ companies should reduce dividends and pursue growth strategies.

Perhaps if he revisited a thinking process he might argue that a KiwiSaver fund ought to select growth shares rather than income shares, to match the aspirations of those savers making up a fund.

Simplicity selects nothing.  It replicates the index.

If a fund is built on the savings of a 30-year-old, rather than a 60-year-old, he might find a supporting argument.

The truth is that NZ is a small, low-growth market, its sharemarket largely comprising companies that have limited growth potential but achieve reliable margins with which to serve the income needs of the largely older age bracket that own the shares.

Obviously there are a few exceptions, including Mainfreight, Ebos, Fonterra, Port of Tauranga, and Auckland International Airport, all of which could fairly be asked to retain profits to facilitate growth.

Here in Europe New Zealand is seen as a relatively desirable haven for yield investment, the consensus being that NZ has a well-managed economy based on delivering much-needed food to a world prepared to pay a premium for that produce (meat, cheese, butter, vegetables, fruit, fish, wine, honey).

As a result Europe allocates more of its investments to New Zealand than to almost any other country of such diminutive size.

We need that money to develop.  We borrow it by bond issues and with bank deposits, and we attract it to invest in our listed companies.

The Europeans expect, in return, a reliable high yield.

If they invest for growth they go to much bigger markets.

Britain and Europe are increasing dividends rather than reinvesting surpluses at a time when markets are at all time highs.

What is Simplicity thinking?  What expertise does it offer?

Whose thoughts does it represent?  Why would the media publish the musings of someone who represents virtually no relevant voice?

I remind readers that NZ has previously had dopey forays into growth strategies, pouring shareholder wealth into a furnace.

Recall Air New Zealand (Ansett), BNZ (Australian lending), Telecom (Australia), Michael Hill (shoes), The Warehouse (Yellow sheds), and may I be so impolite as to mention Stubbs earlier employer, Hanover Finance (Spanish property lending)?

New Zealand’s value to share investors is the reliability of its dividend policy.

Please let no idle thinking seek to change that.

 _ _ _ _ _ _ _ _ _ _ _ _

TRAVEL

 

Kevin will be in Dunedin on 18 August and in Christchurch on 31 August.

Edward will be in Remuera on 1 August and Albany on 2 August, and in Nelson on 22 August and Blenheim on 23 August.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

Anyone wanting to make an appointment should contact us.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.

 

 

Chris Lee

Managing Director

Chris Lee & Partners Limited

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TAKING STOCK 13 July 2017

 

THE growing disconnect between investors, the public and on the other side, the corporate executive world, is becoming an urgent issue in Europe.

With a narrow majority favouring an exit, Britain’s referendum on EU membership was seen as a protest against elitism.

Also anti-elitist is the current drive to shame those who grossly overpay their executives.

Now we are being told that a dual-pronged attack on corporate elitism is being arranged by wealthy hedge fund managers under the headings of ‘’activism’’ and ‘’constructivism’’, as well as by regulators.

You might wish to defer judgement on any self-acclaimed ‘’help’’ from fund managers but they believe their motives are altruistic.  Perhaps leopards can change their spots, after all.

The origin of the growing problem is obvious.

Whereas a few decades ago the level of income awarded to senior executives was often no more than four times the amount paid to the average person, the ratio today is revolting.

In New Zealand the ratios have blown out inexplicably to a point where the best paid corporate chiefs earn 20 times the average wage.

Indeed even the irrelevant and mediocre radio or television chat hosts can earn nearly 10 times the average wage, a ratio that compares revoltingly with the premiums paid for real talent just four decades ago.

In the 1970s the Prime Minister of New Zealand was paid nearly five times the average wage.  Today the ratio is nearer nine times.

In Britain the ratios are now so revolting that the politicians and market regulators are revolting.

The average package paid to a FTSE 100 public company chief executive is 150 times that paid to the average worker, and in the USA that equivalent ratio is worse.

My view is that the disposition of available money, whether in the private or public sector, is so inappropriate it is hard not to think of it as theft, a modern form of feudalism.

In Europe, and in Britain, the first step of the solution has been assigned to disclosure.  I suppose the facts must be displayed to generate the energy to enforce change.

Companies will have to publish the ratio of their executive remuneration to average worker pay.

Ironically, this ratio might be less offensive in the most vulgar companies.

For example, a company like Goldman Sachs, whose executive packages are in tens of millions, might employ very few people who are paid leanly, so the ratios may be in tens, rather than hundreds, hiding the exaggerated executive payments.

This might contrast with a company providing home care for the elderly, where, if New Zealand is typical, the shareholders and executives earn millions per year, yet the average pay is barely $35,000pa, despite recent increases.

As an aside, one wonders who is in charge of our health budget that allows a bleak home care provider to create such extreme surpluses that its owners quickly capture tens of millions of wealth and travel in private jets.

Here in Europe compulsory disclosure is imminent and is expected to have a ‘’shaming’’ effect.

There is also much talk of a reversion to elephant-sized tax surcharges to disincentivise the gluttony.

When I worked in the UK in the 1970s there was much focus on a 95% tax rate applied to extreme salaries.

Currently that immoderate rate is not in the plans but while Britain and Europe are beginning to accept the changing mood of the people, some dramatic policy ideas are being discussed.

While the regulators seek to enforce disclosure and follow up with what Muldoon called ‘’jawboning’’, those with the real power to bring about immediate change are also planning action.

Those with the power to act in the private sector are the shareholders.

In most examples this voting power rests with fund managers and hedge fund managers.  Neither group are known for their moderation, or even their connection with ordinary folk.

Currently the fund managers are describing their approach to the board of directors of public listed companies as being ‘’activism’’ or ‘’constructivism’’.

I guess the constructivism approach seeks to engage on a friendly basis, with an intent to persuade the directors to initiate change.

Lurking behind the constructivism strategy is what the fund managers regard as their nuclear weapon, an activist attack.

This implies a do-as-we-command approach, backed by an ability to vote off any directors who oppose the measure, insert directors who will effect change, and replace executives who resist.

It is hard to see a return to the days when I worked in a public company, and the top salaries were sane.

I recall that the chief executive was paid about six times the earnings of the man in charge of the internal mail deliveries or those who served at the canteen.

At Fletchers that ratio today is not six, but more than sixty, and in the new world in London, in a company equivalent to Fletchers, the ratio would be nearer 160.

One wonders whether Britain and Europe have passed the point of no return, in terms of social conscience at corporate levels.

If that were the case the solution might be a surtax rate of 95%.

Of course the consequence of much lower executive remuneration would be either lower-priced goods and services, or much more nett profit, facilitating an increase in useful spending (research, development, staff training, corporate culture, staff welfare) which in turn would switch the corporate focus from short-termism to a Swiss-like long term mindset.

Could anyone argue that ‘’useful’’ spending and ‘’long term’’ focus would be a bad idea?

 _ _ _ _ _ _ _ _ _ _ _ _

ACTIVIST fund managers already claim some victories.

In recent months they claim to have ended the tenures of several high profile chief executives.

Included in the scalps in the USA are the CEOs of IAG, GEC, Uber and the railroad operator CSX Corp.

Those seeking change will have been studying recent global research, analysing the composition of the extreme packages paid to CEOs of large companies.

Salaries make up, on average, barely 10% of the total CEO packages granted by S&P 500 companies.

The packages on average are made up of:

Salaries 10%

Bonuses 20%

Stock awards 50%

Option awards 15%

Other 5%

My view is the focus on gifting shares, or even just subsidising shares, might align the motives (why is more reward needed to achieve this?) but it also creates a stock price focus that undermines every long term strategy.

Stock price focus demonstrably leads to a desire to use company surpluses to buy back stock, pushing up prices and raising debt.

This focus leads to short-termism, and other undesirable behaviours, like cutting research budgets and staff numbers, while reducing focus on quality and on long-term strategic initiatives.  Is this the mindset that the corporate world wants?

 _ _ _ _ _ _ _ _ _ _ _ _

GLOBALLY, change in mindset is essential.

Maintenance and development of infrastructure is inadequate in virtually every corner of the globe.

Some would say there is an inverted relationship between marinas filled with rarely-used, crassly excessive corporate yachts and public infrastructure budgets.

In the USA there are nearly a million bridges over rivers, highways, canyons or ravines.  They are essential for transport and a necessary feature of big cities, whose workers need to get to their work places and back.

Some 10 percent of America’s bridges are now described as obsolete and not for purpose while a similar percentage are described somewhat worryingly as being ‘’structurally deficient’’.

The funding that is not being found to address this is also not being found for many other vital demands.

The state of Illinois and its main city Chicago has unpaid bills of US$14 billion and runs a multi-billion deficit every year.

Not surprisingly, many of its residents vote with their feet, escaping before local taxes rise even further, making even greater holes in the already tatty household purses.

In the past five years a nett figure of 500,000 people have left Illinois.

Around 300,000 have left the troubled state of New Jersey.  It seems they migrate to Florida, which has gained 700,000 new people in that time, while Arizona has gained 220,000 people.

Perhaps the flight is for fulltime employment.

Of those aged between 18 and 64 only 53 percent of Americans have fulltime employment.

The percentage of people with fulltime work is now lower than at any time since the great depression in the 1930s.

The unemployed do not get much sympathy from some.

Peter Cove, the author of the in-vogue book Poor No More, advocates an immediate end to all forms of unemployment benefits and all poverty programmes in the USA.

In his book he advocates switching these funds to create jobs, in effect incentivising a work culture rather than addressing the misery of those who cannot (or will not) find work.

One assumes Cove will soon have the White House calling, with an attractive offer!  God save America (from civil war!).

 _ _ _ _ _ _ _ _ _ _ _ _

AMERICA and Europe are both experiencing the social pressures of the corporate drive to cut costs.

Italy is in a chaotic state, the result of corruption, appalling misallocation of wealth, a dreadfully unstable political system, and Mafia-dominated, ill-managed banks.

Fulltime employment is merely a dream for many, but particularly the young, in a country where nearly half of those aged less than 30 have any work, many living at home at the expense of their ageing parents.

To illustrate this disparate work shortage, a bank has released some data after advertising for thirty new staff for fulltime employment.

The bank received 85,000 applications.

It short-listed 1200 and had them sit examinations to establish their suitability.

Some of the positions were for tasks remunerated at a level that would be illegal in New Zealand and in enlightened countries like Australia, Canada, Germany or even China.

Italy, I remind you, has the 11th largest economy in the world.

 _ _ _ _ _ _ _ _ _ _ _ _

THE world may not have the right approach to providing everyone with a job and enough money to live with dignity, but there is enough money to keep the breweries busy.

Astonishingly, Ho Chi Minh City, in the slowly recovering Asian country Vietnam, consumes more beer per citizen than almost anywhere in the world, and despite its low wages it does not over-subsidise its booze.

Beer is the preferred drink in Vietnam, with 91% of all alcohol consumption being with beer drinkers.

Clearly Cloudy Bay winemakers should not focus their export drives there.

Beer Consumption by City

Ho Chi Minh

Litres per head: 119l

Average Spent: US$634

Auckland

Litres per head: 116l

Average Spent: US$869

Toronto

Litres per head: 85l

Average Spent: US$1,136

London

Litres per head: 79l

Average Spent: US$1,078

With some relief I record that here in sunny Malta (33°) a cold Heineken pint costs €2.00 (NZ $3.20).

Many of the locals drink shandy, which is even cheaper.

_ _ _ _ _ _ _ _ _ _

THE world has no money for those of the generations that find it amusing to play electronic games on their various devices.

The global spend on these games is now 91 billion US dollars.  I am totally innocent of any of this spending!

While there is enough money to spend on electronic games, there is not enough to satisfy Australian men and women cricketers.

The Australian cricket body (Cricket Australia) last year paid its average international male players A$1.16 million and offers to increase that to $1.3m next year and then to $1.45m per year by 2021.

Provincial (state) cricketers would see their pay go from $211,000pa to $235,000.

Their female international players are promised to go from $79,000 last year to $174,000 next year and $210,000pa by 2021.

The female state players would go from $22,000 last year to $52,000 next year and $55,000 by 2021.

Please note that even in Australia, state cricket matches for men attract tiny numbers of attendants.

I do not know the numbers who pay at the gate to watch the women inter-state matches.

These wages all seem pretty flash to someone whose sport at provincial level was played in an era when you paid your own way, bar the transport to other cities.

However today things are different.

The men and women cricketers in Australia have rejected the proposed CA pay scales.

The money offer was not good enough.  The players will withhold their labour.

 _ _ _ _ _ _ _ _ _ _ _ _

THE UK reaction to the recent Lions tour of New Zealand has been joyous, not just because of the exciting drawn series but because of the generally cheerful experiences of the 26,000 Lions fans who shared our country with no fear for a few weeks.

The satisfaction level of the NZ experience has been described as very high in the UK media.

Curiously, this has been best reflected by the media reports of the former rugby internationals, like Stuart Barnes, Ben Kay and others.

By contrast the UK reporters with no sporting talent, but with media responsibilities, have been a mix, the boorish, like Stephen Jones, replicating the single worst and most boorish, dull sportswriter I have ever met (in the 1970s), the late John Reason.

New Zealanders, one hopes, would never behave as crassly as Jones and Reason, when visiting countries.

The fans themselves have publicly described a helpful, friendly, somewhat expensive country, pleasingly underpopulated and with attractive landscapes and lifestyles.

Perhaps the boorish, lacking any understanding of the nuances of sport, and not able to differentiate great sporting contests from win/lose emotions, deserved the equally ugly reception of exploitative pricing from our hotels, covered car parks, and streetside vendors.

How interesting that those visitors who were great sportsmen themselves appear to be charming, appreciative guests, leaving those without any accomplishment other than newspaper reporting to reflect their own vulgarity and lack of manners.

Gracious hosts, mixing with gracious visitors, combine to produce joy, and the economic benefit of a desire for repeats!

 _ _ _ _ _ _ _ _ _ _ _ _

TRAVEL

Kevin will be in Christchurch on 3 August.

Edward will be in Remuera on 1 August and Albany on 2 August.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

Anyone wanting to make an appointment should contact us.

Chris Lee

Managing Director

Chris Lee & Partners Limited

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TAKING STOCK 6 July 2017

 

CHAOS reigns at the recently ASX-listed New Zealand investment company, Powerhouse.  It may reign for a while yet.

Perhaps Powerhouse’s survival depends on a network of Australians who might be behind the brand new Powerhouse chairman Russell Yardley; certainly Yardley says his network is meaningful.

Powerhouse has made many errors, at least one of which could destroy the company.

To understand its fragile existence one needs to revert to just a few years ago when Powerhouse succeeded in signing up as the preferred partner of various NZ universities, whose research specialists were producing ideas that Powerhouse believed it could incubate and assist those ideas into hatching into great, growing NZ companies.

Powerhouse believed its directors had the private wealth, the credibility in capital markets, the intellect, the experience and the governance skills to convert great ideas into commercially profitable entities.

It branded itself as a ‘’patient’’ investor and sold itself to a wide range of wholesale investors as having the connections and skills to help NZ grow more of the ‘’Hamilton Jet’’ companies that create jobs and wealth, and attract global attention to our nation’s reputation for resourcefulness and ingenuity.

These were lofty and admirable goals.  I supported the concept.

Ultimately, Powerhouse raised capital by placing shares with professional investors (like me, and particularly many BNZ executives), and set the price for those placements at levels that sought to forecast the intrinsic value of the ideas which Powerhouse were seeking to commercialise.

Some ideas were commercialised faster than others, Hydroworks being the flagship, the company which Powerhouse hoped would succeed rapidly and list in its own right.

Some 23 other ideas were acquired by Powerhouse, often for a sum not much more than the cost of an Audi or a Mercedes Benz.

Last year Powerhouse sought to list its shares and raise new capital in Australia, having failed to win the support of capital markets in its own country, its directors having failed to connect with, or impress our bankers, investment banks and major investors.

In some respects, the NZ response was brutal, and perhaps unfair.

For example the youngster Sam Morgan (son of) displayed his views without feeling any need for diplomacy and without any need to justify them by quoting his research.

Sam Morgan said:  ‘’ These sort of (rubbish) tech IPOs just ruin it for all the companies that are actually making stuff, selling stuff and have a business model.’’

He opined that nobody in their ‘’right mind’’ should invest in Powerhouse given it had ‘’no track record’’ of selling or spinning off successful investments.

Since then Powerhouse has sold about $700,000 worth of Syft shares, but in essence Morgan was right about the failure to exit, let alone exit at a price that validated its valuation.

Powerhouse would counter that it ‘’incubates’’ and is ‘’patient’’ while building value.

My comment would be that Powerhouse ‘’incubates’’ with other people’s money, while paying its executives handsomely, indeed at a rate that seems to exceed value-add.

But these matters may be just ‘’noise’’.  Here are some facts:-

1.  Powerhouse raised money late last year at A$1.07 per share.  The shares trade at around A0.60c, a few months later.

2.  Powerhouse has had FOUR chairmen in less than a year.  Recently its new chairman, American Blair Bryant, resigned over his previous failure to disclose a bankruptcy in an earlier part of his career.  Bryant then declined to leave the board but in recent hours has done that.  He had the appearance of an agent for change.

3.  The Powerhouse flagship and great white hope was, and is, Hydroworks, which was assigned an enterprise value by a third-tier valuer (Edison Research) of around $25-45 million when its gross revenues were less than $5 million, and its business plans had been abandoned.  The valuation equated to the roughly 340,000 shares having a value of $75-$145 per share.

That valuation now looks absurd.

Any Hydroworks share price exceeding $40 would by my calculation assume that it executes quite brilliantly its current (2017) business plans.  Indeed it may be successful and achieve these successes but if it does the success would have virtually nothing to do with Powerhouse’s input.

4.  Powerhouse’s contribution to Hydroworks’ need for working capital involved a loan arranged by Powerhouse for which it charged Hydroworks a rate of 48 per cent per annum.  Is this what you call ‘’incubating’’ a start-up?  I understand that ‘’loan’’ has now been partly converted to equity.  Did the directors of Powerhouse lend the money to Hydroworks at ‘’cost plus’’ and borrow it from Fast Loans Ltd?  I find it astonishing that a parent would so exploit an infant company.

From all of this you might guess that being in my ‘’right mind’’ I have flogged off the 40,000 shares I bought years ago.

I have not.  I am a patient investor, who risks being a remorseful investor.  I have several ‘’patient’’ investments.  Happily, sometimes patience is rewarded.

My hope now rests with Powerhouse’s latest chairman, a Victorian with real experience in growing tiny companies.  Russell Yardley is the new chairman and appears to bring with him a network of Australian investors who have shared some successes with him and are well-heeled.

He is enthusiastic about the Powerhouse concept, but probably will have to accept the future of Hydroworks is most likely to hinge on a change of shareholding, Powerhouse exiting, someone with synergy and capital replacing the incubator.

If Powerhouse could exit Hydroworks, find access to real capital, real expertise and win capital market credibility, Yardley is likely to be the key man.  There appears to be no other candidate to do this.  He may need to refresh his board.

Very clearly Hydroworks can be a real business but it does not need smart suits and 48% short-term loans.

It has already dumped the strategies that Powerhouse had overseen and looks nothing like the company that Powerhouse presented during its IPO less than a year ago.

Indeed I wonder how the IPO presentation could have been performed with a solemn visage, given that it alleged that the incubator’s greatest asset was Hydroworks and presented it as having an enterprise value of around $20 million.

This valuation troubles me.

Its original valuer was Edison, a company based on a young researcher, John Kidd, with experience of energy companies.  John Kidd founded Edison Investment Research.

Edison Research, about a decade ago, was the valuer of Pike River Coal, had a connection with the small sharebroking firm McDouall Stuart, and sought to advance its reputation as an analyst by publishing annual books based on its research on finance companies.

Edison had no practical knowledge of this sector but in fairness its genuine attempt to be helpful was undone not by its obvious inexperience but by the appalling non-disclosure (I would say deliberate concealing) of crucial matters like capitalised loans, loan rollovers, related party loans, conduit loans, false description of capital, failure to submit to fit and proper person tests, and straight out, through the teeth lying.

This behaviour by finance companies, unchecked by auditors, trustees or regulators, made nonsense of Edison’s books.

As a valuer of companies, Edison Research is no doubt sincere and arithmetically competent, but the assumptions it accepted when valuing Hydroworks were not dissimilar to the cow manure that lay beneath finance companies in 2006 and thereabouts.

Its valuation, which guided Powerhouse directors, assumed that Hydroworks would sell dozens of in-race transportable mini turbines, making fat margins on each sale, producing nearly half the forecast profit.

It assumed that its acquired manufacturing base, Mace Engineering, would grow its profits to millions per year.

It assumed that the contracts Hydroworks was winning in Australia would be nicely profitable.  Revenue was assumed to be $75m by 2020.

The truth is that there were virtually zero sales of in-race turbines, in fact that strategy had been abandoned in early 2016, when Hydroworks acquired a new CEO (Andrew Rodwell).

Hydroworks lost money on its Australian projects, largely through its inexperience in negotiating contracts there.  It did a fine job with the actual work, so might regard the projects as ‘’loss leaders’’, but there was no profit.

Mace Engineering, acquired at a generous price, from day one has been making losses, and losing market share, hampered by an unimpressive unionised culture, ageing owners, and outdated plant.

How on earth were the assumptions about Hydroworks still relevant in late 2016, when Powerhouse had its IPO?

So what happens next?

Powerhouse, hopefully led by a new, well-heeled chairman, must show that its leadership in matters like governance, its access to capital markets, its experience in growing companies and its valuation models are going to be validated by the performance of the 23 companies it part owns.

I assume it must sell Hydroworks to a more appropriate owner, or at very least bring in a stronger shareholder, with a commitment to what is still a promising company.

Powerhouse must succeed in adding value to its nursery companies.

If it wants to discover the next Hamilton Jet it may need better skills than it has so far displayed.  It needs a much stronger board.

Perhaps it might need to explain to its new public shareholders why it has the appearance, at least to me, of a group of smartly-dressed people with little obvious value to add.

One hopes that Russell Yardley will see all of this, change the culture and fend off those who might feel litigious about the somewhat hairy IPO, which raised the minimum amount sought, probably with the help of smoke and mirrors.

I have not sold out.  The edge of my seat is wearing thin.

 _ _ _ _ _ _ _ _ _ _ _ _

MEANWHILE Hydroworks has its sights on achievable goals, having abandoned in early 2016 the somewhat unachievable goal of putting transportable mini-turbines into every dairy farm’s irrigation canal.

It now sees itself as being clever at building hydro-plants in many countries, and in refurbishing existing plants.

It accepts that its technology is not unique, but it is of high value, and it accepts that its intellectual property does not quite give it an exclusive market position.

It has recently completed two major contracts in Australia, one in South-east Queensland, the other in Melbourne.

It has won high praise for its work and has built a long-term relationship with Melbourne Water, if you believe the media articles in the Victorian Press.

Perhaps it will win many or even all of the ten contracts to do similar work in Victoria in the near future.

Yet its most exciting venture might be in Indonesia where coal is still used as an energy-source, in tea plantations and in other areas.

Hydroworks has formed strategic alliances with a project manager, Genco, it has an agreement for civil work with Fulton Hogan, and it has progressed a relationship with two large fund managers who allocate resources to projects that are environmentally attractive.

It hopes to win contracts to build hydro-plants each with planned output of between one and ten megawatts, believing it will be seen as skilled, flexible, blessed with excellent technology, and able to operate effectively in a segment of the market that might not attract the big global players, like Siemen (Germany).

The new Hydroworks CEO, Andrew Rodwell, is probably best known for his role at ArborGen, the forestry company that uses genetic engineering and cloning to produce superior forests.

ArborGen might be a sullied name, because of the behaviour of its parent companies (Rubicon, in particular) but under Rodwell it grew in revenue dramatically, and no one in the market condemns its achievements or his.

Since he has arrived at Hydroworks he has restructured the Mace manufacturing base and now has a work force that should be efficient.

He has also driven the progress in becoming a geographically-diverse hydro-plant developer and probably deserves a little credit for confronting the behaviour of Hydroworks’ major shareholder, Powerhouse, whose performance I regard as being negative.

Rodwell sensibly will not discuss these matters but unless I am sadly mistaken, the conflict with Powerhouse must be resolved soon.

Under the new regime, and assuming access to capital, Hydroworks aspires to produce a million dollars of nett profit after tax in the 2020-21 year, at which point its 340,000 shares might be worth nearer $40 per share.

Alert readers will wonder how Powerhouse could have valued those shares at $57 per share in 2016 and will be intrigued by the assumption Edison accepted when it did its valuations at $75 - $145 per share.

Currently I would value the shares at nearer $20, reflecting my hope, but uncertainty, that Rodwell will succeed with his Australian and Indonesian ambitions.

Doubtless Hydroworks will continue to win projects in New Zealand, where the likes of Trustpower have great admiration for its work, but ours is a small market, margins are lean and there is competition.

I have not sold my 1,500 shares in Hydroworks, either.

Sam Morgan might be questioning my sanity.  That’s okay.  That would not be an original question.  I ask it myself, often.

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

READERS with a special interest in Hydroworks might want to consider the Australian view of the company’s expertise by Googling the headline: ‘’Inside Melbourne’s secret suburban hydro power system’’.

Note the last sentence in a long article, extolling the recent projects.

It reads: ‘’They were manufactured by the New Zealand company Hydroworks.’’

This might be as close as any Aussie will ever get to acknowledging that the Timaru horse Phar Lap could run a bit!

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

MY travel to Europe again comes at an intriguing time with many on my visit list being doubtful about Britain’s ability to exit the European Union.

The sheer weight of huge issues that would need to be solved is leading to a growing view that Britain will not exit, but might instead see major changes in the composition of the two largest political parties.

Both parties are divided by an issue that itself divided Britain.

It will be interesting to listen to the views of German business leaders on this subject.

Of course the EU itself is also under pressure, the latest concern being the breach of EU and ECB rules, regarding the use of tax-payers’ money to save banks.

Italy has twice ignored the rules in recent weeks.  Spain also faces the need to recapitalise a bank.

Someone prepared to back the Lions on Saturday might also be brave enough to punt on the return of the Deutschmark in coming years.

I will write Taking Stock from Europe over the next few weeks.

 _ _ _ _ _ _ _ _ _ _ _ _

TRAVEL

Kevin will be in Christchurch on 3 August.

Edward will be in Remuera on 1 August and Albany on 2 August.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

Anyone wanting to make an appointment should contact us.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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