Chris Lee & Partners Ltd

Taking Stock 25 July 2024

IT MAY be the tight mesh of the safety nets created by regulators, or it may be the global desire to pretend that excellence is not a desirable goal.

Whatever the reason, two of the most obvious changes to have occurred in my 50-year career in financial markets have been the encouragement to invest in index funds, and the recent trend to direct money into private equity funds, rather than into banks or listed securities.

The deluge of money into index funds probably is linked to the general willingness to accept an average outcome, and the desire of financial intermediaries to be free of regulatory scrutiny.

If funds base selections on research, and seek to differentiate the excellent from the mundane, the market gets real price discovery.

The active manager sets what he believes is the right price for the prospects of the companies he chooses.

If all transactions come from index funds, then prices would be set solely by the volume of money, reflecting supply and demand. Momentum would create prices, no matter how nonsensically.

The index fund manager pursuing a bit of everything will never be prosecuted for missing good signals, nor blamed for missing poor signals. He will own Infratil. He will own Air New Zealand.

The world's investors have increasingly voted to accept the “average” rather than trust research to uncover the potentially excellent and eliminate the weak. The regulators like this.

The move to private equity seems at odds with the logic of the trend to use index funds.

Private equity is virtually unregulated and has minimal transparency, minimal accountability, yet it now attracts trillions of investor dollars. (I cannot be specific as estimates vary between 3 trillion and 13 trillion, too wide a gap to offer useful guidance.)

The private equity funds do not offer to “mark to market” as there is often no market available, upon which to “mark”.

These funds do not offer liquidity. The funds will sell their holdings when they choose.

These funds engage with their chosen valuers.

Is it unfair to query the process of choosing the most careful valuers, the most optimistic, and even to wonder whether valuer fees are linked to their willingness to accommodate the opinions of the private equity managers?

The one certainty is that private equity managers are growing at breathtaking speed, gradually funded by pension funds and other fund managers wanting to step aside from “mark to market” disciplines.

By definition, private equity funds can take long-term investment horizons, higher returns eventually resulting from long terms.

And, by definition, private equity funds can take the higher risk strategy of buying illiquid assets at times when the assets might be out of favour.

The American private equity bid for the care provider Arvida, announced last week, is an example of how long-term investors with no defined horizon to achieve a result can buy assets they perceive have more value than that ascribed by those suffering from short-termism, such as most of our Kiwisaver providers.

The Americans clearly see replacement value and future cash returns as being far more valuable than most of our investment managers recognise.

Private equity is just as adventurous when it enters the money lending game, often funding leveraged buyouts, or second tier corporates.

Often private equities offer “light” covenants, seeking higher margins as an offset for the high risk of weak covenants.

If there is to be a day of reckoning for this adventurous approach, that day has not yet dawned.

Acting logically, the mainstream banks often are happy to lend to private equity funds, taking a prior security, meaning all pension fund money put into the private equity fund is subordinated behind the banks, effectively capital.

Are the returns for the investors sufficient to offset their “equity” risk? Hmm. We will see.

The takeover of Arvida is clearly a recognition that if you accept long-term success, you must put aside short-term objectives, like dividends and liquidity.

The asset backing of Arvida was about double the price of its shares, few NZ fund managers wanting to be patient (Harbour Asset Management and Milford the obvious exceptions).

Recall that just a few years ago the Swedish bought Metlifecare from the NZ shareholders, also taking a long-term view, knowing its Swedish funders would be patient.

The late Brian Gaynor often warned that the short termism of NZ fund managers threatened investors, leading to impatient sales at ugly discounts to perceived long-term value.

There seems little symmetry between the flood of money going into index funds, where the investment horizon is set daily, quarterly results the first measurement of success; and the flood into private equity, where lack of transparency, lack of regulatory support and a focus on very long-term results is the objective.

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THE population of Malta, around 550,000 not including tourists, is similar to the Greater Wellington area.

Malta has two excellent daily newspapers, costing 1.3 euro, or say NZ $2.50.

The Times of Malta is printed in English and in Maltese, typically it comprises 24 pages of which six are dedicated to the national news, six to world news, two to chatter (letters to the editor etc.), four to business news, four to sport, and two to a range of puzzles.

The national news is relevant, indeed riveting.

 For example, the paper at which I am looking as I prepare this item has a half-page article on the changing levels of Maltese students’ success in O level maths and English.

It highlights that 20% of students fail in these subjects. More than 40% of students received A levels, while 14% failed to pass.

Of those who sat advanced maths 20% failed to pass.

I record all of this to highlight the relevant detail of a subject that would greatly interest parents, grandparents and, of course, students in any country which places emphasis on education. This information is what I want to read in newspapers.

Maltese absenteeism is low, though during Covid that became a concern.

The paper's coverage of global events is excellent. Those who enjoy reading entertainment pieces about “celebrity” media people, or about broken marriages and the subsequent miseries of punctured tyres, sick pets and unpleasant neighbours would find the Maltese papers rather plain.

Such magazine content is absent from the papers I read each day while in Malta. I do not miss such dross.

Does the fact that two papers can succeed with a modest circulation and very little advertising indicate that content matters?

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AN array of summarised items I found interesting follows: -

- Britain proposes to place VAT (tax) on private school fees.

- It proposes to increase its windfall tax on North Sea oil producers from 35% to 38%, meaning total tax on North Sea profits will be 75%. Producers observe that capital for exploration has ceased. The North Sea produces 50% of Britain’s oil and gas and employs 200,000 people.

- In 2013 one in 90 British 18-year-olds vaped. Today the figure is one in four.

- Moodys (credit rating agency) has placed 21 US regional banks on review for a credit downgrade because those banks have commercial real estate lending volumes greater than twice their capital.

- Europe's Stoxx 600 share index is at an all-time high, with the expectation of earnings increases. Conversely the economic outlook is said to be deteriorating. Disconnection?

- Labour Government in the UK plans to build 1.5 million new homes in five years. Britain has 43,000 bricklayers. Three quarters of them are at or near retirement age. Britain will train 33,000 new bricklayers to enable it to build 1.5 million new homes.

- Britain limits welfare to families by stopping extra payments after funding two children. Voters support this two-child cap by a margin of 2:1.

- Bankrupt UK council Croydon is to implement a new tax on companies that provide more than 11 car parks for those of its workers who drive to work. The tax will be paid by the workers. Four other councils propose to follow this lead.

- When the recent internet outage occurred, the cause of the error, CrowdStrike, saw its market capitalisation fall from NZ$130 billion to $110 million in one day.

- Necessity leads to invention. Massive new 100-metre-high wind turbines are much more efficient, and have a lesser carbon footprint in their manufacture, than two 50-metre high turbines. But transporting such monstrous machines is a problem. They are too big for bridges, tunnels, and most roads. 

So an American company is building a massive cargo plane to transport the turbines to their destination. The plane will be around 110 metres long and will be able to land on, and take off from, dirt tracks. The first plane will be in service in 2030.

- For the first time ever VW will close a European car manufacturing plant rather than reduce shifts, or reduce margins to compete with Chinese imports. Europe responds by discussing tariffs. Internal combustion engines and hybrids have reversed their market share losses in recent months. 

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New Investment Opportunity

BNZ - Perpetual Preference Shares

Bank of New Zealand (BNZ) has announced that it is considering making an offer of perpetual preference shares (PPS).

The PPS are expected to constitute Additional Tier 1 Capital for BNZ’s regulatory capital requirements and to have a credit rating of BBB.

This investment is perpetual, with an optional (and in our opinion likely) redemption date in six years’ time.

The initial six-year distribution rate has not been announced, but based on comparable market rates, we are expecting a rate of around 7.00% per annum.

BNZ will be paying the transaction costs on this offer; accordingly, clients will not have to pay brokerage.

More details are expected on 5 August.

BNZ is one of the top four banks in New Zealand and a subsidiary of National Australia Bank. It has a strong credit rating of AA-.

If you would like to be pencilled in on our list, pending further details, please contact us promptly with an amount and the CSN you wish to use.

Indications of interest will not constitute an obligation or commitment of any kind to acquire this investment.

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Travel

26 July – Timaru – Fraser Hunter

25 July – Auckland (Ellerslie) – Edward Lee

26 July – Auckland (Albany) – Edward Lee

1 August – Wellington – Edward Lee

21 August – Christchurch – Johnny Lee

Please contact us if you would like to make an appointment to see any of our advisers.

Chris Lee and Partners Limited

Taking Stock 18 July 2024

IF those who preside over New Zealand’s economic and social problems believe that our country is facing unique problems they should get on their skates and come to Malta. Our problems are far from unique.

At a dinner I attended this week in Malta I listened to local leaders dissecting Malta’s problems and discussing the solutions.

For context, Malta is a former British colony, has fewer than 600,000 people, yet is growing its population well beyond the capacity of its infrastructure. It has a surging number of immigrants and an alarming shortage of labour in necessary sectors.

Its people do not like the consequential stress. Does this sound familiar?

Property prices have risen sharply, with new developments fed by low debt costs and unshakeable confidence in the sustainability of growing living standards. Its outstanding health sector is under pressure, resulting in the privatisation of emergency services.

Its long-term Labour government is alleged to have allowed a new era of “hidden commissions” and is scrutinised by a grumpy opposition and media.

The population numbers are telling.

In line with trends in other wealthy countries, Malta’s reproduction rates have collapsed to barely one child per woman after decades when that number well exceeded three.

People live longer. The population grows as the younger generations move into well-paid jobs in vibrant sectors like technology, abandoning their previous roles in health, aged care and, most of all, tourism.

Malta’s generous social services, its peerless weather, its low levels of crime and the ease of getting paid work lures large numbers from countries including Albania, Romania, Italy, India, Nepal and Egypt.

The Maltese, boosted by an excellent education system (with no problems of non-attendance), line up careers in software, engineering, medicine and in the professional sectors, in which the demand leads to relatively high salaries.

As a strategy, Malta has enticed major global professional companies to shift specialist tasks to the sunny islands. One imagines the lifestyle in Malta is somewhat more agreeable than almost anywhere, certainly anywhere I have visited often.

A leader in the software sector told me at dinner that salaries in software development have doubled in the past two years. He now recruits in Egypt, where skilled people are available at much less than half price.

Malta’s population is ageing. Carers are in great shortage. Care is provided by both the private and public sector.

We visited a relative in a care facility. To be polite, the facility and its range of activities for its residents would rank as a two out of 10, if any Ryman facility was ranked a 10.

Yet the weekly fee was similar.

One would be displaying nastiness if one expressed the hope that the haughty bureaucrats in NZ who criticise our care standards should one day be sentenced to a year of living in care facilities in Malta. Yet it would be a fitting punishment for the amount of unadulterated rubbish such people spout, never having taken the risk of working in the private sector, let alone creating a service.

Unsurprisingly the carers in Malta are mostly immigrants.

The population growth is challenging. The forecasts are that Malta will grow by another 30% in the next five years, having had an estimated 40% increase in the past decade.

Remember Malta comprises 300sq kilometres, almost exactly the size of the exploration licence owned by Santana Minerals in Bendigo, Central Otago. Malta’s infrastructure is stretched.

In the month of July this year the incoming number of tourists will be close to one million, meaning a country that just a few years ago accommodated 500,000 tourists will have its infrastructure in July tested by 1.5 million people.

Imagine how stressed NZ would be if we had equivalent tourist arrivals, more than doubling our population in the summer months.

How would our electricity supply cope? What would be the effect on our sewerage plants, roads, rental car fleet, hotels, airports, inter-island ferries, restaurants and hospitals. Those seem like rhetorical questions.

Malta’s growth has followed a strategy of lifting salaries to retain its highly educated people. The strategy has worked. Wages have trebled in the past decade in many sectors.

Malta has also targeted wealthy Europeans, selling its residency for a million Euros and imposing other conditions, such as building houses and creating employment.

This focus on money has inevitably uncovered weak and greedy people who cheat. Politicians and property market people have been caught cheating, though, ironically, in one political swindle, the country received a great payback. In that case a tiny number of politicians allegedly accepted bribes to switch contracts with its supplier of natural gas, which runs its grid.

Russia had the contract. Azerbaijan secretly negotiated to take the contract off Russia. All sorts of stories emerged, involving brown paper bags and perhaps Panama trusts.

Azerbaijan took over the contact in about 2018.

When Russia attacked Ukraine, the European Union sanctioned all Russian gas.

Had Malta not changed supplier it would have had to play the European game of cheating by re-labelling Russian gas to avoid the sanction. Austria will today still be watching large numbers of gas canisters arriving each day from “Azerbaijan”, though Austria would struggle to keep a straight face if asked to reconcile the quantities received with the export capacity of Azerbaijan.

Malta’s property sector has boomed, bringing with the boom all sorts of rumours about the sales processes, the consenting processes, and strange exemptions.

Yet the result is magnificent. Buildings unfit for purpose, usually through decay, have been bulldozed, replaced by splendid hotels, apartments and snazzy shopping centres. One imagines Malta has no earthquake concerns because buildings seem to be built quickly and to budget.

Most of the construction labour is imported, North Africa a supplier of large numbers, the workers often escaping from genocide or misery, sometimes in tiny boats.

None of this hectic growth seems to alter the languid lifestyle of tourists, for whom the sea and the 4000-year-old history are attractions.

To be fair many of the decisions of recent governments, of both colours, have been pragmatic and successful. For example:

1. Rental property owners have the right to act independently, setting their own rents as they like and creating short-term leases. These landlords pay a hefty capital gains tax.

BUT those who offer 20-year leases and lift rents only by the amount set by the government pay no capital gains tax. The vast majority are in the second group.

2. Students pursuing relevant degrees (medicine, mechanics, engineering, construction, healthcare, technology, software, arts) are paid to attend university in return for a bonded period of work in Malta.

BUT those who pursue degrees in knucklebones will pay their own fees.

3. Pensions are calculated by paying a percentage of the average wages earned in the years leading to retirement. This somewhat removes any incentive to understate income to avoid tax. Those on lower pensions are provided with subsidised rates, electricity and petrol.

4. The government pays the private sector for emergency hospital services.

5. Government debt is around 55% of GDP, a much lower percentage than is common anywhere, let alone in the EU where large countries have twice as much debt, relatively. As a habit Maltese people are not big users of debt, credit cards or Pay As You Go. They are pretty canny about finding lower prices.

So Malta is in a period of transition.

It has been in the EU for 20 years and is a vastly different country from that which I first visited in 1976 when it had just become a republic, was run by Dom Mintoff, and was arranging long-term oil discounts with Libya, the discounts offset by a promise not to drill for oil in the elephant oilfield that reached from Libya’s waters into Malta’s.

In 1976 wages were pitifully low, the Catholic Church dominated life and the relics of British Trade Union practices prevailed. Facilities for tourists then were modest.

The country today is based on the excellent fundamentals of its British coloniser but has none of the “entitlement” culture that so undermines Britain. Malta retains ample energy and ambition, fuelled by its aspirational younger people.

New Zealand would be wise to send its public sector leaders to Malta to discover how to design and execute progressively higher standards.

Visiting New Zealanders might also get a heads-up on the risks of rapid change, coupled with pursuit of wealth, colliding with what some weak people will exploit, unfettered appetite for hidden “intermediation” fees, handed over in brown paper bags.

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ONE mistake Malta has not made has been to grow Crown agencies from which airheads can pontificate pompously on the lives of others.

There will be no agency in Malta telling retired people how they should or should not spend their own money.

I suspect Malta has culled from its 150 years of British colonisation a great deal of what have become contrivances to centralise power.

That is another lesson we might take from the sunny islands.

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ONE British experiment neither Malta nor New Zealand would wish to follow would be the privatisation of water.

The UK is now going through a farcical phase, watching its privatised water suppliers fail many of their obligations, with some, notably Thames Water, on the edge of bankruptcy.

Thames Water was unwisely sold to Macquarie decades ago, Macquarie being the Aussie equivalent of the unlovable US investment bank Goldman Sachs. The Aussies simply stripped Thames Water, extracting extravagant dividends, failing to maintain the infrastructure and generally adopting a Ned Kelly approach to the guileless Brits.

Thames Water today, privately-owned, has been so regularly fined and so stripped of reserves that it has advised it cannot meet its obligations. The UK water regulator, which failed to do its job, allows Thames Water to price its water to obtain a return of around 4.5% on the value of its assets.

Thames Water cannot attract debt or equity unless it receives a return of around 5.5%.

If our TAB would offer me 2:1 I would place my bet on Thames Water being returned to public ownership within the next year.

The Crown would then spend hundreds of millions performing the maintenance that its private owners had neglected to undertake, preferring to allocate the depreciation account to dividends.

Why do the names of Tranz Rail and Fay Richwhite come to mind?

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Travel

Our advisors will be in the following locations on the dates below.  Please contact us if you wish to make an appointment:

19 July – Wairarapa – Fraser Hunter

24 July – Christchurch – Fraser Hunter

25 July – Ashburton (AM) – Fraser Hunter

25 July – Timaru (PM) – Fraser Hunter

26 July – Timaru – Fraser Hunter

25 July – Auckland (Ellerslie) – Edward Lee

26 July – Auckland (Albany) – Edward Lee

1 August – Wellington – Edward Lee

Chris Lee

Managing Director

Chris Lee & Partners Limited

Taking Stock 11 July 2024

PATIENCE, said a sage a century ago, is nature’s special secret.

Patience, combined with diligence and energy, is what moves a mountain, another said.

New Zealand’s sharpest financial market mind, sharpest and best, believes the hardest discipline to teach directors and shareholders is patience.

My own observation is that short-termism is a modern curse which in financial markets is spread by short-term incentive plans, quarterly goal setting, a largely unthinking media, greedy young men, and by nearly all who govern or manage other people’s money.

Maoridom’s elders might observe that pine trees grow fast, and fall over easily, while kauri trees, like rimu, produce wonderful outcomes for the patient.

Lack of patience, fertilised by the relatively new breed of index funds, creates false share prices, up or down every day.

Conversely, farmers generally understand well the concept of patience, though often they have to dance to the beat of impatient, city-based bankers while they seek to build great farms.

One could not avoid reflecting on the value of patience in recent days after attending private briefings with the Ryman financial team.

The issue also arises when one looks at recent announcements by ERoad and Heartland Bank, and even Santana Minerals, all of them companies where medium and long-term plans are underway.

Ryman Healthcare, I recall, reached a nonsensical share price of $16 in very recent years, driven by index funds and those similar investment structures that employ exactly no people with analytical skill or financial market knowledge or relevance, turkeys often kidding the world that they are peacocks.

Ryman’s share price is now nearer $3.50. Both prices were and are absurd.

Would a wise, patient investor have bought when the share price was in the stratosphere, or would he be buying today?

Ryman’s wild price swing was blown up by the index funds but then punctured by a series of errors by its directors and executives, perhaps intoxicated by the thin oxygen levels as their company’s share price left this planet.

Those human errors have had repercussions.

Ryman’s basic model is excellent. Its quality of product is high and in demand. Its clients (residents) have very high levels of satisfaction (though short of the perfect score), and its future looks assured, at least in the world as I understand it today. To replace its various properties would cost billions more than Ryman has spent.

Ryman had built its momentum during a demonstrably unsustainable period of “free” money, resulting in misleading property valuation increases. It generated a mindset that disregarded the financial market songbook that many veterans, including me, have either hummed, whistled or sung, almost to the point of tedium.

The words behind our music are “nett profit after tax (NPAT)” and “cash flow”.

Instead, encouraged by the impatient, Ryman adopted the refrain of “profit after revaluations” and “return on equity”.

A few analysts were smart enough to ignore the modern nonsense and drilled into the numbers to identify sustainable NPAT and cash flow. They were never fooled.

They fretted that the shares were grossly over-valued and sold them to the index funds and to simpletons who lack the skill to assess true value.

Another measurement of concern was the rapid speed of chasing growth funded by free money.

Yet another was the reliance on relatively short-term syndicated bank loans that were always reviewable well before developments produced cash. Ryman did not solve this with long-dated bond issues or cash issues.

Bankers are impatient by nature. Bond investors are not.

Eventually, a most unwise acceptance of conditions from second-tier lenders in America led to Ryman borrowing long-term money (a good idea), that could be recalled at any time, a bad idea. Ryman’s financial measurements deteriorated. 

Inevitably $700 million had to be repaid at an inconvenient time, and with it, additional penalties totalling $132 million, or thereabouts. Even in today’s blasé world, $132m is a huge sum – several years of NPAT, let alone dividends.

Perhaps this penalty triggered the wake-up alarm for Ryman’s governors.

Today the board has been almost fully refreshed with newcomers who can truthfully refer past mistakes to the previous directors.

The management team has been refreshed. The four executives our CEO (Edward Lee) and I met were all relative newcomers, all with relevant experience, the Chief Financial Officer arriving after a stint as CFO with the admirable Fulton Hogan group, which itself has long-term goals.

The new board and management understand that Ryman has a great business model, supplying what the market demands, a high-quality product (close to 5-star living). Generally, the villages are well managed but always staffed by excellent people, the care people, clearly angels.

There is nothing to condemn in this.

But the restoration of Ryman, to regather its industry lead position and excite its investors, requires the new team to address the following issues: -

- Head office costs, where the ratio of head office staff to residents has almost doubled.

- The lack of diversity in its debt providers and the mismatch between its long-term assets and its short-term funding. A continuing bond programme might fix this.

- The mispricing of its development margin (rising costs are an issue), its care cost (unwisely, contracted not to rise), and its deferred management fees (set at a level 33% lower than its competitors). Clearly Ryman needs to reset its deferred fees, collectible on the demise of a resident, and cancel the lifetime commitment never to increase monthly fees, for all residents arriving from today.

- Better reporting standards focussed on NPAT and cashflow, and NOT on theoretical property valuations and on meaningless Return on Equity metrics. Property valuations can be displayed as required but should not be regarded as a key metric, or even as being of much significance.

- Better measurement of individual village financial models ensuring that those new villages being planned will have to produce cash and profit within reasonable time frames.

The good news is that these commitments to new disciplines will not affect existing residents and should lead to better decisions, and a narrowing between Ryman’s share price and its true asset backing, which is a higher figure, by far, than its share price implies.

There will still be variables and problems.

The cost of debt may well be higher for longer, for example.

Another issue to ponder is the reliability on the inferences to take from demographic statistics.

This is not a boring grey area.

Ryman has very long-term plans – multiple decades. It must plan. It must understand incremental change.

Population growth occurs and longevity increases, creating a natural market, drawn from aging people who, like me, own their home, but at some stage, if they live long enough, may need more comforts and care than is available at home.

The conundrum here is to predict the inclinations of tomorrow’s older people, and how changes may occur. How many will want to live in retirement villages?

New Zealand’s Maori, Pasifika and Asian sectors all contribute fully to population growth, their reproduction rates exceeding the national average (1 woman, 1.6 children).

Pakeha rates are well below 1.6. Pakeha will be a decreasing percentage of New Zealand.

Maori, Pasifika and Asians now provide around 40% of our population and soon will be 50%.

The population in 2060 will be very different in make-up and in attitudes towards the care of ageing families. 

The retirement village I chaired for decades had few residents other than Pakeha, because virtually none outside Pakeha wanted to live in the culture created by village living.

So the natural demand for villages may not be quite what the bare demographics imply. Ryman will have to prepare for changing demographics.

There is a further problem.

Increasingly, the large ageing family home is not selling for the premium over smaller homes that might have been expected in the past.

If the gold standard of retirement village dwellings cost ever greater sums to build, but the new resident is receiving less for the home being sold, then there will be issues of affordability, magnified by the growing cost of health providers and care.

If we live longer, and move in with less surplus cash, a problem awaits.

Those living in their own home will increasingly be needing to create pocket money with a reverse mortgage, a product virtually certain to rise in relevance even faster than it is today.

But those moving into retirement villages will own a licence to occupy, not a title of ownership, so the reverse mortgage model must adapt.

How will village dwellers top up, if the model does not change?

My guess is that either the likes of Heartland Bank will adapt its offerings, or else the villages themselves will need to hold the capital that enables the likes of Ryman to lend the money needed for pocket money, charge some sort of interest, and effectively retrieve these loans (and interest), as well as deferred fees, upon the demise of the resident and thus the sale of the dwelling.

Growing longevity might mean that the availability of that loan becomes critical to the decision to buy.

So more capital might be needed; much more.

Ryman, Summerset and Oceania all look like long-term survivors, needing patient bankers and patient shareholders.

Arvida is probably best suited to private ownership.

Radius should definitely be owned privately, its history comparable with privately-owned, third-tier operators. I would contend that it should never have been listed as a public company. I said that loudly when it listed (at 80c). Its price is now 20c.

In my view, the owners of the impressive villages that are NZX-listed (Ryman, Summerset, Oceania) will be rewarded provided they are patient, and provided the companies have skilled governors and executives who focus on sustainable excellence, delivered affordably, generating nett profits after tax, the residents top of mind, as they always should be.

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HEARTLAND, a supplier of reverse mortgages to the retired, is another company which should reward patient investors.

It is now the owner of a bank in New Zealand (soon to be Crown-guaranteed up to $100,000 a person) and a bank in Australia (already guaranteed up to $250,000 a person).

The acquisition of the Australian bank will enable Heartland to grow its impressive Australian reverse mortgage lending book, probably pricing it more sharply, now that it can raise money through its bank at a much lower rate than it was having to pay to attract non-guaranteed depositors.

The repayment of higher-cost funding will occur over the next year or two, and be replaced with lower cost guaranteed deposits, enabling Heartland to grow in volume, and in nett margin.

It is on that logic that Heartland’s directors forecast a doubling of profits after tax, by 2028, leading to higher dividends and, logically, a share price that reflects those higher dividends.

Its current strength and its evolution into an impressive organisation is somewhat of a miracle given the ashes of the 2008 finance company bonfires, to which a very poorly managed Marac had contributed generously. Heartland’s origin was from the marriage of Marac and three smaller lending institutions.

Marac was rescued by a huge recapitalisation in which the mercurial George Kerr and Jarden were key players, followed by nearly 15 years of cautious, careful, occasionally inspired management by Jeff Greenslade and his team. Greenslade had been a well-regarded banker, a disciple of New Zealand’s greatest ever banker, the late Sir John Anderson.

Now 62, Greenslade is to retire within the next year, having overseen the rebuilding to a standard where the Australians eventually allowed Heartland to buy an Australian bank, a proposition that Ockers might have found awkward.

My guess is that the Heartland bank in Australia will become the core of the group.

Greenslade had been materially helped by the late Geoff Ricketts, who chaired the new bank until his recent death, and more recently by Greg Tomlinson, unarguably one of New Zealand’s greatest business leaders.

Tomlinson bought 10% of the bank in 2010 as it was being formed and is now its chairman. He is an astute, patient man with unusually high EQ and IQ.

Investors who are patient can expect Heartland to make incremental progress, measurable by slowly rising NPAT and dividends.

What a wonderful outcome for what was revealed as a dreadfully managed finance company 16 years ago. Patience, you see, does allow recovery.

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AND yet another reward is slowly emerging for the small number of patient investors, which does NOT include very many fund managers, who believed in the ability of ERoad to develop and sell its transport technology here, in Australia, and in the USA.

Less than a year ago ERoad was being ditched by impatient fund managers as it struggled to lift its income from the sales of its technology to a level that met its ambition to grow market share in Australia and the USA. Covid did not help. Fund managers made little attempt to understand ERoad’s ambition.

As an aside, It is hard to understand the value of public utterances of index fund salesmen, when they are approached by lazy reporters for a “rent-a-quote” response to complex business matters such as ERoad faced.

Index funds do not employ knowledgeable analysts or researchers. They simply sell Vanguard or the like, which invest to formulaic software. In some cases the index funds employ cheerful volunteers to perform the administrative roles. Analytical skill is not required.

ERoad had seen its share price hydraulicked by index funds to a high of $6.70 before Covid, and before its product range and sales progress stagnated.

The share price was then slaughtered by largely institutional and index fund selling.

The price slumped below 70 cents. The price today has risen by 80% from that low point. Patient investors have not quit.

I twice visited ERoad’s Albany headquarters, met with the company’s CEO and team, and was carefully shown its plans, its ways of measuring progress, and its very cautious publicly released forecasts.

In recent months its progress and share price recovery seem to have rewarded its cautious optimism.

It has achieved significant new sales numbers in Australia and the USA, developed a wider range of clever products and built on the $180 million of annual contracted income, making it a rare NZ technology company that generates a cash surplus.

If its sales continue to meet the company’s expectations, it would generate real surpluses, and justify its board’s decision to decline an opportunistic takeover offer last year.

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PATIENCE is also rewarding the investors in the Bendigo gold project near Cromwell, the project now owned by the ASX-listed Santana Minerals, which supplied the necessary cash for an expanded drilling programme.

Last week, Santana announced it would seek to dual list on the NZX, acknowledging the NZ ownership (40% of the shares).

In search of detail, sitting in a café out of town, I googled “Santana to seek NZX listing”.

Google supplied several links, the first of which was to a client newsletter I wrote, referring to a dual listing in the future.

Our newsletter was written more than two years ago and discussed the pathway to an NZX-listed future, while explaining the value of the discovery.

Patience has been rewarded. A listing now seems imminent.

Consent needs to be granted. And the gold price needs to be within two thirds of its current level, if the company is to deliver extreme value to its shareholders.

We would then have a major contributor to New Zealand’s prosperity and welfare, and hopefully have a miner that meets most of the hopes of those who prioritise environmental standards.

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Travel

Our advisors will be in the following locations on the dates below.  Please contact us if you wish to make an appointment:

19 July – Wairarapa – Fraser Hunter

24 July – Christchurch – Fraser Hunter

25 July – Ashburton (AM) – Fraser Hunter

25 July – Timaru (PM) – Fraser Hunter

26 July – Timaru – Fraser Hunter

25 July – Auckland (Ellerslie) – Edward Lee

26 July – Auckland (Albany) – Edward Lee

Chris Lee

Chris Lee & Partners Limited

Taking Stock 4 July 2024

AFTER the 2008 collapse of most NZ finance companies and mortgage trusts it was obvious those structures were not fit for purpose.

The public could not trust the financial information provided.

They could not trust directors, auditors, regulators or company owners.

Around 300,000 retail investors lost more than $2 billion, and that was AFTER the governments of the days had used taxpayer funds to underwrite some of the companies.

The model was shattered.

It still is.

Today around 10,000 brave, some would say poorly-advised, investors still trust a small number of finance companies to honour their promises. Some will be reliable, of some I have doubts.

It is true that there have been useful changes in the laws controlling non-bank deposit takers.

Most of the 13 changes I labelled “essential” in my book The Billion Dollar Bonfire have been implemented.

The most important recommendation - that directors and owners fully compensate investors for lies and dishonesty - has been sidestepped. That would have been a highly effective way of lifting behaviour.

I guess that suggestion would have been a hazard for many former politicians and political donors.

Yet today we have finance companies succeeding with a much more credible funding model, not engaging with retail investors.

The credible non-bank lenders either fund from their shareholders, or from their bankers, and have sufficiently bundled up enough credible loans to securitise them; that is on-sell the loans to pension funds and various institutions, as a means of recycling their money to use for more lending. 

The 2008 companies that survived - the likes of Broadlands and Instant Finance - have switched from retail investor funding to bank funding, and even Geneva Finance, which I would have described as an artificial survivor, no longer chases the public.

Geneva, a tiny third-tier lender with around $120 million of loans, has a $100 million facility with Westpac, the bank which, curiously, was the keenest to support the sector, going back well before 2008.

For example, Westpac provided support for Provincial Finance, though it silently withdrew that support in the lead-up to Provincial’s collapse (Provincial was headed by an ex-Westpac commercial lender). Many Westpac managers progressed from manual-driven jobs in Westpac into free-spirited lenders in finance companies.

Geneva is today in the spotlight, having sensibly identified that its status as a tiny NZX-listed company was not justified, its shares rarely sold, and only in small numbers, never to institutions.

It was part owned by Peter Francis, an ex-Chase Corporation founder, Chase having floundered and then foundered after years of quite dreadful governance and management, culminating in its pillaging of the Farmers retail chain. 

In the 1980s, Chase bought Farmers to capture Farmers’ pension fund, then plundered the fund, filling it with useless investments (Chase shares) until the Farmers' staff, whose money was in the pension fund, found they had nothing, pensions destroyed by appalling corporate manipulation.

Geneva fell foul of authorities more than once, having to compensate victims of its lending and insurance sales to what I would politely call the third tier of hire purchase borrowers.

Yet Geneva survived, thanks to a scheme that rescued its shareholders by persuading debenture investors to forgo their prior claims on the loan book, switching to shares in Geneva.

My view, and that of the NZ Shareholders Association, was that the debt investors should have been paid out, the small number of private shareholders encouraged to learn how to whistle.

But to its credit Geneva over many years has reached such stability that it now has a major shareholder (Federal Pacific), making enough profit to reward its shareholders, proudly has a share price of two digits (just) and has Westpac willing to oversee its lending and supply the money Geneva lends.

That formula is far more credible, aligning those who reap the benefits of third-tier lending rates with those who help provide funding, and who are likely to be personally liable to Westpac for the $100m facility.

Westpac should be able to monitor Geneva on an hourly basis, using modern live banking technology.

 So Geneva now wishes to de-list, provide any rare share investor with a trading platform on Unlisted, and rid itself of cumbersome NZX supervision and various other related costs.

Its plan would be better if it simultaneously made an offer to buy out all shareholders who may feel trapped and may feel that they would not be front of mind when Geneva looks to allocate its nett revenue.

The NZSA is no longer particularly acquainted with the finance sector, its chief executive having had a career managing the Boy Scouts, and not visibly familiar with finance companies.

He has condemned the switch to Unlisted, citing doubts about Geneva’s independent governance and about the liquidity available to anxious shareholders.

I am not sure that I can see his point.

Geneva's governance has always been what it is, and there rarely has been even remote interest in the shares, except by those who have the power to execute its policies and divide up the nett revenue.

Geneva last year described its performance as “disappointing” but did pay a one-cent dividend.

I support Geneva’s switch to Unlisted. I support its use of a bank to fund its lending, and I observe, simply, that its governance clearly satisfies its major shareholders.

The finance company structure and management that I absolutely admire is that of Avanti, a privately owned Auckland based second-tier lender, specialising in personal loans, maybe at 19.9999%, and unconventional residential mortgages, at much lower rates.

Like Geneva it also has a subsidiary hawking insurance products.

Like Geneva, it has a history connected somewhat tenuously to Chase Corporation, in that its owner Glenn Hawkins is the son of Equiticorp’s founder Alan Hawkins. Of course, Equiticorp had a central role in the 1980s triumvirate, Chase, Rainbow and Equiticorp, which did many deals with each other, Rainbow the sole survivor, folded into the company most deserving of it, Brierley Investments.

Avanti's founder and chairman, Glenn Hawkins, was a fast learner from his father's ill-fated ambitions, and has built a remarkable empire, without any public funding. He keeps a low profile and has had no interference from regulators.

His company has a portfolio that must now be near to a billion, using bank finance, shareholders’ funds and a highly successful, and totally sane, securitisation programme, bundling up loans and selling them to institutions.

In effect, the securitisation forces Avanti to meet its promised lending standards, high standards of governance, and forces it to manage such crucial matters as its liquidity and its credit control. The buyers of the securitised loans would be (should be) knowledgeable judges of Avanti’s standards. 

Clearly Avanti has rewarded its shareholders over the past three decades, young Hawkins having achieved considerable wealth, affording him the type of toys that so appeal to those with the energy and risk appetite to chase mansions built on golf courses.

I never have wanted to borrow money, and have not done so for 38 years, but if I did decide to borrow money, I can loudly promise I would never be knocking on Avanti’s door.

Yet I admire the model Hawkins has developed, support his reliance on much more discerning sources of funding (bankers), understand any dislike of regulators and often clueless enforcers of rules (like auditors and trustees), and I acknowledge the quality of executives and shareholders (Pencarrow an example – 10%) that he has attracted. Avanti may now be our most valuable non-bank lender.

I have never met Hawkins, who must be in his 50s, but from a distance I acknowledge a finance company model that seems well suited to the market he addresses.

Of course I remain strongly opposed to the old finance company model, overseen by mediocrity, soon to be Crown guaranteed by the proposal that looks set to be installed in mid-2025.

Free to grow deposits because of the guarantee, this guaranteed model looks likely to produce more bonfires, as NZ and the globe shuffles towards the next round of loan failures and asset price falls, the most painful of which are always endured by second and third tier borrowers.

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CLIENTS often ask in wonderment who exactly are the funders of America's death-defying levels of sovereign debt.

The USA's sovereign debt, as measured by repayable Treasury securities, is now abutting $35 trillion, almost exactly 35 times what it was in 2000 when the philandering Bill Clinton was “in office”.

At that time debt servicing was less than 1% of the US tax take and little more than 1% of the USA's GDP.

Today, following the funding of ghastly wars all over the place, and following the growing costs of natural disasters, the USA owes $35 trillion and as interest rates reset from the years of “free” money, the cost of debt servicing is measured in trillions.

That cost of servicing has quadrupled, and even that multiple relies on the willingness of the likes of China to subscribe for new issues. Effectively, the USA is borrowing to pay the interest on its debt.

To increase the issue of bonds would require foreign investors. Would they demand higher margins to keep increasing their purchases?

Of the $35 trillion, most of the funding comes from within America - institutions, pension funds, retail investors, and of course the government itself, which buys its own bonds, a form of money printing.

But $8 trillion - hardly chicken feed - comes from Europe and Asia, with China the biggest single contributor.

Investors can ask themselves - if you were asked to lend, and to keep lending more, to anyone or any entity, would you want more margin or less, each time you lent?

The Congressional Budget Office, which assesses US future debt programmes, forecasts that the USA's debt will hit $50 trillion within the next decade.

Does New Zealand look any smarter than the USA?

More so than the USA, we depend on overseas support, as we continue to run huge deficits. Will the volume of borrowing we require allow our long-term bonds to be set at lower, or higher, rates?

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LAST week I printed a letter regarding carbonisation, the letter offering information based on NIWA research. The research posed the question: is NZ seeking a solution for a problem (nett carbon emissions) that does not exist?

The letter written to the editor of the Wellington paper, four years ago, was rejected.

I wondered why, probably leaving Taking Stock readers to infer that I suspect that the media slavishly follows its own ideology, rather than do its job of providing interesting information on both sides of any social or scientific debate.

The newspaper executive who selected the letters to be printed four years ago has defended vigorously his decision to reject the letter. It was too long, well beyond the guideline for the length of publishable letters, he advises.

The newspaper man is a friend, a vastly experienced journalist, completely trustworthy. So I accept his explanation. He was not biased.

In my response to him, I left hanging the thought that often his previous employer (The Post) publishes “contributed articles” by often boring university policy people, usually banging on just one edge of a drum, seeking university bonus points for each time their views were published.

Perhaps the newspaper should have run the letter in full, acknowledging its merit, as a “contributed” editorial page article.

That is what I would have done if my guideline of word number had to be applied.

Some Taking Stock readers have welcomed our publishing of the letter.

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LAST week I sought to explain the possible investigation of market manipulation allegations, relating to a bank’s advice to the government on the rate setting for an issue of inflation bonds.

The allegation is that the advice might have been based on dodgy data, costing the Crown $33million of unnecessary extra interest.

A group of readers asked this question; If a formal investigation is justified for a $33 million additional cost to taxpayers, who will investigate Robertson's errors with the government stock buy-back that delivered a $11 billion loss to be paid for by taxpayers, the four Australian banks making the gain.

I suspect that at my age this is a question both beyond my pay grade, and beyond the energy level I would need to write another version of Billion Dollar Bonfire!

Robertson now practises his skills at Otago University where presumably he has access to some skilled staff.

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Travel

Our advisors will be in the following locations on the dates below.  Please contact us if you wish to make an appointment:

5 July – Wellington – Edward Lee

11 July – Tauranga – Johnny Lee

12 July – Hamilton – Johnny Lee

19 July – Wairarapa – Fraser Hunter

25 July – Auckland (Ellerslie) – Edward Lee

26 July – Auckland (Albany) – Edward Lee

Chris Lee

Chris Lee & Partners Limited