Taking Stock 29 July 2021

THE release last week of the results of an investigation into 42 of New Zealand's largest insurance companies has highlighted two issues that no investor should overlook.

The Financial Markets Authority (FMA) released its findings, after surveying the insurance sector, specifically the fire and general insurance sector.

It found that in almost every case, rotten, self-serving practices have prevailed for years.  I would guess they have prevailed for decades.

Insurers did not just use rotten practices to obtain premium income for events that the sector then tried to side-step.  It also promised rebates for multi-insurance loyalty and did not apply the discounts.

It allowed the public to fill in forms, accepted the forms, accepted the premium payments, and then when a claim was made, used the fine print of the law to debate, and try to avoid, payouts.

Investors should make themselves well aware of this foulness.  The FMA believes refunds, totalling many millions, are due to investors.

Just one simple example is commonplace.

To obtain income protection or health insurance, a new client might be asked to testify that he/she has had no medical history that might suggest an existing health condition.

Someone who once fainted in church, but did not think to disclose that, might find any claim was disqualified.

It seems some insurers would seek to debate whether the full disclosure had been made if there were any possible excuse for not accepting a claim.

The second issue that all investors should record is that there is now undeniable evidence that the Financial Markets Authority has teeth and knows how to chomp.

It has attacked various KiwiSaver managers, nearly all of whom are much better at marketing than they are at adding value.  Their fee structures, especially for the index funds, are absurdly high.

The FMA has attacked various financial planners and has had them brought in front of the courts.

It has the banks on high alert that it is not just the Reserve Bank which is watching bank behaviour.

The FMA is now intervening to ensure that, in the finance sector, remuneration policies reward excellence, but do not set their rewards based on selling targets.  Quantitative assessment will gradually replace bonuses based on the volume of sales.

I expect there will be new internal criteria to ensure profit-sharing, or bonuses, are decided on excellence and value-add.

The extreme salaries and bonuses that have made multi-millionaires out of people, who in at least one case was a crass front-runner, will soon have to be justified by excellence in client outcomes.

The FMA was initially headed by a gutsy ex-banker, Sean Hughes, who fought the finance company cheats, albeit with an inadequate budget, and with government interference that placed hurdles in his tracks.

When Hughes left, a softly spoken but competent British lawyer, Rob Everett, arrived, genuinely experienced in matters of governance and institutional behaviour.

He leaves in a few weeks, at a still young age, probably seeking relief from the grind of working his way around those who resisted decent standards during his seven-year reign.

Hughes and Everett have done much to erase the memories of the Securities Commission, whose contributions in the 1980s and 90s, despite a pitifully low level of political support, far exceeded those of the Securities Commission's last leader, Jane Diplock, who oversaw the finance company sector.

Diplock was saddled with co-governors whose achievements in most cases bore no obvious pathways to the governance requirements of a regulator.

She seemed in awe of the NZX, whose record as a regulator was even worse than Diplock's, its leader Mark Weldon simply inept, talents misdirected, a brat, in my language.

To be fair to Diplock, she too had pathetic political support, leaving her with weak staff (Liam Mason, her senior counsel being one honourable exception).

The Clark government's Commerce Minister, Lianne Dalziel, would probably be the first to agree that the finance company debacle was largely attributable to her own ignorance and her inability to understand the sector, and maybe her unwillingness to apply energy to learning about the sector.  She watched, as looters ran down the streets, brandishing investor money.

She and Clark could not be convinced to apply attention to the sector, but Diplock shared the blame; a regulator with no empathy for investors or markets.

The FMA has reached far greater heights than Diplock's Securities Commission.  Everett, like Hughes, will leave knowing that he has opened doors on poor behaviour that can no longer be closed, silently.

The insurance sector, like the banking sector, has had a toxic culture for decades; generally dreadful governance, arrogance from overseas owners, poor practices known but not addressed.

Taking Stock was fairly aggressively discussing those matters a mere 35 years ago.  Nobody seemed to care.  The insurance sector's response was to ask me out for dinner, rather than to fess up and address the behaviour.

There is very little satisfaction in noting that at last the doors are being prised open, but meanwhile hundreds of millions have been captured by the people who escaped the regulators' attention.

 _ _ _ _ _ _ _ _ _ _ _ _

THOSE who pay premiums to buy insurance should be protected by a simple new practice.

When an application for insurance is made, the attached premium payment should be held in a trust account.

After a prescribed period – say, thirty days – the payment should be returned to the client if the insurer believes there are errors or omissions in the application form.  Thirty days is enough to complete due diligence.

Alternatively the payment should transfer to the insurance company, signalling that unless clear fraud has been committed by the applicant, the disclosure has been checked, validated, and the policy is thus approved.

Accepting premiums for years, and then seeking to invalidate the policy because of error or incorrect omission, should be a practice that the FMA's enquiry will abolish.

Congratulations to the FMA for its refusal to bow to this Old Boys Network.

Next up, will they please do this to liquidators and receivers, where too often equally rotten practices are left unchallenged, at the great expense of those who are not bankers, trust companies, lawyers, accountants, repossession agents, storage suppliers, financial advisers, investment banks or, in a few cases, close friends or relatives of the liquidator/receiver?

 _ _ _ _ _ _ _ _ _ _ _ _

WHEN the Ponzi scheme clown David Ross was exposed, his investors lost at least $100 million.

The ANZ had been the banker for his magic mining stock fund for many years.  The bank and a tiny number of under-powered financial advisers helped Ross build credibility.

Any inspection of his bank accounts would have made it obvious that he intermingled client money with his own business funds, and frequently used incoming client money to pay his personal and company bills.

Unsurprisingly, those who lost vast sums have posed a question; how come his banker, ANZ, took no apparent interest in what by any description was an illegal business?

Equally unsurprisingly, the investors have found a litigation funder (LPF) to bring a case to court to test the possibility that the ANZ breached its duties by taking no interest in how Ross accounted for other people's money.

It is sad to record that there is no market surprise that the ANZ has inadvertently lost a swathe of records that might have shed light on the alleged neglect of the bank.

Did anyone in the bank notice the anomalies, record them, and take no further action, or, more likely, hand them on to others who saw no fire under this smoke?

A fair alternative question is whether a bank has any obligation to oversee accounts, other than to meet money laundering laws, or the potential funding of terrorism, its only responsibility being to ensure any credit facility it offered carried minimal potential bank loss, in the future.

We will learn the High Court's opinion of what highly privileged bankers must do to earn the privileges that come with a banking licence.  The licence is a pathway to soft profits, we all would acknowledge.  Surely a bank has to earn this privilege.

That ANZ has lost important records will not mean that this case dies for lack of evidence or proof.

Indeed it is conceivable that the bank's mistakes will not help to convince a judge that the ANZ has conducted itself faultlessly.

The case will set important precedents.

Either the banks do not need to oversee accounts and take action where there is reasonable doubt that the account holder is behaving legally and fairly, or the banks are expected to blow a whistle when smoke implies underlying flames, in this case from the incineration of other people's money.

It is fair to note that if the banks do owe a duty of care to those who interact with a rotten business, a whole new raft of costs would fall on the banks.

Someone would have to pay this cost.  Might this imply a new fee - call it account supervision fee - applicable to all new account holders?

We will discover the outcome of this matter unless, of course, a confidential, out-of-court settlement is reached, the penalties paid out to Ross' investors, subject to their signing a confidentiality agreement requiring full repayment should any investor breach that agreement to remain silent.

Of course with such a settlement no liability would be conceded by the bank.

We would not want, after all, to set a precedent and create new law, would we?

There are many ways of reining in the Australian banks and forcing them to appoint appropriate directors, rather than politically-savvy hacks.  Politics, after all, is the central skill of most executives in banking.  Careers are built on office politics, sadly.

A court ruling might be a decent tug on those reins.

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

THAT ANZ is accused of such poor supervision is not altogether surprising.

Other large banks offend regularly, the most recent bank to be accused being Deutsche Bank, the German giant which has now retreated from New Zealand, after ending a presence through its link with the Tauranga-based sharebroking, funds management business, Craig & Co.

Deutsche Bank is accused of allowing German Ponzi schemes to blossom, failing to observe the most obvious discrepancies.

Of course, Deutsche Bank has the undesirable sobriquet of being Europe's most delinquent bank, having paid billions in fines, some resulting from its involvement in allowing the likes of Putin and other Russian billionaires to smuggle their ill-gotten money out of Russia and into equally complicit American and British banks.

Deutsche Bank is Europe's equivalent of Goldman Sachs.

The highest profile misdeeds of American and British banks have centred on the revolting bonuses stolen from shareholders, the most obnoxious example being Merrill Lynch's misuse of government subsidies around the 2008 global crisis, when the US taxpayer poured tens of billions into a banking salvage operation.

Literally billions of this troubled asset relief programme were purloined by bank executives, billions in bonuses given to the same incompetent and greedy idiots who over a decade had caused the banks to falter, with their no-documentation, liar loans, their absurd speculation in foreign exchange, derivatives and commodity trading, and their personal greed.

I guess one day we should move on from these memories but even when that day arrives, we should still refuse to pay homage to those ex-banking millionaires who were the beneficiaries of the bonuses from that era.

They were not then, and are not now, self-made millionaires, basking in the rewards of their admirable achievements.

They are simply people who escaped banking before the balloon went up.

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Johnny Lee writes:

Z ENERGY has provided an update to market in the form of its Investor Day, giving current and prospective shareholders a glimpse into the vision and long-term plan for the company by the current management team.

Z Energy – once something of a staple of income portfolios held by retail investors – has been on a consistent downtrend over the last few years, driven by technological and societal change, an extremely competitive environment and of course the dramatic impact of Covid-induced lockdowns.

The update addressed many of these points and serves as essential reading for Z Energy shareholders.

The first and most obvious message conveyed is that, while Z Energy is aware of the headwinds facing its long-term future, it sees ''more risk to shareholder value by rushing in (to change), so we will retain optionality''.  Effectively, it sees an industry with many moving parts and rapidly evolving market forces, that would heighten the risk of an early bet on a particular horse.

The risks associated with technological change are obvious.  Z Energy's primary business is the distribution of petrol and diesel to motor vehicles.  Electric vehicles, while a tiny part of our current fleet, are unlikely to be anything but an accelerating force.  With global vehicle manufacturers ramping up their commitments around electric vehicles, it is only a matter of time before this flows through to New Zealand.

As the Climate Change Commission's report noted, our vehicle market is heavily reliant on Japanese imports, in part due to our minority position as users of right-hand drive cars.  Accordingly, our progress will be entwined with the government policies and consumer choices of the Japanese, which adds an additional degree of difficulty with forecasting.  Broadly speaking, the expectation is that electric vehicles will overtake traditional internal combustion engines in the mid-2030s.

One point made by Z Energy specifically regarding this was the likely distribution of such uptake, and indeed what an average petrol user will look like at this time.  Motor vehicle owners who live in central cities, drive infrequently and fill their tanks even more infrequently, are not generally sought-after customers.  These vehicle users are perhaps more likely to be at the forefront of electric vehicle adoption, as concerns around battery life and range anxiety are less relevant to the car owner who drives from Taranaki Street to Lyall Bay one day a week.

Conversely, the customer who drives fifty kilometres to work from Paraparaumu to Wellington - via Transmission Gully of course – will face a different set of needs.  The trucking industry, bus services, Uber drivers and airlines are all facing changes on this front, and Z Energy is actively analysing its response and trying to position itself as having the flexibility to address this new consumer.

Electric vehicle adoption is not necessarily a death knell for Z Energy.  The company instead highlights the opportunities that exist in this space – in terms of participating in the ''High Speed Charging'' space in strategic locations that users will occupy.  Geographic location may also become paramount in capturing the demand of the remaining internal combustion users, if their vehicle use is to be relegated to long-distance travel.

Z Energy also gave a formal forecast around jet fuel demand, predicting it will not fully recover until 2025.  At this point, it almost seems pointless to try to accurately forecast such a recovery.  With the globe now in the grip of a Covix resurgence, driven by the Delta variant, investors need to accept that such forecasts are going to vary wildly from company to company.

Alternative fuels including biofuel and hydrogen were also discussed.  The impact of biofuels is likely to be limited to partnerships with local producers, while hydrogen is being examined through the lens of servicing the heavily vehicle transport market.  Z is exploring what this market may look like, and whether it would consider a role in hydrogen production.  It sees itself as ''well placed to offer hydrogen refuelling'' should the trucking industry move in that direction.  The company also believes hydrogen may have a role in decarbonising the aviation and shipping industries.  Readers may recall Contact Energy and Meridian Energy's recent comments regarding hydrogen production in the South Island, as the two electricity generators sought to stimulate discussion around such an idea.

In terms of capital management, Z Energy made it clear that the company wanted to de-leverage (repay debt) and focus on producing a sustainable - in the short-term at least - dividend of no less than 19 cents per share.  That dividend does come with the increasingly common caveat ''under all plausible circumstances'', a reminder of the dark days of the national lockdown which saw Z Energy crumble in value.  Nevertheless, a 19 cent dividend will entice more than a few investors, although the rise of ESG funds globally will naturally make the share trade on higher multiples than it otherwise would.

This fall in value, and the absence of a recovery, has led some to label Z Energy as a potential acquisition target, highlighted by the sudden rationalisation within the oil and gas industry.  Time will tell if there is any truth to such commentary, but in the meantime shareholders can enjoy their 19 cent dividend, as the company aims to position itself to face the challenges ahead.


Johnny will be in Tauranga on 26 August.

David will be in New Plymouth on Thursday 19 August.

Kevin will be in Timaru on 5-6 August and Christchurch on 11 August.

Michael will be in Auckland on 18 August then Hamilton and Tauranga in September.

Chris will visit Christchurch on August 17 (afternoon) and 18 (morning) and begin again to earn his keep! Clients wishing to review their portfolios are welcome to contact him now, as he is unable to extend his stay to accommodate late requests. He will undergo his second operation on 8 September and thus will not be returning to Christchurch until October.

On Wednesday 25 August he will be in Auckland, able to meet by arrangement in Ellerslie and Albany. To date, he has six available times in Ellerslie, beginning at 10am (Ellerslie International Hotel).

If you would like to make an appointment, please contact our office.

Chris Lee & Partners Ltd

Taking Stock 22 July 2021

THE myriad of reforms and changes that Ardern, Robertson, and Parker have been preparing have to date met little resistance from the productive sector, though the farmer discontent might be a signal that moods are changing.

But an even more effective hurdle for one of their changes may come from just a tiny handful of private sector interests.

One of the policies of the Labour government has been to bring about, immediately, new practices in public and private sector governance and leadership.  It wants diversity ahead of any other factors.

My own preference is to elect directors and executives through a thorough, open-minded process that vigorously disrespects the Old Boy Network BUT selects on merit, prioritising knowledge, experience and high personal standards. I am not the boss, however.

Public entities must introduce effective policies ensuring that governors and executives are selected to ensure equality in issues like gender, race, creed, and other differences.

A Crown entity governed or managed by a group that is predominantly white, male, and able-bodied, is now compelled to replace retiring white males with women.

The policy has already been introduced.  Diversity is now a formal priority. People new to authority and responsibility are being bulldozed into new roles.

There is no sign that the result has seen tectonic changes in outcome.  At least in the public sector, the governance and leadership seem no worse than before.

In the private sector, there is growing pressure for the likes of listed companies to introduce gender equality, first disclosing numbers, then setting about achieving the government's quota preference.

Here is where the problems will surface.

Directors and executives of all companies, but most dramatically public listed companies with thousands of shareholders, now face an era of intense scrutiny and potential litigation for errors, or for achieving outcomes that dissatisfy shareholders.

The courts have accepted that class actions, including those funded by litigation funders, may be filed for any potential breach of duty by an officer or director of the company.

Talk to Shipley about Mainzeal, or the Crown about the Ministry for Primary Industries, and you will hear how costly stupid errors or omissions can be in the new era.

Directors seek to offset their liability by buying insurance that covers the cost of litigation and/or settlements, up to a stated amount, often a few million dollars per director.

In Shipley's case, it is at least possible that she and her hapless directors will be personally liable for close to $100 million of losses, run up after the date when the company should have been closed down, thus stopping the increase in creditors who would never be repaid. Their insurance was limited to around $20 million. Ouch.

To cover some of their liability the directors have always bought Directors and Officers Insurance, the premiums until recently being perhaps $50,000 per person, per million, per year, but much more, or not even available, for directors with little knowledge and experience, or worse, a track record of being a poor performer.

Premiums were paid for by the shareholders, effectively accepting that a director was entitled to be covered for his errors, at the expense of those who suffer when errors occur.

The new emphasis on imposing quotas on both the public and private sector faces a problem that may defeat Ardern and Robertson's diversity plan.

Insurers, in recent years facing ever bigger, and far more frequent claims, will be doing just what a car insurer does to a young or unproven driver.

Premiums will rise by double, triple or even ten times, to reflect the new risks from an era of litigiousness.  Policies will be written only when the insurer can assess the skills of the people directing or managing the company.

Those who are new to the role, perhaps pushed up the ladder by the quota concept, by definition will not have evidence of experience, even if they have evidence of knowledge for the new role.

Of course, some will meet the insurer's criteria.

My guess is that others will not, and will be insurable only at much greater cost, if at all.

The public sector might just pay – it would after all be using other people's money – but it is virtually certain the private sector shareholders would baulk, even at the risk of defying the new policy.

Would that mean any new bunch of directors/managers would not be covered by insurance?

Would those newcomers want a role that is fraught with risk if they could not be insured?  Would they simply decline the new role? I am sure I would decline the role.

Would Shipley have taken on her role had she known she might be bankrupted by a failure, perhaps caused simply by her inexperience and lack of business nous?

This quota system needs to contemplate these issues.

Perhaps the quota dictate should simply be delayed for the private sector, which should instead be given a long lead time to develop courses and programmes aimed at creating a pool of diverse people large enough to make the policy credible.  Such a programme would take a decade to bear fruit.

Perhaps the small number of insurers that offer this type of cover will thwart the implementation of the new government policy by simply having a differential pricing system that makes the policy unaffordable.

 _ _ _ _ _ _ _ _ _ _ _ _

WHEN the British ex-Macquarie staffer Andrew Barnes linked up with the Canterbury entrepreneur George Kerr to build a trust company with scale, the market spoke with its pocket.

The loans to facilitate this concept were extremely expensive.  Mezzanine rates are cruel.  Mainstream lenders were not pricing this idea favourably.

Then the market declined to buy the group Barnes created by acquiring Perpetual Trust from Kerr, NZ Guardian Trust from its weak owners, and Covenant Trust from its even weaker owners.

One absurd offer from two Australian lads to buy the new group fell over, probably costing them their deposit, and the sober investment banks declined to list Barnes' group at the sort of future profit ratio that the British fellow aspired to achieve.

Eventually Ross George's Direct Capital acquired an option to buy half the company, the conditions of the option naturally favouring Direct Capital, as it was Direct Capital money that was being used to pay down expensive debt.

A further complication arose when Kerr sued Barnes claiming that there was an agreement that Barnes would pay PGC an extra $20 million, if the new group that Barnes and Kerr had planned could be profitably sold (or listed).

Barnes countersued.

The spectacle resembled jelly wrestling in a back street bar by two people short of supportive barrackers.

I doubt that Ross George enjoyed the years of watching this spectacle unfold but his private equity fund may finally be rewarded for its tolerance and patience.

Guardian Trust and Covenant have been bought this month by an Asian company and will be separated from Perpetual, whose future seems to rely on the media support for Barnes and his recent New Zealand wife, Charlotte Lockhart, who aim to monetise their advocacy for four-day working weeks, a concept that is decades old and has been practised by many, including my firm, for more than 10 years.

Whether Covenant's former senior executive Stewart Lockhart is also involved in this four-day week story is not known by me.

The media's acceptance of Barnes seems to imply that he has a real skill in talking to journalists.

One piece of good news is that Barnes has agreed to pay Kerr's PGC around $13 million to end the agreement they made years ago. Jelly wrestling is an ugly spectacle.

PGC desperately needs the money, its progress in recent years being hindered by illiquid, distressed assets.

I guess one outcome from all this rather untidy behaviour is that PGC, armed with $13 million, might find a way to list its shares in a liquid market, enabling its trapped shareholders to escape.

Since PGC abandoned its NZX listing, those who neglected to escape from Kerr's unknown plans have received no dividends and in effect have been unable to find buyers for their shares. Kerr, not known for any focus on small shareholders, might change his reputation if he used the money from Barnes to develop liquidity for PGC stock.

Barnes, Lockhart and Perpetual, meanwhile, might still be looking for a trade sale or for an investment bank that would sponsor a listing of Perpetual, a company that I would regard as a poor performer, trapped in a sunset industry.

Perpetual itself has never, to my knowledge, been admired for its work.

Indeed, in this era, anyone allowing any trust company to manage their financial affairs has not performed due diligence, in my opinion.

Perpetual, as was the case with the Yellow Pages, is likely to be observing the setting of the sun, in an era when value for money and the exclusion of unjustifiable cost should be the focus of all investors, institutional and retail.

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Johnny Lee writes:

THE undisputed success of the recent capital raisings in market, from Radius Health Care and Eroad, should give some confidence to companies waiting in the wings in the lead-up to August's reporting season.

There remains an abundance of capital ''searching for a home'' and willing to take risk.  Anecdotally, little of this seems to be from profit taking, suggesting recent bond repayments and term deposit maturities have migrated to an excess of cash, still available for investment.

The retail issue for Eroad, which opened this week and closes on 3 August, will likely be similarly swamped by demand if pricing holds.  The jump in share price immediately following the announcement suggests the market is enthusiastic towards the Coretex transaction. The price offered of $5.58 is well below current market pricing.  Investors rarely forego opportunities to invest in shares with a known discount.

The true test for the market will be the well-signalled capital raising by Air New Zealand.  Air New Zealand has publicly stated that the capital raising will occur before the end of September.  The company also reports its full-year loss in August, which it believes ''will not exceed $450 million''.

Air New Zealand remains in the portfolios of many retail investors around the country.  Some may be unwilling to crystalise losses, while others may firmly believe airlines will recover and prosper in the fullness of time.  The Government has thrown its support behind the company, although one imagines that with escalating public pressure around healthcare and housing, the Government might be keen to ensure a strategy is in place to limit its exposure.

Dividend-seeking investors will not be the target of such a capital raising.  It would seem counterintuitive to announce a loss of half a billion dollars and raise hundreds of millions of dollars from existing shareholders, while simultaneously touting an expectation to begin paying out large dividends in the near future, or even the distant future.

Instead, short-term investors seeking a trading profit, and those willing to endure short-term volatility in the hopes of long-term returns, will be the most likely candidates to offer support.

Such short-term volatility remains highly probable.  While countless surveys suggest that people are keen to re-engage with the tourism sector, the repeated issues across maintaining a travel gateway just with Australia suggest that the road to recovery for Air New Zealand will be a lengthy one. There are also growing numbers who regard recreational air travel as anti-social.

The long lead-in time will have settled the share register, and no remaining shareholder should be surprised by an announcement of a substantial loss and a discounted capital raising next month.

This month's much smaller capital raisings with Eroad and Radius have shown there is both ample capital sitting on the side-lines, and an appetite for risk.

The challenge will be to convince investors that the company has a future worth investing in.

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

LAST week's data, showing an unexpectedly large rise in inflation, has caused economists and financial journalists to review their predictions on the trajectory of interest rates.

Economists are now keenly anticipating next month's decision from the Reserve Bank, currently scheduled to be made on 18 August.

The data prompted some to suggest the Reserve Bank must begin aggressively raising rates, no doubt to the delight of savers around the country who have endured record low interest rates in recent years.  The current annualised rate of inflation of 3.3% is today marginally above the target band of 1% to 3%, after several years of ''looking through'' rates below the target range.

In terms of the data, the areas seeing the largest price increases were somewhat predictable – new housing, petrol, second-hand vehicles, and international transport.  Curiously, women's footwear also stood out as a sector seeing large price increases.

Issues surrounding our export and import supply chain are well known and were expected to have a distortionary impact on pricing for the quarter.  The oil price, which has soared this year after the drop-off experienced during the Covid lockdowns, fell 10% this week as OPEC production begins to respond to demand, though the daily variations showed no convincing signal in either direction.

The Reserve Bank must now consider whether inflation is on a pathway to low-level, sustainable price increases within its target band, or whether inflation is on a track that needs to be reined in.

These same conversations are occurring globally, as central banks try to gauge the amount of stimulus required to ensure inflation goals are met.  In the US, expectations remain that the quarterly spike is a result of factors unique to the pandemic, are therefore temporary, and will moderate.

New Zealand financial markets anticipate interest rate rises by the end of the year. Disagreements only relate to the scale and timing of the rises. Home loan rates and term deposit rates have begun to climb in the lead-up to the August announcement.

The time to lock in mortgage rates may well have been yesterday.

While there are no calls for a return to the lofty rates of yesteryear, it appears that the era of falling interest rates has ended – or at least been placed on hold.

_ _ _ _ _ _ _ _ _ _


Edward will be in Auckland CBD tomorrow, Friday 23 July, and has a few spots left.

Johnny will be in Tauranga on 26 August.

David will be in New Plymouth on Thursday 19 August.

Kevin will be in Timaru on 5-6 August and Christchurch on 11 August.

Michael plans to be in Auckland during August then Hamilton and Tauranga in September.

Chris will visit Christchurch on August 17 (afternoon) and 18 (morning) and begin again to earn his keep! Clients wishing to review their portfolios are welcome to contact him now, as he is unable to extend his stay to accommodate late requests. He will undergo his second operation on 8 September and thus will not be returning to Christchurch until October.

On Wednesday 25 August he will be in Auckland, able to meet by arrangement in Albany (morning) and Ellerslie (afternoon).

If you would like to make an appointment, please contact our office.

Chris Lee & Partners Ltd

Taking Stock 15 July 2021

EVEN the least cynical of investors know there are at least two ugly risks to consider when trusting the capital markets with their savings.

Perhaps the biggest risk is that politicians, regulators, or Mother Nature will introduce unexpected new rules, leading to unpredictable changes in financial markets.

That, of course, has happened. The Covid19 virus has led to a political foot race, as fervid as anyone will see at the Olympics in Tokyo, with the participants chasing more years of power by printing tens of trillions of free money. Unimaginable asset price increases resulted from this. Who knows where China will fit into the next financial chapters?

A second undeniable risk to investing comes from the people at the centre of financial markets.

That population has never succeeded in banishing the element that lives by the creed that if they can steal legally, or cheat without getting caught, they will. No one has displayed the strength to apply zealously the fit and proper person constraint.

For all the focus on excellence and value-add of the best participants in capital markets, there is a countering weight of cheats, at the tail end of the markets.

Consider this:

There were perhaps two groups of people in New Zealand who were surprised last week when US regulators announced they were charging the bankrupt faux ''rich lister'' Eric Watson with insider trading.

The US regulators allege Watson tipped off a broking mate that Watson would be announcing that an American company he part controlled would participate in the soaring crypto currency market, in 2017.

The price of that company's shares, naively driven by those who do not know Watson, soared, and Watson's mate allegedly pocketed a six-figure overnight gain from his insider trading crime.

The two groups of New Zealanders who might have been surprised by Watson's alleged behaviour were an ancient Inca tribe, who some believe exist on the Auckland Islands in the Southern Ocean, and a loin-cloth-wearing quartet of hunters in Fiordland, who claim to live amongst a pod of moa.

Everyone else, with the possible exception of the New Zealand Herald, recognise Watson as a long-term pretender, one whose formative years with the NZX-listed McCollam Print led to settlements of insider trading claims, one whose purchase of Elders Rural Finance led to disastrous losses from the company he renamed Hanover Group.

They will recall how Watson used the ''sick puppy'' syndrome, installing some key people whose personal frailties made them compliant with the appalling practices of Hanover, accepting money as a pay off for dreadfully mis-represented selling claims..

They may recall the view of a British judge, who described Watson's evidence under oath as ''virtually worthless'', and they will recall the jailing of Watson in London for lying about his assets, and hiding some of the assets from creditors.

They might even recall his treatment of his ''business partner'' Owen Glenn, and his indebtedness to our Inland Revenue Department. Angry victims might want to blame their losses on those who presented Watson as a ''rich lister'' whose views were worthy of presenting to the public.

The New Zealand Herald would plead guilty to this, perhaps in the hope of sympathy when sentenced for any grief it caused its readers.

Possibly to settle an irritating potential defamation claim, the NZ Herald just a few years ago spent a whole year with fawning coverage of Watson, photographing him at his social appearances, granting him a column, and treating him as though he were anything but the fake that the public would have seen.

Sadly, capital markets, even in New Zealand, have dozens of such fakes.

When there is too much money sloshing around, and when the opportunity to help oneself appears to be free of a fear of being caught, the weak, the greedy, the people who are not ''fit and proper'' cannot find the moral compass to lead them to long-term success, which some would say is measured by respect, by value-add, and by social contribution, rather than by the guileless whose obsequious attitudes allow fakes to gain credibility.

From such empty vessels, ''rich lists'' are born, and myths are perpetuated.

I recall in the 1990s how one such sick puppy indulged in ''front running'' in a major institution, leading to his dismissal.

Of course the market participants all knew about this but the weak institution did not publish the misdeed, so the miscreant was able to resume a career in a market that should have labelled him as unsuited to handling other people's money.

The ''sick puppy'' syndrome works, because greedy business owners often want sick puppies, knowing they will pledge undying loyalty to kind people who rescue them.

Right now, the world is discovering sick puppies everywhere. Here in NZ, so-called managers of other people's money have been jailed in Dunedin, in Christchurch, and of course not long ago, in Wellington.

Last month the Financial Markets Authority displayed testosterone by removing from a Dunedin property fund manager its right to manage other people's money.

The High Courts have spoken bravely and sternly about another group whose standards I view as being greedy and self-focused, the insolvency practitioners.

Judges have asked some interesting questions about costs and the delays in ending insolvency issues. There are many ways to take more than your fair share.

These examples in NZ are risibly insignificant on a global scale.

In Canada, a great country with many values aligned with New Zealand, a large Canadian manager of other people's money (US$19 billion) has been charged with front running (illegally trading his own shares before his company made price-changing transactions).

His alleged offences these days carry a maximum of 20 years in prison. It is a pity that was not the case in the 1990s.

In a country where one is all but incarcerated for sneezing in church, Singapore's regulator alleges that a fund manager has this year purloined $200 million from those who entrusted him to manage their money.

Allegedly he employed a butler and a chauffeur with the money that ''trickled down'' to his personal accounts. How sick is that?

Some of the blame for the corrupt mindset that is now being exposed is allegedly the result of Covid.

Car thefts in the USA rose by 25% during the past 15 months. Petrol, food, alcohol, and construction goods all were stolen at record levels.

Last year the US Securities and Exchange Commission had double the number of tip-offs, data ransoms have doubled, and delivery packages were stolen in record numbers.

The worst states for those rising crimes, as you would expect, were those in the big cities, not the food-processing states in the Mid-West.

One area of concern to many investors in New Zealand has been the extreme wealth now being collected, usually legally, by the funds management sector, where value-add has no relationship to the incomes captured by the fund managers.

The biggest game in town today is to launch a fund and anchor it with a contract that grossly over-rewards the manager, not recognising that the growth of the fund does not cause matching rises in costs. This game started in the 1980s but is now rampant. It should have been stopped then.

Worse, there are many funds that claim ''bonuses'' based on spurious benchmarks, some, absurdly, wanting rewards for equity (risk) investments based on cash (little risk) benchmarks.

Imagine a fund that puts half its clients' money in cash and the other half in equities, but claimed a bonus based on ''out-performing'' the cash returns, not the returns of both cash and equities.

Many undistinguished people are involved in the funds management sector.

Those who sit on top of funds that simply double intermediate - that is collect client money and hand it to another index fund manager - are leg-pulling if their fees are not fixed, and at a very low quantum.

Nor is there anywhere near enough effort made by most fund managers to ensure every client understands all the risks taken, and all the factors that determine the quantum of fees and bonuses claimed.

One very good recent suggestion has come from Janine Starks, a Christchurch based columnist for Stuff, a woman who at some stage has worked for a fund manager, and unlike so many, does not peddle platitudes in a Dorothy Dixie manner.

Starks is easily the best of the daily newspaper columnists, perhaps it being no coincidence that she actually has capital market experience. She would be an asset to either of the two market regulators.

Starks suggested every fund manager should be forced to display a dashboard covering comparable issues.

For example, it would disclose the levels of asset types used and define those carefully, so rather than just discuss the benchmark for equities (say 40-60%) it would also disclose that, say, 90% of the equity portfolio had to be in the largest 20 stocks of an index. More aggressive funds might be disclosing that only 10% of their NZ equities were top twenty stocks.

The dashboard would also disclose fees, and bonuses (which should not exist in my view), and should demonstrate a sliding scale, so that fees fall from, say, 0.5% when an account is less than $100,000 to, say, 0.1% when that account exceeds $200,000.

Starks' suggestions mirror the disclosure chart I sought to be displayed when the hapless Securities Commission was mis-managing finance companies in the early 2000s. The Securities Commission inexplicably did not seem to have sufficient competent people to understand the problem.

A dashboard approach would make it easy for investors to make true comparisons, and to make sensible choices, after assessing comparable information.

This might challenge the absurd, such as the index funds which should charge almost nothing at all, if they double intermediate. It is equally absurd that the executives and owners of fund managers are not forced to publish their salaries, their bonuses, and their share of dividend pools.

In the 1980s it was the property companies, the valuers, and the banks that grossly mis-managed their affairs, leading to ridiculous incomes for those far more lauded by the media than by their investor victims. Anyone reading the prospectuses and annual reports of that era would have choked, had they known then what we know now.

Yet in that era virtually no finance company failed to repay every one of its debenture investors. Even the rotten Equiticorp company eventually repaid its debenture investors.

By the 1990s we had entered the Somers-Edgar, Moses, Syms era of ''financial planners'', where the investors were again victims of awful incompetence, the regulators failing in their duty to protect investors from crass over selling, stupid practices and dreadful disclosure.

In the 2000s the hungriest entrepreneurs, people like Petricevic, Reeves, Butler, Podmore, Fitzgerald, Finnigan, Watson, Hotchin and Tallentire presided over Bridgecorp, Lombard, Dominion, St Laurence, Strategic, Hanover, and Capital Merchant Finance, producing losses that totalled billions. Few were ever accountable for those losses.

Today there are some excellent people in funds management. Typically they have had careers in research and analysis, adopt long-term strategies, and are careful with other people's money.

The likes of Harbour Asset Management, Milford, Devon, Mint, Salt, and Aspiring are held in respect by many in the markets.

But there are many others who milk investors and extract fees at a rate unrelated to their value-add. They pay themselves millions.

For decades the insurance mutuals had virtually stolen value, producing the most dreadful returns for their investors, camouflaged by tax anomalies. They ''sold'' tax breaks, not value-add.

Today the camouflage is obfuscation, not tax breaks.

Starks' dashboard suggestion is one the FMA would do well to consider.

Disclosure is one thing. Visibility is another.

Useful information is another.

Investors, in a world awash with money, and infested by crooked people who somehow have escaped the ''fit and proper person'' examination, deserve and need much better disclosure than is currently offered.

 _ _ _ _ _ _ _ _ _ _ _ _

Johnny Lee writes:

LAST week's capital raise, conducted by sharemarket newcomer Radius Residential Care, closed hours after soliciting bids, finishing well oversubscribed at a price of 52 cents, barely a sixpence higher than the agreed price floor.

The company listed in December last year at a price of 80 cents, before swiftly doubling in price, then returning to earth shortly afterwards to settle around a dollar per share. The company did not raise capital when it listed at 80 cents – meaning the price was somewhat arbitrary and not determined by market forces.

This style of listing is usually used by firms that do not yet require additional capital, but wish to offer transparent liquidity for existing shareholders, and allow companies to grow their shareholder register to facilitate a future capital raising. The capital raise at 52 cents is the first for Radius since listing.

The price of the capital raising represented a significant discount and was almost certainly the main driver for most of the demand. The lengthy settlement period for the placement shares prevented any immediate profit taking from new shareholders, but there is no doubt many participants in the offer anticipating short-term gains. Ultimately, Radius is unlikely to be particularly bothered by this profit-taking, as sellers will, logically, require a buyer with perhaps a different mindset.

For long-term investors attracted to the broader macroeconomic appeals of the retirement village operator sector, Radius is unlikely to top the list of potential investments at this stage of its maturity as a listed company. Ryman and Summerset have produced a business model that has a long history of revenue and profit growth, have both acquired a significant landbank and are well on their way in the pursuit of further growth.

Radius has a different model, focusing on Aged Care as opposed to a focus on selling and reselling occupation rights within villages. As such, almost all of the company's revenue is derived from its Aged Care facilities, meaning a large proportion of its revenue is funded by the government of the day. A majority of Radius's assets are leased - not owned - although this is likely to change as the company continues to grow.

The likes of Ryman and Summerset have a distinct advantage over their smaller competitors, having both amassed enormous tracts of land around Australasia to satisfy their large waitlists. Location is a definitive competitive advantage in this sector, and large scale allows Ryman and Summerset to take longer-term positions, using cashflow from existing assets to fund further growth.

For Radius, the company now welcomes hundreds of new shareholders to its register at a deeply discounted price. Some will likely take any available gain upon settlement later this month. Longer-term shareholders will be prepared for further capital raisings in the future, as the company takes its first step towards growth since listing.

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

Immediately following the conclusion of the Radius placement, Eroad announced its own placement, raising $64 million across both its Australian and New Zealand shareholders to purchase telematics firm Coretex. Demand for stock in the placement easily exceeded the amount being sought.

A subsequent retail placement will be offered next week to ensure smaller shareholders are able to maintain some degree of proportionality – although the small amount of stock available in that offer will almost certainly doom it to harsh levels of scaling.

This method of capital raising is in contrast to a pro rata rights issue – where all existing shareholders are given the right to maintain exactly the same proportion of their holding, while applying for more should some shareholders elect not to participate.

Eroad listed in Australia late last year, seeking to diversify its shareholder base and access the deeper pools of liquidity offered on the ASX. The offer is underwritten by its Australian Lead Manager, Canaccord, perhaps suggesting the company is seeking to expand these ties.

The price listed for the placement - NZ$5.58 - was reached for the first time in April of this year and this capital raising certainly seeks to capture recent share price strength in both Eroad and the market at large.

The acquisition has been labelled by Eroad as ''transformational'', and opens a number of doors for the company. Coretex specialises in new areas for Eroad – waste and recycling management, construction, and food and beverage transportation. Coretex's technology uses data to analyse performance of a vehicle fleet, to improve efficiency and provide information to the fleet owner. The company uses an example of recycling trucks analysing customers recycling habits to optimise routes, while allowing residential customers to monitor the truck and be notified before it arrives.

The acquisition price – about $200 million if incentive targets are met – is hefty for a company with a market cap of $500 million. The size should give some context around the relevance of the purchase. It marks a significant move for the company, and expands its product offering and allows Eroad to target large-scale customers by operating a broader suite of products. Coretex will remain a large (14%) shareholder of Eroad, and Coretex's CEO will join the board of Eroad. The company estimates that the acquisition will advance its growth plans by two years.

A transaction of this size does carry risk - particularly surrounding pricing, and integrating such a large existing company into an existing culture - but shareholders will have a chance to vote on 30 July at the Special Shareholders Meeting.

Existing shareholders will receive further details of the retail component of the capital raise in due course. 

_ _ _ _ _ _ _ _ _ _


Edward will be in Auckland on 21 July (North Shore), 22 July (Remuera) & 23 July (CBD).

Johnny will be in Christchurch on 22 July and in Tauranga on 26 August.

Kevin will be in Timaru on 5-6 August and Christchurch in mid-August, dates still to be confirmed.

If you would like to make an appointment, please contact our office.

Chris Lee & Partners Ltd

Taking Stock 8 July 2021

WHEN TV1 last week led its evening news programme with an aggressive item, alleging multiple work safety infringements within the Talijancich empire (Talleys), there were three astonishing aspects to these allegations.

TV1 alleged that over a few years, there were more than 100 work and safety incidents at Talleys investigated by WorkSafe, and it quoted anonymous Talley staff members, from an Ashburton plant, and displayed photographs, revealing hygiene and safety issues.

The single most astonishing aspect of this was that a poorly-resourced media channel, with precious few staff with any commercial experience, would take the chance of running such an investigation fraught, as the investigation was, with the possibility of litigation.

None of the NZ media has any appetite, or any meaningful budget, for litigation so even the most error-filled letters from feeble, ambulance-chasing, nouveau lawyers, with often empty threats of defamation, bring terror into media executive and board meetings.

That a young reporter was empowered to tackle a prickly empire like Talleys was most unexpected.

Talleys of course, is not a publicly-listed company, has no involvement in public debt markets, is funded by banks and the family, and owes the public no disclosure of its affairs.  It has not been, and never will be, tempted to share its ownership with the public.

The second most astonishing aspect of TV1's investigation into Talleys was that it centred on a food processing plant, easily the least sensitive aspect of Talley's empire.

The Talijancich family founded Talleys on the fishing industry, basing itself in Motueka, where its fishing fleet is harboured, and where it processes the fish for which it has quota.

Fishing is one of the most brutal industries in the world.

Perhaps not in New Zealand but in most countries, it attracts hard men, it accepts high risk, and it greatly rewards those who borrow to buy the vessels, borrow to buy the processing plants, borrow to acquire the rights to fish for some of the prized varieties, tolerate the risks, and take on the responsibility of employing people who work in high-risk zones.

Those at sea face the risks of the ocean, the risks of operating gear that takes no prisoners if mis-used or used in dangerous seas, and the owners accept the risks of employing people whose long days at sea do not provide ideal safe lifestyles.

In countries like Italy, Greece, Croatia, Ukraine, Turkey, and many others on the coasts of Africa and South America, fishing is dominated by hard men.

I saw a little of this myself several decades ago, when my company had lent money to entrepreneurs seeking to process scallops and export the delicacy.

To attract supply from those who trawled, the new company had to provide baskets for the fishermen to store the shellfish; it had to incentivise the trawler operators; it had to build to high specifications a processing plant.

It was elbowing its way into the sector.

Obviously some did not welcome the newcomers.

The baskets at the wharf were stolen or incinerated.

The trawler operators who accepted the incentives were physically attacked, on the wharf and in public bars.

The processing plant caught fire one night, though arson was never investigated.

The newcomers were deterred. Nobody will ever know who chased them away.

Fishing is a tough industry. One might accept it has a high ranking as a work and safety threat.

Even those wielding the sharp knives in fish processing plants are exposed to serious injury.

They should be, and probably are, well paid if they are skilled processors.

Had TV1 reported that there had been safety issues in the fishing operations of Talleys, every investor in that sector would have understood.

Food processing (peas, corn, beans etc) is also an industry that involves danger, but most would regard this sector as much more anodyne.

Talleys other food sector is the meat industry. It bought AFFCO, which processes meat.

This activity also involves knives, sharp machinery, heavy carcasses, though the platform on which workers operate does not swing violently when oceans are disturbed.

The meat industry has had a long history of worker discontent, going back to the union-dominated days in the 1950s, 60s, and 70s, when the workers were so well paid for the risks involved that they could accept the no-work, no-pay outcomes of stupid strikes, often on days when a rugby match was involved, or a local horse race was running.

So meat processing and the fishing industry have much more inherent danger than pea processing.

Of Talley's three activities, few would have anticipated that the food plant in Ashburton would be the hottest area of discontent, on which a television investigation might focus.

The late Sir James Wattie, founder of the food processor Watties, would rightly be affronted had his business been fingered as a threat to the safety of his people.

The third surprise was that Pete Talijancich himself would be a fellow whose business attracted criticism.

For heaven's sake, he is Sir Peter Talley, knighted for his contributions to his workforce and to the sectors in which his empire operates.

You do not get knighted for paying off the debts of political parties, or lending your personal aircraft to politicians, or buying enthusiastically at private political events which are trying to sell donated prizes to raise money for party coffers.

You get knighted for outstanding leadership in areas that make New Zealand a better place, either with charitable work (those wonderful volunteers), with intellectual excellence (those who solve health issues), or with brilliant, employment-creating activities (like designing radio communications).

Perhaps you are knighted for some sporting achievement, or making good films, or singing heartily or beautifully. (Dame Lorde, do I hear?)

That TV1 found the will to focus on such a dangerous subject is amazing. To pick on a food processing plant seems strange, and to pick on a knight seems completely out of sync with the honours system.

We will surely hear more about the outcome of this journalistic inquiry.

One hopes from all of this, good will arise.

 _ _ _ _ _ _ _ _ _ _ _ _

WHETHER Talleys will use the media discussion to audit, and if necessary correct, its own processes is somewhat irrelevant to the main lesson from TV1's unusual energy for investigative journalism.

The real value of its work was that it highlighted the potential of a real ''fourth estate''. Such energy has been missing for decades, a victim of falling media revenue, leading to a level of fear (of litigation costs) roughly equivalent to a child's fear of what monsters lie under the bed when thunder and lightning strike.

The truth is that defamation cases cost BOTH the litigant and the defendant a large sum of money, irrespective of who ''wins'' and is usually a stupid solution for conflict.

Nearly always at fault is the law firm that, for reasons of its own greed, provides dreadful advice to the offended party, exploiting the opportunity to milk the bruised ego of some company or person with an ample purse.

Nearly all of those who are offended could find a sensible solution without wasting the court's time, and filling the pockets of a grouping of lawyers whose value-add is next to nothing. A leading QC summarised this succinctly, noting that every lawyer is bound to give the client the best and most appropriate, neutral advice.

In virtually every case a correction, a clarification, perhaps even a polite apology, is the most cost-effective solution to a conflict.

How well I recall the dozens, maybe scores, of unintelligent, incorrect and often pitifully misleading letters I have received over the years, usually from bottom feeding barristers, many of whom acted as though they were under internal pressure to increase the billing hours they submitted to the law firm's partners, and figured the legal letterhead gave them some sort of credibility to bluster and spray bulldust.

One greenhorn, not long out of law school, wrote me a pathetic letter, telling me, inter alia, that truth would not be a defence in the litigation she was concocting with her magic potions. She had not listened very well and clearly miscalculated her credibility.

Heaven knows how careless was her client in allowing her to run up bills to pay for her concocted accusations, which had no show of achieving the claimed objective.

Another sad case, reacting to my perhaps belligerent response, told me he was ''simply doing as his client instructed'', an admission I took to mean, ''he gave me a chance to run up an unnecessary bill, rather than simply tell him he had no case''.

Yet the truth is that deep-pocketed media, like TV1, are soft touches for aggressive lawyers, and are right to take the view that fending off even the silliest of writs is expensive, and adds nothing to the value of its services, unless it forces the litigious party to scuttle off and never to revert to such wastage.

We need the media to challenge every aspect of society.

We need it to hold business to account, to force better audits of work safety procedures, to scrutinise the way people handle other people's money and to examine conflicts of interest, fake advertising etc.

We need the fourth estate to examine the motives and behaviour of politicians, the competence of public service governors and executives, the treatment of children, the wisdom of those who set our education and health standards, and the decision-making processes of our councils.

Yet many in management roles mis-allocate resources, over-rewarding the egomaniacs who present talkback shows, with all their irrelevant personal opinions and ignorance on display, while it underpays, and thus rarely attracts, experienced, mature, wise people with the patience, knowledge, and thoroughness to address real issues.

Who will forget TV1's incineration of $5 million when an underpowered newsreader resigned after a few days and was awarded the huge sum, rather than being shown the door?

The rare exceptions are diamonds.

This week one highly relevant (to investors) subject was tackled by an old-timer, winner of awards in business journalism, who has resisted the lazy option taken by so many of her Auckland peers, who ''interview their typewriter'' and produce occasional columns, written as though their views are the ''news'' on subjects like politics and trade, rather than interview those who have the relevant knowledge.

The diligent, mature journalist was Jenny Ruth, who examined the very real issue of how those in charge of index funds choose to use their irrelevant, sometimes goofy, views to vote the shares, owned by others, trapped in an index fund.

One could argue that index funds are simply a software creation, requiring management by modestly-paid administrators whose personal views on companies are as irrelevant as their views on All Blacks selections. For heaven's sake, these people are just salesmen or administrators, not analysts or researchers.

Yet in some cases these people are using the power of the shares in their index fund to peddle their irrelevant opinions to directors and shareholders of companies in which the index has invested.

Ruth did us a favour by raising this issue, publishing her article on Business Desk's newsfeed.

Who are these people voting with our shares, what merit do they have, why are they paid seven-figure salaries to perform a task that has no requirement of commercial acumen, and thus rarely, if ever, attracts those with research, analytical skills, or useful knowledge?

The subject leads to deeper questions, which I shall discuss next week.

The questions follow the reality that when deeply-rich, green grass thrives in the paddock next door, lesser neighbours will want their sheep to graze on those paddocks.

Funds management is now arguably the most over-paid of all sectors.  Within the sector are some excellent people, whose skills are research and analysis, both requiring experience, knowledge and intellect.

Also within the sectors are charlatans.

In recent times in Christchurch, Dunedin, and Wellington, we have observed their white collar crime but in the past week this disease has also surfaced in Singapore, Canada and in other reputable jurisdictions.

Next week I will suggest ways investors can differentiate between those who do, and do not, provide value for the multi-millions they extract from their clients.

 _ _ _ _ _ _ _ _ _ _ _ _

Johnny Lee writes:

THE surge in ''M&A'' activity – Mergers and Acquisitions – continued last week, as asset values soar and the cost of money remains close to historically low levels.

The announcement last week of a takeover bid for Sydney Airport is the latest such move and one of the largest deals in this space to have entered the market in recent times.  A consortium of Australian superannuation funds made the $22 billion bid for Australia's largest airport, viewing the asset as grossly undervalued relative to its long-term value.  The share price of SYD rose sharply in response, and fuelled speculation that competing bids would soon follow.

The dramatic reaction to its share price should give confidence to those investors who are wary of asymmetrical information within the sharemarket.  Clearly, there was little to no leaking of information prior to the announcement, judging by the share price move.

Auckland International Airport enjoyed a temporary and much smaller increase in value on the coat-tails of the announcement.  It marked a rare instance of good news for AIA shareholders, who have seen their investment, logically, decline in the face of Covid restrictions.

Large-scale investors are continuing to pursue these distressed or undervalued assets, and appear to have confidence in the sector at large.

Indeed, investing in airports at present requires both a specific investment strategy and high levels of confidence in that market.  Virtually no one would believe that our airports will not play a major part of our future economic prosperity – but certainty remains low in this sector, as the global population refreshes its knowledge of the Greek alphabet amid the global outbreak of the new Lambda strain of the Coronavirus.

Auckland Airport’s most recent update to market re-iterated its expectations for the year – a loss of $35 million to $55 million – and noted the strong correlation, observed globally, between vaccination rates and local demand for air travel.

Retail investors, seeking profits and dividends from companies with predictable cashflows, have largely turned away from the likes of Auckland Airport.  Pension funds, usually made up of investors with very long investment horizons and with lesser need for regular dividends or distributions, are in many ways uniquely placed to take such long-term positions on infrastructural assets.  The price tag of such an asset limits its liquidity, and Government controls around ownership can also be an impediment to any eventual sale.

Long-term shareholders of Auckland Airport will recall the efforts of a Canadian pension fund, which unsuccessfully pursued a takeover for the company in 2008.  The bid was rejected on the grounds of national strategic importance – with the Government of the day effectively deciding that the airport must remain as a listed share, where it had a smaller degree of foreign ownership.

Sydney Airport is subject to similar rules, limiting potential bidders by forcing local bidders to retain majority ownership.

This argument of strategic importance sparked furious debate at the time and is indeed a curious one to make after being sold into public ownership a decade prior.  Auckland Airport remains a publicly listed company, with a shareholder base ranging from Kiwisaver funds to global ETFs.  It continues to be driven towards long-term profit, and until recently was paying dividends to investors across the globe, as it navigates changing regulations and rapidly evolving economic conditions.

Regardless, the takeover – at a price less than half of its price today – never transpired.  One can only theorise whether the bid to privatise the airport would have been successful had it come from a New Zealand company with exactly the same strategic objectives.

Wellington Airport, of course, is majority owned by Infratil (itself publicly listed) with the balance owned by Wellington City Council.  Wellington Airport's ownership structure will carry both advantages and disadvantages, as its shareholders manage the sometimes competing objectives of an infrastructure investment company and elected politicians on a three-year election cycle.

Christchurch Airport, by contrast, is 75% owned by the Christchurch City Council, with the Government holding the remaining 25%.

Auckland Airport's fate is now entwined with the rollout of an effective and accepted vaccine, perhaps one requiring annual booster shots.  New Zealanders' willingness and indeed desire to utilise air travel does not appear to have waned, but ultimately global intentions surrounding air travel will prove more relevant to Auckland Airport's fortunes.

With a share price significantly lower than its 2019 value, as it wades through the most turbulent conditions it has ever experienced, Auckland Airport investors can feel buoyed by this $22 billion dollar investment into the aviation sector.

_ _ __ _ _ _ _ _ _ _ _


Edward will be in Auckland on 21 July (North Shore), 22 July (Remuera) & 23 July (CBD).

Johnny will be in Christchurch on 22 July and in Tauranga on 26 August.

Kevin will be in Timaru and Christchurch in August, dates to be announced.

If you would like to make an appointment, please contact our office.

Chris Lee & Partners Ltd

Taking Stock 1 July 2021

THERE were several reasons why Westpac would never have been sold but the most obvious reason was that it makes wonderful returns for risk, for its Australian owners.

Despite largely shoddy management, and almost a contemptuous attitude towards New Zealand, it has around 20% of the NZ banking market and, inexplicably, has often been our government's bank of first choice.

At a high level within its own bank it has been seen in New Zealand as the victim of an arrogant attitude by Australian executives, who were often said to regard NZ as East-Tasmania, meaning a tiny and irrelevant outpost requiring secondary or even tertiary consideration.

Westpac's outlier status changed when one of its former executives, Adrian Orr, became the governor of our central bank, the Reserve Bank, which sets and monitors the rules for Westpac.  Orr had been an executive there at a time when the Australian banks were being pressured.

As part of a Minister-appointed team of senior officials, Orr visited the Australian banks with the full knowledge of which closed Westpac cupboards contained the bones.

He has been relentless in challenging arrogance, heavily penalising Westpac for exploiting its right to calculate its capital obligations, quite rightly fingering John Key and the ANZ for its Teflon-like responses when the ANZ was guilty of American-like behaviour towards disclosure.

Indeed many would argue that the ANZ's selection of Key, a foreign exchange trader, as ANZ New Zealand's chairman, was a direct affront to the new mindset required of bankers, a requirement that has a focus on commercial detail rather than on corporate politics.

Westpac's origins were in the Bank of New South Wales.

It changed its name to Westpac Trust after it succeeded in buying the various Trust Bank local branches about 25 years ago.  Trust Bank had community-owned regional banks throughout NZ. Soon afterwards it dropped the ''Trust'' word, no longer relevant to its image.

Westpac's first visible arrogance had been in the 1990s when, under weak NZ leadership, it had promoted a retirement fund, using projections based on one unrepeatably successful year.

Westpac's front desk and pamphlet marketing was egregious, encouraging novices to believe that the future returns could continue to reflect one stellar year.

To be fair, AMP, National Mutual, Tower, and other poorly-led organisations played the same short term game.

Westpac eventually capitulated, and repaid investors, accepting that its behaviour had been crass.

Today, there are many reasons why its recent ''review'' was simply a pointless pop gun fight with the Reserve Bank, futile in that the Reserve Bank, had it chosen, could have produced from its arsenal some thunderous AK47s.

As Johnny Lee wrote in Taking Stock months ago, NZ had no capacity to pay the $15 billion price tag that a trade sale would have required, nor was Westpac likely to accept a discounted price.

Recall that in the past decade New Zealand struggled to find roughly two billion to buy half of Meridian Energy.  In fairness, demand had been slashed by a goofy politician (David Parker) who with all the authority of a lance corporal had threatened to declare war on the electricity market.

Nor was demand unaffected by an irrelevant and poorly-informed newspaper columnist who declared he would advise his clients not to buy Meridian, a declaration that threw a surprising amount of cold water on unadvised, or poorly advised, investors.

A $15 billion sale would be a sum far too large for our funds management sector even allowing for the power of the ACC and the NZ Super Fund which stumped up the money to buy half of Kiwibank.

No bank would want to have a share register lacking the sort of aligned shareholders that might understand banking governance.

Had Westpac sought to release its NZ operation gradually, it might have retained, say, a 51% shareholding.  But that would not have released it from the role of perceived guarantor of good behaviour.

In effect the major shareholder would be taking on all the responsibility for half the profits.

So the obvious outcomes of this sham review were the ''discoveries'' that:

- Westpac (Australia) makes fabulous returns for risk, not seriously threatened by tougher Reserve Bank supervision.

- NZ could not easily produce a credible major owner to develop Westpac under a new brand.

- NZ fund managers would not be suitable owners other than as minor (less than 5%) shareholders.

- A $15 billion float (7.5% of the NZX) would be indigestible.

- A sale of half of Westpac would leave moral hazard as a risk if the Westpac name remained, just as the Crown retains moral obligations to fund Mercury, Genesis, Meridian, Kiwibank, and the doomed-to-mediocrity Air New Zealand.

The best decision Westpac could make today is to find someone the equivalent of the late Sir John Anderson, authorising the new leader to switch from a culture of arrogance to a culture of partnership, with the country and the clients.

 _ _ _ _ _ _ _ _ _ _ _ _

WHEN Fonterra listed two companies some nine years ago, its plan was to convert it cooperative model into one company whose shares were owned by dairy farmers, and one company into which the public could invest.

The goal was to have access to capital markets, debt and equity, enabling Fonterra to proceed without the risk of being over dependent on the banks.

The share prices rose to a high point some 20% beyond listing, debt was raised, the Australian banks lost some of their power, and Fonterra was comforted by the knowledge that at some sort of price it could always raise capital.

The problem it has faced is that this capital structure always relied on its suppliers (dairy farmers) being satisfied by two conflicting income streams.

As suppliers were forced to own shares, in a one-for-one ratio with supplied kilograms of milk solids, the dairy farmers needed to be happy with Fonterra's share price and dividend flow.

But those same farmers wanted to receive the maximum value for their milk.

The more one pays for milk, the less is available for dividends, and the lower the dividends, the lower the share price.

One could easily argue that the listing structure was doomed to be a problem.

The hoped-for solution was governance and executive excellence at adding value to the milk, and excellence in investing.

As we all now know Fonterra had many years of inept governance, poor-performing grossly overpaid management, and, sad to say, dreadful investment decisions.

The old Fonterra headquarters had a car park in Auckland where the parks around the front door were exclusively for the executive and directors.  Visitors were directed some distance away.

This demarcation seemed to reflect a mindset.

Today Fonterra has a much sharper chairman, with what seems like a sane focus on fixing up errors of the past.  He has some excellent minds around him in the boardroom, and the CEO is no longer gluttonously overpaid and no longer expects serfs to carry him in his gold chariot when he needs to use the bathroom.

Fonterra is fighting to retain the loyalty of around 80% of the country's dairy farmers.  Synlait, A2 Milk and other unlisted milk processors battle to increase the roughly 20% share they currently achieve.

The new Fonterra initiative begins with examining the capital structure, modelling Fonterra's ability to attract farmers, pay for milk, and access debt markets comfortably.

The sharemarket has been spooked by the fear that the cooperative might find a model that precludes outside capital, reduces dividends, focuses on the milk price, and thus ends the attraction for outside investors.

The Fonterra price for those non-dairy farmer investors has separated from the price of ''wet'' shares.  Both share types have lost significant value.

Dairy farmers who use the value of their ''wet'' shares to support their bank debt are hurting, some farmers so fearful that they have imaginatively conjured up a mysterious belief that the directors have manipulated the share price and somehow are accountable for the fall in share price.

Some, presumably highly leveraged, dairy farmers are chatting about a class action, suing the directors for what I would have thought was their primary job – finding a sustainable strategy to ensure survival and revival of value.

Cooperative models can work well.

Listing the shares of cooperatives is a complex task.

Favouring one group (the milk suppliers) over other groups (outside investors, lenders) suggests traversing a tortuous path.

Having some stressed (over leveraged?) people finding lawyers who will run the gauntlet of an improbable class action, attracts media attention, at a time when the directors are unlikely to need such distractions, least of all sensationalised and ill-advised threats of litigation.

Many might hope that New Zealand's biggest export product will find a way of rewarding the producers and encouraging outsiders to provide the capital to add value to the base product, thus gaining rewards by sharing in the value-add margin.

Such optimistic people would hope that Fonterra can attract the right people to oversee the dairy farming sector, and the right people to invest and to oversee the development and marketing of dairy based products.

What is clear is that the previous Fonterra directors and many of their executive (but not all) were not equipped to separate these functions and were essentially hopeless at performing due diligence before investing other people's money.

A similar fate will meet investors should NZ Rugby ever be foolish enough to confuse its objective – protecting all of its players and securing a viable future for the sport – with the unnecessary task of feeding dividends to shareholders, and investment banking fees to uninsightful and opportunistic intermediaries.

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Johnny Lee writes:

THE relatively stable performance of global markets over the past month may have fooled some into thinking that markets have ''settled'' or that risks have diminished as the world's vaccine rollout continues.

Instead, the market appears to be waiting for a clear lead as uncertainty soars and competing concerns pull sentiment in different directions.

The New Zealand market, when compared to its peers, appears to have underperformed this year. However, investors will recall the bizarre actions of a handful of US fund managers at the end of 2020, which sent our electricity stocks soaring on the back of ''Clean Energy'' investors overzealously valuing our hydropower assets.  Our electricity stocks make up a sizeable proportion of our index, meaning that our sharemarket began the year at a very high benchmark.

The recent concerns surrounding a global outbreak of the ''Delta variant'' have highlighted the very real risks that remains for investors around the globe on the healthcare front.  Locally, the narrow escape from an infected Australian in Wellington also illustrates just how precarious our situation is and will again raise questions around the cost of shutdowns when weighed against the benefits of open travel.  These resurging risks have had a range of impacts around the globe.

The price spike in Fisher & Paykel Healthcare which occurred over the past fortnight reiterated the company's value in a share portfolio as a defensive stock in regards to this specific risk. 

The soaring value of US technology companies has also been notable.  Facebook has joined the ''trillion dollar club'' alongside Apple, Alphabet (Google) Amazon and Microsoft, as investors flock to these ultra cash-rich companies as they continue to grow by acquisition.  Growing concerns surrounding their immense market power do not appear to be dampening the enthusiasm from investors.

The ASX-listed exchange traded fund ''FANG'' has followed this upwards track.  FANG owns ten global technology companies – including the likes of Apple and Amazon.  FANG recently declared an intention to pay a large dividend to investors, locking in some of the gains experienced over the past year.

Conversely, Air New Zealand's declining share price shows the risks associated with these efforts to ''return to normal''.  Shutting down businesses appears to be much easier than re-opening them, as staffing emerges as the biggest challenge facing these businesses.  Many staff ''put on ice'' during the Covid lockdowns appear to have moved on to other roles, exacerbated by a growing tide of workers crossing the Tasman Sea in response to better opportunities.  A possible capital raising by Air New Zealand is also weighing on investors' minds.  Buyers purchasing shares today do so knowing that a large-scale scrip issuance, at a rate likely to be discounted, is imminent.

Analysing the risks surrounding investments has been particularly challenging in recent times, as many risks emerge that are simply unpredictable or unknowable.

Regulatory risk is an ever-present risk, as politicians seek to gain favour among the electorate.  Shareholders of Z Energy, by way of example, are familiar with the triennial accusations of uncompetitive conduct which inevitably fizzle into nothingness after the political impact is achieved.  The banking sector is another particularly predisposed to this risk.

Interest rate risk is generally well understood by retail investors.  Holders of bonds and other fixed interest securities know that rising interest rates will inevitably diminish the value of long-dated bonds.  Expectations around interest rates have a broad range at the moment, with some economists predicting rising inflation to force the Reserve Bank's hand with regard to lifting interest rates, while others expect the Reserve Bank to be as measured and patient on the upside as it was when interest rates were falling.

An illustration of this risk would be the Auckland City Council 30-year bonds sold to investors last September.  The bonds were issued in response to investor demand for very long-dated securities from an issuer with a strong credit rating.  The bonds now trade at a steep discount – not due to any sudden concerns around the credit-worthiness of the council, but due to the risk of rising interest rates deeming a 2.95% coupon as an unacceptably low return for such a tenor.

Diversification remains the best tool against the unknown risks of tomorrow.  Diversification includes both diversification across asset classes – shares, bonds, cash - and geography.  The current suite of Exchange Traded Funds offered on the NZX give investors much greater access to global markets than yesteryear.

The rapid decline which occurred last March, at the height of the Covid-induced volatility, will have (and should have) caused investors to re-evaluate their tolerance for volatility.  Many of these risks have begun to subside – but risks remain and new risks will emerge, while investors must ensure that asset allocations remain within bounds acceptable to their tolerance for risk.

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Edward will be in Wellington on Tuesday, July 6 and in Nelson on July 8 and July 9.

Edward will also be in Auckland on 21 July (North Shore), 22 July (Remuera) & 23 July (CBD).

Johnny will be in Christchurch on 22 July and in Tauranga in August.

If you would like to make an appointment, please contact our office.


Chris Lee & Partners Ltd


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