Taking Stock 29 March, 2018

 

David Colman writes:

 

Crowdfunding

THE collapse of New Zealand fashion retailer Andrea Moore did not grab my attention at first as there have been a slew of retail failures over the last decade.

When the scale of the money the company owed to creditors was revealed in the media to be in the millions ($2.5m and counting) I was surprised that a business with just seven stores, an online presence and 20 staff owed such a significant sum (approximately $350,000 per store).

I was also surprised to learn that less than 18 months before the company's collapse it had used the crowdfunding platform Snowball Effect to raise $750,000.

The company had been in business since 1999 so it was not the more common equity crowdfunding offer of new shares in a new business.

Fifty Four investors provided funds to receive 17.65% equity in the company as well as rewards which included gift certificates and tickets to fashion shows.

Potential shareholders were enticed by the long-term possibility of dividends and an increase in value over the even longer-term.

At the time of the crowdfunding campaign in August 2016 the company gave itself a pre-funding value of $3.5 million, cited annual revenue of $4 million and positive earnings of $300,000.

Revenue growth was 'conservatively' forecast to grow by 20% and earnings by 100% in the following year alone, not something that was supported by prior years’ performance.

What happened between the crowdfunding campaign and the appointment of receivers McGrathNicol was described as a perfect storm by Andrea Moore managing director Brian Molloy.

Late deliveries, creditor payment defaults and roadworks were components of the storm, a storm that destroyed a company with an estimated market capitalization defined as being $4.25 million immediately following the crowdfunding round. The company’s capital value is now nil.

Yet this offer now sits on the ‘Successful Offers’ page of the Snowball Effect website.

Crowdfunding platforms have no liability if a fully-funded project fails.

Their protection is in receiving a licence from the FMA to operate as a crowdfunding platform based on a range of criteria including that the people behind the platform are considered fit and proper persons.

A platform must:

- have systems that are equitable and easily evaluated;

- have policies in place to prevent fraud;

- not allow funds raised to exceed NZ$2 million in a 12-month period.

This last limit will need close monitoring by the FMA to avoid any business in future offering rolling $2m fundraising efforts only to run into an inevitable wall of failure.

Of the eight providers which have received licences, two are suspended (AlphaCrowd and Fulqrum).  

The licence requires the front page of the crowdfunding platforms website (including Equitise, PledgeMe and others) to display warnings to investors.

The following warning is displayed on Snowball Effect's homepage (you have to scroll a long way down the front page to see it, but it is there):

- Equity crowdfunding is risky.

- Issuers (companies issuing shares) using Snowball Effect’s facility include new or rapidly growing ventures.(Andrea Moore didn’t meet either of these tests.)

- Investment in these types of businesses is very speculative and carries high risks.

- You may lose your entire investment and must be in a position to bear this risk without undue hardship. (I’m not sure that I am comfortable with crowd funding being described as investment, based on early users.)

- New Zealand law normally requires people who offer financial products to give information to investors before they invest.

- This requires those offering financial products to have disclosed information that is important for investors to make an informed decision.

- The usual rules do not apply to offers by issuers using Snowball Effect to raise funds. As a result, you may not be given all the information usually required. You will also have fewer other legal protections for this investment.

- Ask questions, read all information given carefully, and seek independent financial advice before committing yourself to any investment.

The warnings should be taken seriously, particularly the warning to seek out independent financial advice and those which remind you that total loss is possible and you have few legal protections.

There are other significant compromises that would restrict an investor’s use of crowdfunding such as the lack of financial information provided by an offeror and the serious lack of a secondary market.

The lack of in-depth financial information closes a crucial window into the company's accounts.The majority of offers tend to concentrate on forecast revenue and earnings forecasts above all else.

Minimal disclosure to shareholders would be expected after the fund raising.

The lack of liquidity should be a major concern - considering any investment should take into account whether there will be some mechanism to sell or realise your gains in the future or not.

Many offers deny smaller shareholders a right to vote at shareholder meetings.

Strangely, there are few restrictions regarding who can give money via crowdfunding.

The FMA's accommodative regulations for crowdfunding platforms are in stark contrast to regulations being considered regarding 'eligible investor' benchmarks.

Certain offers of complex and/or speculative (often not-listed) investments are made through brokers only to 'eligible investors' as described by the Financial Markets Conduct Act 2013.

There are rules being considered to restrict the definition of an eligible investor to an entity which has been certified to have both large wealth and investing experience as opposed to one and/or the other as is currently adopted.

It has been proposed that an eligible investor may be required to meet standards where they can show they are able to invest over $750,000 in any single investment. This would be a prohibitive hurdle to all but the wealthiest individuals and organisations.

Many investors with enormous experience or extreme wealth would not qualify.

Very few offers through crowdfunding sites prescribe that an investor be an 'eligible investor'.

People with limited finances can send their life savings to almost any crowdfunding project they choose. Completely unsophisticated investors can invest money that might be most of their savings.

This disparity highlights a gap created when a technology outpaces the regulators.

Crowdfunding has evolved quickly in the internet age where it originated as largely gift-based. The concept of a gift is more appropriate than an investment, in my view.

Awaroa Beach in Golden Bay was bought by pledges of cash ‘gifts’.

The UK has just unveiled a bronze statue of David Bowie. It was crowdfunded (gift!).

The 'crowd' at first referred to internet users who paid small sums towards a common cause such as funding an artist to produce a work, the production of a movie or the publishing of a book.

Rewards quickly became a part of attracting funds where contributors might receive something related to the fund such as a coaster, a coffee mug, a t-shirt etc, representing the level of funds given.

Charity-based crowdfunding led to equity-based crowdfunding where percentages of a company's shares are offered to anyone who has access to a crowdfunding platform.

Kickstarter is a well-known US based crowdfunding site and has been used to raise in excess of 3 billion US dollars for all manner of projects.

Equity crowdfunding campaigns have evolved to offer investors access to funding anything from 'Little Eatz' to 'Exploding Kittens'.

'Little Eatz' are healthy, vegan treats that can be eaten by a dog and/or a human but neither enough dogs nor humans were willing to fund the idea.

'Exploding Kittens' is a card game for people who are into kittens and explosions (and laser beams) and, incredibly, successfully raised $8.7m dollars.

I can't argue that there hasn't been a diverse range of projects to give money to. 

Approximately a third of all Kickstarter projects have been successfully funded using an ‘all-or-nothing’ funding approach, with New Zealand funds having a higher percentage of success of extracting funds using the same approach.

‘All-or-nothing’ funding is only successful if the funding goal is reached within a specific time period as opposed to the alternative 'keep-it-all’ approach where any funds raised are kept regardless of the goal or time limit.

I'll admit that I expected to find equity crowdfunding to have a much higher failure rate but am reminded that the success of funding a business gives us no idea how the business performed once it was funded - as opposed to funding a book, for example, where the success of the fund is that the book is published.

The success of a company is far less obvious if it is not listed on an exchange or doesn't achieve some sort of measurable milestone.

The Andrea Moore offer is an example of a fund where there was no clear path to being able to realise any monetary value if successful, other than vague references to dividends.

The full funding of the Andrea Moore campaign may be tied to the fact that the share market and property market were riding high at the time.

Crowdfunding would be difficult after a major market shock and investors would have practically no way to sell shares that are not on an exchange.

Powerhouse Ventures (PVL.ASX), a beneficiary of crowdfunding, did list on the ASX and has since fallen to AUD 25c from a listing price of AUD $1.00 but is just one example of a crowdfunded company that progressed beyond the funding stage.

Frankly though, Powerhouse’s trip to the crowdfunding trough came after various failed attempts to raise additional equity from the professional investment community. Perhaps the FMA could make this a disclosure question required in all crowdfunding offers: ‘Have you approached the professional investment market for funding, prior to this crowdfunding offer?’.

No New Zealand crowdfunding platform includes an exchange to buy and sell the equity crowdfunded project shares they offer despite in many cases the platforms providing a share register for the companies.

Has equity crowdfunding in New Zealand provided a worthwhile option for retail investors, or should crowdfunding be a portal for gifting?

We need a great deal more evidence of longer-term results to be published before we will know.

_ _ _ _ _ _ _ _ _ _

Brief Note on Interest Rates

Following the Global Financial Crisis the world's central banks painted themselves into a corner by lowering interest rates close to zero (in some cases to negative interest rates) and reducing their tolerance for failure to zero which pushed repayment further and further into the future.

In the USA the paint has dried enough for them to start raising interest rates from a very low level. The Fed believes there is sufficient evidence of US growth and is using this as a catalyst to lift rates.

The new Federal Reserve Chairman Jerome Powell increased the federal funds rate target range to 1.5 - 1.75% last week.

Part of the evidence is that the US unemployment rate is close to 4.0% after getting up to 10% in the wake of the GFC. (The current US President certainly seems comfortable to add many of his employees to the unemployment queue on an almost weekly basis).

The Federal Reserve may find that US protectionist foreign policy including tariffs and stepping away from trade agreements may curtail its growth forecasts at some point.

In New Zealand the Reserve Bank has indicated it is not looking to raise the Official Cash Rate any time in the immediate future and has now kept it at a record low of 1.75% since November 2016.

Recent and ongoing Government reviews of the RBNZ and the appointment of a new governor, Adrian Orr, will have only a minimal influence over interest rates, with inflation likely to continue to dominate the Bank’s decision making.

The Fed funds rate and NZ OCR are now at very similar levels as well as both countries having similar measures of inflation. The US dollar is likely to gain a little against the Kiwi with each lift in its target range while the NZ rate remains the same.

Sadly, for fixed interest investors, it seems New Zealand companies look like they will enjoy lower, local borrowing costs for a little longer yet.

_ _ _ _ _ _ _ _ _ _

Travel

Edward will be in Remuera on 10 April and Albany 11 April.

Chris will be in Auckland on April 17 (pm) at Albany Motor Lodge and April 18 (am) at Waipuna Lodge, Mt Wellington, and in Christchurch on April 23 and 24.

Kevin will be in Ashburton on 12 April.

Our future travel dates can also be found on this page of our website: https://www.chrislee.co.nz/request-an-appointment

Any person is welcome to contact our office to arrange a meeting.

David Colman


TAKING STOCK 22 March 2018

 

NEVER underestimate the power of the banks.

Placed in charge of billions of other people’s money, and effectively in charge of the process of trade, bankers have almost unbridled power.

Yet one should never underestimate the power of the Crown.

The Crown has the power, and sometimes the intellect, to reign in the banks.

Australia is now witnessing a battle between the banks and its Crown.

A commission of enquiry with almost unlimited power is investigating the behaviour of the banks in Australia over the past several years.

In that time the banks have cheated with interest rate setting, cheated with foreign exchange dealing, dealt with banned countries and people, and ignored anti money laundering laws.

The pursuit of profits, power and personal, revoltingly excessive wealth has been ugly.

In addition, the banks have failed to meet social expectations.

There have been allegations about boyish, offensive behaviour in dealing rooms, the banks have been slow to promote equal pay, and the numbers on boards and in executive teams have not reflected that a good ratio of the work force are not males.

The banks may be charged with making too much money!

The commission will be poking its nose into corners not usually examined by outsiders.

It may sound pious to suggest that NZ has not had the same levels of lousy behaviour.

Perhaps being smaller, New Zealand does not allow the same opportunity to behave badly, but with some hope of anonymity, though the corporate grapevine does not always work well.

Here when a Westpac lender was fired for exploiting his position as a lender, everyone in his town, Christchurch, knew about it, but somehow he emerged later with even greater authority in another financial institution.

Perhaps the trail of gingerbread biscuits does not always lead back to Hansel’s house.

The Australian enquiry will undoubtedly lead to demand for much more accountability, much better social behaviour, and much stiffer penalties for those who want to cheat.

We are already seeing the Australian banks proactively bringing about changes that might mitigate some areas of criticism.

The appointment of the former Merrill Lynch foreign exchange manager, former NZ Prime Minister John Key, as chairman of the somewhat figurehead-only NZ board of ANZ, was frankly a pretty feeble move to acknowledge that the bank wanted to show a new face, and was prepared to pay for a familiar face.

When Key was appointed to the board with real power, the ANZ Australian parent board, one could see that the ANZ was keen to display the need to have a respected fresh name at a meaningful level.

Key had a career as a fairly ruthless power broker in an American bank (Merrill Lynch). He was known as the ‘’smiling assassin’’.  He has morphed through his role in politics into someone now seen as ‘’connected’’, worldly and telegenic.

He has made speeches about the need for social responsibility and social goal-setting, in large corporates.

Whilst his old workmates may be chuckling at his transition, the fact is that his status, and his presence, has been judged by the ANZ as being valuable for the bank’s image.

It is not just the appointment of Key that illustrates the ANZ’s urgent wish to be seen to be adapting to a new order.

Within the bank now it is commonly noted that if two people want a new job, and only one is male, the man may as well not apply.

Gender, rather than merit, might be the only relevant factor, as the bank addresses an issue that grew in visibility when women became more available for executive careers.

I expect to learn that the banks are all reviewing their executive bonus schemes, while the Australian commission of enquiry continues.

The banks will not want to look like the US bank Wells Fargo where the CEO, after yet another poor year, has received a revolting multi-million-dollar bonus.

Banks are really seriously powerful; V8s, twin turbo.

Commission of enquiries are more powerful; bulldozers well able to crush any V8.

We will observe the outcome of this enquiry, soon.

 _ _ _ _ _ _ _ _ _ _ _ _

INVESTORE Properties may be pondering whether its new secured bond is paying interest at a higher rate than it required.

Its issue has been over-subscribed.

The property trust owns a large number of Countdown sites, subject to leases of an average 13-year term.

Its bond is for six years and is secured by a first mortgage over those properties.

Investore will pay 4.4%, a significant margin over similar bonds available on the secondary market, and it will pay the transaction costs, rather than dump the cost on the investors as, increasingly, others are choosing to do.

The over-subscription might make IPL wonder if its coupon was set too generously.

My view is that the secondary market rates are where the errors are occurring. I think IPL has set a fairer rate than the secondary market offers.

IPL has wisely offered a three-week collection time, the offer closing on April 9.

Those wanting an allocation should contact us urgently, certainly within a week.

_ _ _ _ _ _ _ _ _ _ _

THE Air New Zealand chief executive Christopher Luxon is being touted as the top contender for the role of chairman of Fletcher Building Ltd.

The FBU chairman’s role becomes vacant when Ralph Norris resigns, wisely accepting that his performance as FBU chairman has been inadequate.

A group of FBU shareholders have been contemplating what credentials FBU needs.

They conclude it needs a leader from the service sector, a leader who has demonstrated commitment to a culture of quality, and a leader with the energy and reputation to bring about change.

You might say that former Air NZ CEO Rob Fyfe fits that description; so does Luxon.

Ironically Norris, a banker, was once CEO of Air New Zealand.

A new chairman will be needed if the recently appointed FBU chief executive, Australian Ross Taylor, has failed to drag out of his executives all of the potential risks and costs of its construction division.

Taylor believes he may have over-provided for risk.

Market mumbles continue to speculate that Taylor may still not know the potential costs.

If FBU has yet another year of being in the public stocks, facing tomatoes, perhaps tomatoes in tins, it will need a highly accomplished leader to reverse the demoralisation of the long-term, committed staff.

Perhaps a name change, a new chairman, a new culture and a clean balance sheet might be the start point.  Did I suggest that years ago?

 _ _ _ _ _ _ _ _ _ _ _ _

THE desire of Auckland Council (AKC) to sell low-yielding ‘’green’’ bonds is being expressed at an appropriate time.

Bond yields are low, and will remain low, so the rate discounted to accommodate green aspirations will be insignificantly lower than all other rates.

Rate-conscious investors will step aside but it is easy to see an AKC green bond being attractive to some investors who perhaps have given up any hope of a fair return for risk.

 _ _ _ _ _ _ _ _ _ _ _ _

AS the financial advice sector heads for its umpteenth iteration of rule changes - this time a review of a prescriptive code of conduct - many investors will be required to adjust their expectations.

The code has always been lengthy. It was prepared by a committee.

Many will recall how the group that initially sought to create the Financial Advisers’ rules and code of conduct comprised some inexperienced, in one case inept, advisers.

Some resigned when their competence was debated in public documents, like the Consumer Magazine.

Ultimately the Financial Advisers Act was implemented in 2011 and did the nation a great favour, ensuring that the likes of Douglas Lloyd Somers-Edgar would not be able to exploit trusting investors. (He ‘’retired’’ before the code arrived.)

The FAA and the attached Code helped to rid New Zealand of at least ten thousand ‘’financial planners or advisers’’ and set up visible channels for protection from charlatans.

By far the most obvious demand of advisers became the all-embracing requirement to put clients’ interests ahead of all other considerations.

To most of us this was like the Road Code’s first requirement being ‘’Do not crash into others’’.

The change now affecting investors has come about during the logical process to merge the relevant, but in some cases different, requirements of the Securities Act with the Financial Advisers Act into one new piece of legislation, the Financial Markets Conduct Act.

An obvious anomaly previously was the different definitions of those investors who were eligible to consider financial offers that were not overseen by the market regulators.

Let us say a cousin wanted to raise $100,000 to set up a business specialising in decorating balloons.

He could prepare a one-page ‘’information memorandum’’ and pass it around friends, family, wealthy individuals and people who said they had investment skills.  (Today he might visit one of the ghastly ‘’crowd’’ funders.)

They were either ‘’eligible’’ investors, ‘’habitual’’ investors or ‘’wholesale’’ investors depending on which clause of the acts you were reading.

Effectively this meant that informal, unapproved, unregulated offers could be judged by some potential investors who certified that they were capable of making a judgement, and would not grizzle if the business venture failed.

Such investors could also participate in underwriting or sub-underwriting panels.

Well, this is changing.

The new Financial Markets Conduct Act is very specific, and will set a high bar for those who might want to invest in ventures that do not offer an approved investment statement. Curiously it will not close off crowd funding.

In practice, extreme wealth, investment experience and high incomes will be irrelevant unless the investor is working in an investment business or, interestingly, as worded ‘’the person is large’’.

(I will qualify.  There is no need to ask which of these criteria will qualify me.  By some definitions, the answer would be both.)

There will still be room for ‘’eligible’’ investors but such an investor will need to certify in writing some quite specific qualifications.

Frankly, the rule as it was before was loose, and inconsistent across different legislation.

It was exploited by financial advisers that either could not have passed the relatively modest educational standard or would not have been deemed to be fit and proper people to offer retail investors advice.

Many such advisers/financial planners chose to offer services only to ‘’wholesale’’ or ‘’eligible’’ investors, effectively requiring clients to sign certificates about their wealth or skill.  This relieved the advisers of displaying AFA competence.

To tidy up this looseness seems a useful objective.

The new FMCA law is not worded as I might prefer but if it is used with honest intentions it will do its job.

The rewriting of the Code will also be of some importance.

It is currently unnecessarily long.

I can attest that not once in seven years has any of our several thousand clients ever made reference to the Code. It seems to be written to control advisers rather than to display to investors the rules of the game.

It should be succinct and unambiguous, should demand client-first ethics, transparency, disclosure and behaviour that is honourable.

I wish it would mention good manners. (That might help Russell McVeagh to move forward with its own code.)

It should describe an obligatory complaints process (as required of all financial advisers).

I would be happier if all advisers were required to display a minimum level of capital and be constrained to manage client money in volumes that related to capital.

This would certainly put an end to those money chains, like Edward Jones in America, that will employ anyone who knows how to sell over a phone.

A capital requirement would also ensure that only those with meaningful capital can ever have control over large sums of money. As Warren Buffet once noted, there is an irony in people arriving at your office in a Cadillac to seek advice on wealth from people who ride the train to work.

I would also prefer that the new Code differentiate between those who simply sell for fund managers and those who know the securities markets, and understand the details of the securities used by clients.

I guess the weighting is probably 80% in favour of salesmen for fund managers, the sales people neither knowing nor necessarily caring what strategies or securities are used by the fund managers.

If an investor wants to test the validity of my guess he should ask his adviser if the various funds his money has entered leaves him exposed to the disastrous CBL company.

Likewise it is highly unlikely that most salesmen of ETFs would have any specific knowledge of their actual holdings in securities.

The new Code should acknowledge the difference between those two types of advisers and should apply sensible constraints on those who want a client to give the salesmen discretion to buy and sell client securities without reference.

In this area the gold standard is admirable and well enforced by competent, active compliance managers.

The bottom tier of this discretionary service might have portfolios filled with stocks in companies that are linked to the employer of the advisers.  Chinese walls may be made from penetrable materials. Again, investors can check their portfolios so see if there are links between the investment chosen, and the promoters of the original issues.

If any investor discovers his portfolio has been stuffed with poor performers, let it be said that Trump is not the only person who can fire people!  Investors have the power to sack poor advisory groups.

 _ _ _ _ _ _ _ _ _ _ _ _

TRAVEL

I will be in Christchurch on March 27 (pm) and 28 (am) in the Boardroom, Airport Gateway Lodge, 45 Roydvale Avenue.

I will be addressing the NZSA meeting at St Christopher’s Hall, Avonhead, at 7pm on March 27. All clients are welcome. Please let our office know if you plan to attend.

I will be in Auckland April 17 (pm) at Albany Motor Lodge and April 18 (am) at Waipuna Lodge, Mt Wellington.

Kevin will be in Ashburton on 12 April.

Edward will be in Remuera on 10 April and Albany 11 April.

David Colman will be Palmerston North and Whanganui on 27 March, and New Plymouth on 28 March.

Our future travel dates can also be found on this page of our website: https://www.chrislee.co.nz/request-an-appointment

Any person is welcome to contact our office to arrange a meeting.

Chris Lee

Managing Director

Chris Lee & Partners Limited


TAKING STOCK 15 March 2018

WITH great sadness it must be said that the event that stripped the lipstick and mascara from the face of John Key’s government was not a one-off.

Everyone with a role in New Zealand’s financial markets will have felt no pride in recalling the illegal deception of investors during the botched rescue plan for South Canterbury Finance some years ago.

For some, the feeling of shame would focus on the Crown’s principal role in allowing the public to be deceived, yet the Crown declined to address those who were robbed of their legal rights and were refused compensation.

One definition of government corruption is a wilful breach of a law that is covered up, rather than remedied. A remedy was available and might have cost $20 million or less.

The SCF deception was ugly.

It was the cause of my commitment to write a book outlining the errors, the incompetence, the deception and the cover-up.

Key’s government will not emerge with dignity.

Remarkably, we are now hearing that the same sort of behaviour may have recurred during the period leading up to the collapse of CBL Insurance. That is what happens when you do not take action to put right a serious error.

Surely this time deeper-pocketed people will have the wheels in motion to ensure a robust outcome for those who have lost money.

In summary, it seems that for a period of almost a year, the Crown, via the Reserve Bank and months later via the Financial Markets Authority, have known that a potentially fatal event had threatened CML.

An overseas subsidiary of CBL had underpriced risk and could not meet legitimate claims, the shortfall being tens of millions of dollars.

An inference is that CBL, the parent, could not meet the shortfall without breaching its own ability to meet claims in New Zealand.

In mid 2017, we are told, the Reserve Bank, the regulator of NZ insurance companies, became aware of a problem.

At a later time the FMA was made aware of the problem.

New Zealand has laws that required symmetry of knowledge of all relevant company events, spelt out in those laws that require continuous disclosure of material events.

If we believe the media reports, the Reserve Bank, the FMA and CBL accepted that this situation should be kept confidential and that the NZX, where CBL is listed, should not receive publishable information, as the continuous disclosure regulations would have anticipated.

Investors, including the most studious of our fund managers, were still buying CBL at a price that valued CBL as a profitable company with a long, bright future.

Their clients have lost hundreds of millions.

Many millions of dollars were still being invested, yet a material event had occurred. It was known to the Crown and the regulators, yet was hidden behind a confidentiality agreement that was thwarting a law designed to ensure material matters were universally known.

A cynic might ask why Crown entities can contract out of the law with a confidentiality agreement.

Because the victims of this secrecy are powerful fund managers rather than retail investors, I can easily imagine that CBL will prompt very thorough legal responses.

It is easy to imagine fund managers suing the Crown for the losses incurred. Remarkably, this has been occurring at a time when Andrew Little, the new Minister of Justice, has been making speeches to market participants about the need for NZ to be corruption free.

One fund manager, Harbour Asset Management (HAM), has revealed that it owned in its various funds a total value of $53 million worth of CBL shares. Did it buy any shares while the CBL problems were being hidden? Will it have a claim to make?

HAM is now accepting that those shares are either worthless or worth perhaps $5 million, should CBL ever be left with any surplus of assets, after all future claims have been paid.

CBL provides unusual insurance policies like Directors & Officers Insurance, cover for house building defects, and bond insurance for contractors.

Its assets now will be easily established but the bulk of its liabilities will be future claims on the policies it has underwritten.

Given past claim patterns, it seems highly probable that legitimate claims will exceed the assets (bank deposits, listed shares etc) that were intended to provide cash to pay all claims.

Furious investors, and startled financial market participants, will need to observe one caveat before reaching an uncontestable conclusion.

The continuous disclosure obligations do provide exits in rare, extreme cases.

For example, a company may not have to disclose an event if it had an imminent remedy.

To use this example, had CBL directors been certain that a huge compensating capital injection was imminent, it might have sought an exemption from the need to disclose a temporary problem.

Such an exemption might have been granted for a few days, perhaps even a week or two.

Nine months might be stretching the credibility of such an exemption.

Without any doubt, I assert that from the moment CBL knew of its problem it should either have disclosed it, or sought to suspend all trading in its shares.

That the Reserve Bank and the FMA believed a confidentiality agreement should prevail over these solutions would dumbfound me had I not been introduced to such Crown behaviour during the sickening period when the Crown was seeking to minimise the losses that were inevitable after it guaranteed $1.6 billion of South Canterbury Finance NZX-listed and unlisted debt securities.

In this case the Crown perpetuated a deception of those who might have bought, sold, or held their listed securities while the rescue attempt was underway.

The rights of some investors were destroyed by regulatory breaches of continuous disclosure obligations and by the wilful ignoring of at least one key provision of the Companies Act.

Where the behaviour of the Crown in their SCF mission was identical with the behaviour of the Crown over CBL Insurance was in the apparent belief that continuous disclosure laws are an option, not an obligation.

Presumably the Crown believed there was an exemption available which allowed it to ignore the disclosure obligations. Surely the Crown can insist that companies conform with laws.

Ironically, the continuous disclosure regime was designed and written to extract New Zealand from the ‘’Wild West’’ grouping of countries which, in the1980s, were sidelined by sovereign wealth funds and many institutional investors, globally, because of our membership of the Wild West Club.

In the 1980s insider trading here was basically legal, governance was appalling, corporate cheating was mundane, and some of the worst offenders were knighted, Renouf being an example.

I still have, and will one day publish, a QC’s detailed report on insider trading.

Given the mores of the times, it might be unsurprising that the independent chairman of the company affected by that insider trading decided it would archive the report and not prosecute the offenders.

The continuous disclosure regime was designed then to ensure symmetry of information, thus locking out the insider trading opportunity.

In 2009-10 we saw the Crown bypass these obligations in preference to a butchered plan to reduce the ultimate cost of the Crown’s obligation.

As will be clear when my book on that behaviour is published, the rescue attempt made the cost far greater than should have been the case. Some might call that karma. The taxpayers bore the cost.

In the case with CBL, I would be mortified if there were no challenges to the behaviour, no compensation sought, and no repercussions for any wrong doers.

In this latter instance I am fairly confident that the issues will not be tucked away, the wrong-doers not able to fade away, without repercussions.

 _ _ _ _ _ _ _ _ _ _ _ _

SHOULD any fund manager or individual have learned of CBL’s problems and immediately sold out, that seller can expect a call from the Financial Markets Authority.

There would need to be a logical, well documented explanation for any sudden sale. Rarely does any fund manager sell all his shares in a NZX50 company.

Very obviously the NZ Super Fund, which is a large holder of CBL, is not a suspect, it still holding CBL.

Insider trading is a serious offence, with jail a likely solution.

In the USA jail sentences for insider trading are often for many years.

Yet the lure of fast money still attracts appalling behaviour in the USA, much of it visible in the tactics of hedge funds.

The central issue is always based on what constitutes research (a legal activity) and what is defined unarguably as inside information.

Interestingly the development of hedge funds was a response to the 1987 global sharemarket slump, when share prices were falling because of bad practices.

Pre-1987 the most ambitious, perhaps greedy, investment specialists were in sharebroking and pension funds, where investments focussed on selecting good companies with long-term futures.

When markets were all fragile, and prices were falling, and the regulators were applying strict new rules, the hedge fund industry grew rapidly. Fund managers with a hunger for personal wealth switched to the hedge fund industry.

The term ‘’hedge’’ came from the strategy of managing (hedging) risk. In the years after 1987 the risk was a general fall in share prices so hedge funds were created to benefit from such a fall, by ‘’shorting’’ shares, a term that means selling shares borrowed from someone else, with the intention of returning the borrowed shares by buying them in the future, at an anticipated lower price.

There were three types of hedge funds.

One, like that created by George Soros, sought to analyse trends and take positions based on the analysis.

He figured Britain would need to devalue its currency, so he shorted the sterling currency and made a billion or two when his analysis was proved correct. Britain did indeed devalue.

The second type of hedge fund has just a day-trading mentality, seeking to exploit short-term volatility, and hoping to gain from nano-second advantages in gathering price sensitive information.

This type of business might be characterised as exploitative but, at least visibly, legal.

Then there is the more common hedge fund, which seeks to use information to make buying or short selling profits by using research or acquired information to reach conclusions before the rest of the market.

In the US, the market describes illegal information as the ‘’black’’ edge.  Arguably legal information is the ‘’grey’’ edge.  Legally acquired information is the ‘’white’’ edge.

There are whole industries built around gaining an ‘’edge’’.

For example, the hedge funds that day-trade will do their best to acquire legally-prepared analyst reports before the reports are distributed and make their buy, or short/sell decisions based on what a respected analyst is about to publish.

In previous years Goldman Sachs, which earns huge sums of brokerage from day-trading hedge funds, might allow the hedge funds to proof-read the reports of its analysts before the reports were distributed.

Another large US company specialised in providing the equivalent of a corporate ‘’Tinder’’ site, arranging to hold a register of people in major companies who would informally talk to hedge funds.

For a large fee, an analyst might be allowed to gain access to specialists in, say, drug companies who in informal conversations might discuss the expectations and progress of new experimental drugs.

Inside information is absolutely illegal but general conversation, even educational conversation, might be completely legal.

The analyst might try to probe and get an ‘’intuition’’ about whether a new drug was being viewed optimistically.

Black edge, grey edge, or white edge – the analyst would have to decide, and he and his hedge fund employer would face the consequences if they made the wrong call, and were caught out.

The value of real research, and its legitimacy, is not in doubt.

The NZ analyst who visits a retirement village and identifies a large number of unusable units (because of water leaks) and then correctly forecasts a below average profit, is doing his job.

The analyst who correctly calculates the percentage of sales by a retailer of goods sold only when discounted is also doing his job, as is the analyst that analyses rainfall patterns and realises some power companies will have been disadvantaged.

However the US day-trader who learns from a guileless employee of a drug company that a new trial of a drug is finding serious side effects, will trade those shares only if he is prepared to risk his career and his freedom.

Astonishingly the American culture has yet to adapt to high standards, and so many greedy traders will take the risk.  (It never ceases to amaze me that rich people will risk their reputation and freedom in pursuit of more, illegally-gained, wealth.)

The risk is growing as technology and higher Federal budgets for investigative teams make discovery more likely.

In New Zealand’s case, if an investor had learned that CBL’s senior people were regularly meeting with the Reserve Bank, and learned this by talking to a lawyer involved in advising CBL, the investor would be living on a ‘’sharp’’ edge!

 _ _ _ _ _ _ _ _ _ _ _ _

ONE of the bigger problems for research-based investment banks is how to be properly paid for excellent research.

By far the most decorated investment bank, First NZ Capital, spends millions on research, and has more than a dozen research specialists.

It has been skilful in attracting the best available talent.

Yet how does it get paid for this expense?

Its brokerage charges for wholesale clients do not reflect the value of its superior research.

To be fair, in recent years the market has risen so relentlessly that even those with low budgets for research have been able to produce satisfactory returns.

The move by low value advisers to herd client money into Exchange Traded Funds (ETFs) has been accelerated by the similarity of research-based returns and non-research-based returns.

Only when markets fall sharply, would results reflect the value of research, it seems. (Any NZX50 ETF would own CBL shares.)

As ETFs are run by ubiquitous software, the fees are low, there is no added-value, but if the returns are similar to research-based funds, then the lower fees become a point of difference.

If investors are to be herded into ETFs, then who will conduct research?  How will investors benefit from the ‘’white’’ edge?

 _ _ _ _ _ _ _ _ _ _ _ _

THE CBL share price meltdown should be watched carefully by those investors who pay advisers to ‘’manage’’ their portfolio.

Most agreements allow the ‘’manager’’ (the adviser) to value all investments at the last traded price and to charge his fees as a percentage of the ‘’value’’ of all investments held for the investor.

Let us say broker X manages shares worth $500,000 amongst which are 5000 CBL shares, last trading price (many weeks ago) being $3.17.

If the hapless investor who has agreed to this arrangement is paying an absurd 1% per annum fees on the ‘’value’’ of the portfolio, he will be paying 1% on $15850 of CBL shares.

That is $158.50 per annum on shares most certainly not ‘’worth’’ $15850.

The shares are likely to be worthless but might be worth a tiny amount. How can a manager add value by ‘’managing’’ a worthless share that is not tradeable?

Any portfolio manager charging this $158.50 is probably asking to be fired!

 _ _ _ _ _ _ _ _ _ _ _ _

TRAVEL

I will be in Christchurch on March 27 (pm) and 28 (am). I will be addressing an NZSA meeting at St Christopher’s Hall, Avonhead, at 7pm on March 27. All clients and investors are welcome. Please advise us if you plan to attend.

 I will also be in Timaru on 10 April.

Kevin will be in Christchurch on 22 March and Ashburton on 12 April.

David Colman will be in Palmerston North and Whanganui on 27 March and in New Plymouth on 28 March.

Our future travel dates can also be found on this page of our website: https://www.chrislee.co.nz/request-an-appointment

Any person is welcome to contact our office to arrange a meeting.

Chris Lee

Managing Director

Chris Lee & Partners Limited


Taking Stock 8 March 2018

Kevin Gloag writes:

MANY traditional bond investors have lost their appetite for the current low interest rates on offer and have turned to income generating shares to boost returns.

The reliability and predictability of dividends paid by the power companies, Spark, Vector, the listed property trusts, and others, has provided some relief for investors in search of returns above bank rates and current low bond yields.

NZ’s sharemarket is high yielding by global standards and many of our best dividend payers are dominant businesses in essential services.

Admittedly risk profiles for share and bonds are quite different but in the current low interest rate environment so are the returns.

For example it was hard to get overly-enthusiastic about Goodman Property Trust’s recent 5.5 year senior bond priced at 4.00%, effectively a gross return of 3.80% p.a. after brokerage costs, especially when your bank is offering rates in the mid-3s for terms of less than one year.

Unfortunately for retail investors not only has there been a shortage of new bond issues but there is now very strong demand from institutional investors, like KiwiSaver funds, who are happy to stick their hands up for big parcels provided the terms meet their investment criteria, effectively taking away any pricing power from retail investors.

So, in the absence of suitable bond options, high yielding shares have found a place in many portfolios and it was pleasing to see the yield stocks deliver to expectation in the latest round of company results.

The five big power companies continue to provide reliable dividends at attractive yields even at today’s share prices, which, in the case of the three sold down by the Crown, are considerably higher today than when they listed.

Underlying earnings for the power companies can fluctuate widely depending on rainfall and earnings from power generation, but they generate sufficient operating free cash flow that it hasn’t affected their ability to maintain attractive dividends, so far anyway.

Other higher yielding stocks - Vector, Spark, Heartland Bank – all announced dividends that met market expectation and even Chorus, which has tested the patience of many of its stakeholders, is starting to behave like a regulated monopoly in terms of predictable shareholder returns (I think it is still too early to add reliable and sustainable).

The listed property trusts continue to provide reliable dividends at returns between 4.50% -6.00% tax paid and we think that this sector offers good value from a risk/reward perspective.

Using the example of the Goodman Property Trust bond above, from a risk/reward perspective some investors might see better value in owning GMT units offering around 5.00% tax paid than the GMT senior bond offering 3.80% (after brokerage) before tax.

Regardless of individual preferences it is pleasing to see that despite low interest rates there are still options available to increase income and still maintain an acceptable risk profile.

Although low interest rates don’t benefit investors, most businesses profit greatly from them so it is possible to benefit in other ways from a low interest rate environment.

High yielding stocks like utilities, telcos and property trusts are all very sensitive to interest rate movements so taking a view on the future direction of interest rates is important when investing in these types of stocks.

Please note: The companies mentioned in this article are examples only and I am not suggesting that you buy these particular stocks.

_ _ _ _ _ _ _ _ _ _

I AM always a bit wary of new share issues when the selling shareholders are private equity firms.

Their strategy is simple; they buy assets they think have potential or are undervalued, try to add some quick value and then resell at a profit, often by offering shares to the public.

Of course sometimes it works out fine, as retirement village operator Summerset continues to demonstrate, recently announcing another big lift in sales and underlying profit for the full year.

Summerset was 97% owned by Australian private equity firm Quadrant when it was offered to the public in 2011.

Quadrant sold down 30% of its shareholding into the initial public offer and then proceeded to sell down completely over subsequent years as escrow arrangements expired.

Summerset has done the job well for its stakeholders as has Scales, NZ’s largest apple grower and cool store operator, a company once majority owned by the late Allan Hubbard.

After becoming tangled up in the South Canterbury Finance receivership, Scales was sold to NZ private equity firm Direct Capital in 2011.

Less than three years later Direct Capital proceeded to sell down its shareholding at a considerable profit, initially through an initial public offer and then later as escrow arrangements permitted (to mostly Chinese interests).

Scales’ profits continue to grow as does its share price and it has been a good result for investors so far.

As always there are two sides and on the not so good side are a couple of battlers, Tegel and Metro Performance Glass which, sadly for their shareholders, have been bringing bad news by instalments since the time they listed.

Both were presented to market by private equity firms with prospectuses that were full of ambitious growth plans and bright outlooks but both have struggled since listing and now trade well below their issue prices.

The Tegel deal looked to raise up to $344m to (a) repay bank debt of $132m, (b) repay Redeemable shares totalling $264m, (c) pay offer costs of $17m and management bonuses of $8m and (d) allow some existing shareholders to sell their shares into the offer and exit completely.

Repaying the Redeemable shares allowed the existing shareholders to subscribe for ordinary shares and in some cases realise part or all of their investment in Tegel.

Major shareholder Asian private equity firm Affinity Equity Partners (87% owner) was required to reinvest sufficient from the redemption of the Redeemable Shares to ensure that it held 45% of the shares in Tegel at the completion of the offer.

None of the money raised in the IPO was invested back into the business.

Instead the funds were used to repay some of Tegel’s debt pile, extricate the existing shareholders (private equity funds, directors, senior managers) from illiquid Redeemable shares at near par value (97c), where there was no prospect of repayment, and allow them to either exit completely or reinvest in tradeable ordinary shares.

And the management bonus pool of $8m? I’ve not heard of raising new capital to pay management bonuses.

Hindsight is a great thing but this looks like a classic example of private equity firms using capital markets to find their way out of a tight spot.

Metro Performance Glass (MPG) has been another disappointing performer since listing in 2014, when private equity firm Crescent Capital sold down its stake to just under 20% through an initial public offer.

 Crescent Capital had acquired ownership of MPG from another private equity firm, Catalyst Investment Managers, after the global financial crisis when MPG was in deep bother with $100 million plus of negative equity.

Like Tegel, MPG was pumped up as a good story by brokers and analysts associated with the lead managers and, also like the Tegel deal, the bulk of the proceeds from the IPO went to the selling shareholders with little or none invested back into the business.

You might recall that when Oceania Healthcare raised $200 million last April it was new capital all of which was invested into their business, to fund new developments and for refurbishments and additions to existing facilities.

Oceania’s owners, also private equity funds, sold none of their shares into the IPO, although they are free to start selling them down this year, if they choose.

Tegel and MPG are by no means on their last legs and private equity is certainly not responsible for all the poor performers who come to market but the structures of the Tegel and MPG share offers provide some valuable hindsight, in my opinion.

IPO prospectuses are marketing documents designed to sell you something and they are prepared by parties with large monetary incentives to succeed.

Broking houses involved in new issues are working for the vendors, not for you the investor, so as always it is a case of buyer beware.

Footnote:  I note leadership changes are finally happening at MPG (new Chairman & CEO) - this might be the start of better things to come.

_ _ _ _ _ _ _ _ _ _

LISTED Property Trusts have become the source of reliable and predictable income with a number of good options to choose from.

Some of the LPTs are still externally managed and operate under a unit trust structure while others have been corporatised and moved the management function in-house.  

There is much debate about which structure is better for stakeholders.

Under the company structure, employees are paid salaries and bonuses, and under the external management structure, the managers are paid base management fees and performance fees. I doubt that the sum totals are much different, regardless of structure.

With externally managed property trusts the base management fee is calculated as a percentage of total assets , less cash and trade debtors, so basically the greater the assets the greater the fee.

On the surface, at least, this suggests that the managers are over-incentivised to grow their book although growing the asset base should lead to growth in rental income and therefore higher distributable earnings and bigger dividends so growth should benefit all parties.

Unfortunately Vital Healthcare Property Trust shot this theory to pieces last week when it announced its result for the half year.

Vital, which is externally managed by Canadian based Northwest Healthcare Properties REIT, reported a $290 million increase in its property assets to $1.67 billion after a series of recent acquisitions in Australia and NZ.

To help fund this growth Vital tapped its shareholders for $160 million through a discounted rights offer in 2016, a dilution that its unit holders probably felt comfortable with on the basis of future dividend growth.

Sadly for investors there was no increase to dividends in the profit announcement (last increase was June 2016) but what was even more disappointing for investors was the announcement of a 49% increase in the manager’s base management fee to $5.6 million and a 66% jump in the manager’s performance fee to $5.6 million.

Most of these fee increases are a direct result of Vital’s expanding asset base although it seems that Vital’s Canadian based manager believes that it is still too early to start sharing the spoils of growth with unit holders.

Maybe next time.

_ _ _ _ _ _ _ _ _ _

THE Royal Commission of Enquiry into misconduct in the Australian financial sector has finally begun.

The Australian Securities and Investments Commission has Australia’s big four banks firmly in its sights.

The commission’s targets are too many to list here but include rigging benchmark interest rates and misconduct in areas covering home loans, car loans, credit cards, add-on insurances, credit offers and account administration.

The owners of NZ’s major trading banks have already paid out huge sums in fines and refunds to customers for multiple indiscretions and like the big global investment banks they seem to treat the fines as the cost of doing business.

The industry’s tarnished reputation seems certain to take another hit and the banks are already preparing for a possible revenue crunch by signalling job cuts and cutting costs.

It is estimated that the big four could shed up to 40,000 jobs over the next five years.

I couldn’t help but chuckle at one report where ANZ and NAB had agreed to pay $50 million each to settle interest rate rigging allegations and undertaken, at the regulators’ insistence, to introduce a mandatory face-to-face training program in ethics and how to look after your client’s interests.

All staff involved in the interest rate riggings had to attend the ‘ethics’ training course and then sit a test – I didn’t realise you could learn ethics this way.

Even more unbelievable it appears that none of the rate rigging staff have been sacked. Some have been temporarily suspended from trading but it seems that as soon as they do their course and sit their test they might be back in business.

Their owners have just paid out $50 million in fines because of their behaviour but their jobs are still intact - I know what message this sends me.

Footnote: The appointment of John Key to the board of the ANZ Banking Group on the eve of the big enquiry looks to me like a desperate attempt to buy credibility and impress regulators.

_ _ _ _ _ _ _ _ _ _ _

BY comparison, NZ’s banks seem to be either a lot better behaved or a lot smarter than their Aussie counterparts, probably both.

One area where our banks have behaved commendably and to market expectation is with the repayment of the ‘old style’ subordinated bank bonds.

As expected Rabobank repaid its annual reset security (RBOHA) last October, followed by Credit Agricole (CASHA) in December and ANZ has recently announced the repayment of ANBHA in April.

All of these securities lost all equity recognition in NZ as from 1 January 2018 under new global banking rules known as the Basel III Accord.

Rabobank, Credit Agricole and ANZ joined BNZ and Kiwibank who had already repaid their non-Basel III compliant securities and we applaud all of these banks for repaying securities that had lost the purpose for which they were issued.

Even though the securities no longer offered equity credits there was no legal requirement for the banks to repay them and some were offering cheap funding through low credit margins.

So as of today the only non-compliant subordinated bonds still on issue are the Rabobank 5 year reset security (RCSHA) and the two annual reset securities issued by ASB (ASBPA & ASBPB) more than a decade ago.

The Rabobank security will be repaid in June next year but judging by current market pricing there seems much less certainty about when ASB might repay its two securities.

The Australian regulators have adopted a longer transition period for securities that don’t meet the new Basel III standards so the ASB securities still offer a small but diminishing amount of equity value for parent CBA until 2021.

Also the credit margins on both securities are very low so even treated as debt they aren’t expensive to carry on ASB’s balance sheet.

CBA is of course also facing the possibility of some very big fines from money laundering accusations and misconduct identified by the Royal Commission of Enquiry so it might be guarding every dollar of capital for the time being.

Despite these factors I still believe that the reputational damage from being the only NZ bank not to repay its ‘old style’ would far outweigh any benefits and I’m still picking that CBA and ASB will do the right thing and repay in May and November.

May is not far away and if I’m right an announcement on repayment of the ASBPBs will be imminent.

No news is bad news for holders wanting to be repaid and current market pricing says I’m wrong.

_ _ _ _ _ _ _ _ _ _

Travel

Kevin will be in Christchurch on 22 March and Ashburton on 12 April.

Chris will be in Christchurch on March 27 (pm) and 28 (am). He is addressing an audience of NZSA and interested clients and investors at St Christopher Hall Avonhead at 7pm on Tuesday, March 27. Please advise us if you are planning to attend.

Edward will be in Auckland on April 10 (Remuera) and 11 (Albany).

David Colman will be in Palmerston North and Whanganui on 27 March and New Plymouth on 28 March.

Our future travel dates can also be found on this page of our website: https://www.chrislee.co.nz/request-an-appointment

Anyone is welcome to contact our office to arrange a meeting.

Kevin Gloag

Chris Lee & Partners


TAKING STOCK 1 March 2018

 

WHEN the Australian company Flexigroup bought Fisher & Paykel Finance (FPF) in March 2016, our broking and advisory company was disappointed.

A well-governed, reliable NZ non-bank deposit-taker was inevitably going to be swallowed up by an Australian company with no history or interest in New Zealand, bar profit seeking.

Inevitably investors would lose a sound option in the search for higher returns.

It took two years for Flexigroup to act, but a few weeks ago came the expected news that FPF would in future fund itself from the wholesale market, and no longer wanted to run a retail debenture issue.

Worse, all investors were to be repaid on February 28.

Michael Warrington responded by re-reading the most recent investment statements and noted that FPF had the right to repay early and would repay at market value.

To our dismay FPF advised that it would repay all investors at par plus accrued interest, rather than at market value.

The company had referred the matter to its trustee, Guardian Trust, which had confirmed that ‘’par’’ was a repayment option for FPF.

Over the next weeks discussions would have taken place, but we were delighted to hear last Friday that FPF’s Board of Directors had reconsidered the matter and that as a result FPF would pay par, or market value, whichever was greater.

This may seem a pedantic issue but to the thousands of investors involved, it was important for several reasons.

Prime concern was that the company had created an expectation of ‘’market value’’ in its documents.

Almost as important was that market practice for decades had been to prepay market price when an early settlement occurred.

If a company seeks to gain from repaying early it was entirely logical that no investor be disadvantaged.

An investor who in 2015 had selected a five-year term at 6.5% per annum, expected to earn 6.5% till 2020, not until an arbitrary earlier date.

As rates have fallen, the market rate for a 2020 FPF debenture today would be nearer 4.75%p.a, meaning an early repayment at par would cost the investor 1.75%p.a for two years (3.5% total value) of lost income.

A $50,000 investment losing 1.75% for two years, is a real loss of $1750, hardly an irrelevant figure.

So had FPF repaid at par, it would have been defying the expectation its own documents had created, it would have been breaching market conventions and it would have been ripping off some investors.

To its great credit, the FPF board, chaired by former Deloittes accountant Carlos da Silva, reviewed its decision to repay at par, and reversed it.

All investors will be paid at par plus accrued interest BUT those whose market value would have exceeded par will get a second cheque, soon, reflecting the additional value of their investment.

A national accounting firm will independently establish the market value. FP Finance will accept that valuation.

One hopes that the accounting firm consults with the major broking firms, FNZC and perhaps Craigs, to discover market value.

We are happy to provide the following guideline.

Were we asked to raise money for FPF today we would be certain that a rate of between 4.25% and 4.75% would attract a large level of support for terms of one and two years respectively.

Therefore any investor holding a 6.5% debenture with a March 2020 maturity should attract a healthy premium, perhaps of 1.75% for each year.

We will watch carefully to ensure the market rates are realistic. We do not want to contest the result of the accounting firm’s work.

There were two issues that arose during this process that all investors should consider.

The National Business Review reported, via its journalist Tim Hunter, that it rang FPF to discuss its original, poor decision.

Hunter noted that after that discussion, FPF seemed to change its mind.

If the two facts – the phone call and the new decision – were linked, then every investor owes a vote of thanks to Hunter and the NBR.

New Zealand has been poorly served by the low level of expertise in business and financial pages of our daily papers, where inexperience and goofiness is commonplace.

NBR has been lifting its efforts in recent months and may be the sole influence in fourth estate business matters.

I have long argued that an informed experienced business press is an important issue for investors, offering an option to sort out real issues, and mitigate corporate excesses or poor behaviour.

I note that none of the daily newspapers even mentioned the FPF issues, despite it affecting literally thousands of investors.

In recent years, the NBR seemed confused about its role, sometimes placing a focus on childish columnists, and seeming to be driven to cover only those areas where advertisers would be looking.

There is evidence that the business paper is now discovering that the people who buy business papers are looking for coverage of business news, and for investigations into controversial business practices.

Those who want to read about politics, or wine, or cars, or flower displays buy the appropriate magazines.

If the NBR’s apparently greater focus on business and investment issues helped FPF to make a better decision, we should all applaud.

The second issue this FPF decision has raised is the utter ineffectiveness of trust companies.

FPF referred the matter to a young man in Guardian Trust, which acts as FPF’s trustee.

This company, presumably a division now of the controversial Perpetual Guardian Trust, is paid to ensure that the FPF trust deed is honoured by FPF, its covenants never breached.

The theory of this role is that it protects investors by ensuring the company respects the promises it made when it set out to attract investors’ deposits.

The investors see the trustee as their guard dog.

In the 1970s and 80s trust companies were well-staffed, solid organisations which performed their task admirably.

When I managed a moneylending company Industrial Advances Ltd in 1980, amongst my tasks was to read the trust deed, and to liaise with the trustee to ensure the behaviour of our company met the letter and the interest of the deed.

The trustee was the judge. He became a useful adviser for me.

Note that in the late 1980s, when virtually all the major finance companies failed, closed down, or were merged, no investor lost money.

I refer, of course, to the major companies like NZI Finance, Broadlands, Marac, General Finance, AGC, Natwest Finance, NAB Finance, and even Auric Finance.

Despite the discontinuation of those businesses, no debenture or unsecured note investor lost a dollar.

Compare that to the experiences in 2006-2009, when literally four dozen finance companies closed down and in nearly every case, the investors were slaughtered.

Could it be that the trust deeds had become cynical or meaningless documents?

Could it be that the country mice engaged by trust companies were good at nibbling cheese but hopeless at scaring the daylights out of finance company owners?

Certainly my observation was that deeds in that later period were dreadfully written, cynically exploited, and policed by people without the energy, intellect or inclination to be the investors’ guard dog.

In the FPF case, the response of the Guardian Trust to FPF’s question should have been to note that every investor would have believed ‘’market price’’ meant only one thing. Fair current value.

The trustee should have examined market practice and noted that all other early repayments would be priced at market.

He could have quoted many examples, the most recent being when UDC Finance thought it had sold itself to a Chinese buyer and thought it would be repaying investors early.

When UDC offered to pay out, it offered investors the right to stay with a similar security (switching to an ANZ term deposit) or it offered to simply switch to a new security with the new owner.

Guardian Trust, the pitifully inept trustee for Eric Watson’s and Mark Hotchin’s Hanover Group of toxic nonsense, earned no respect from me.

Indeed my respect for the value of trust companies is as low as Cape Town’s water supply.

I see no trust company behaviour in any of their product range that offers fair value for their fees and continue to urge all investors who have appointed a trust company to manage an estate or a family trust to reverse their decision before it is too late. Re-Write your will with a lawyer and cut trust companies out of any ongoing role with a trust.

The performance in the FPF issue underlines that disrespect.

How absurd that the NBR might be more effective than a highly paid trust company!

 _ _ _ _ _ _ _ _ _ _ _ _

THE reported results of Summerset, which owns a large number of retirement villages, should lead to questions being asked about the fund management sector.

Summerset reported a nett profit of some $220 million and advised of a significant lift in dividends.

Its result led to a 15% share price lift and led to a temporary lift in the price of Metlifecare. Metlifecare reversed this when it reported this week a drop in profits, its leaky homes costs and problems leading to a lower level of sales, higher vacancies and less income (empty homes). The claim that the fall in profit arose from stabilising prices in housing markets was spin and not very skilled spin.

The fund management sector comes into the spotlight because its forecasts of retirement villages, and its anticipation of their growing profits, have been astray for too long.

Perhaps there is a reason for this.

Regularly I read reports suggesting that retirement village profits are dependent on real estate price rises, often tracking the Auckland property market process and linking those to the likely profits of the villages.

Metlife encourages that view, but I have my doubts.

To some extent, but perhaps a small extent, house prices are a factor in village profits.

It is true that a modern retirement village villa will be priced at about 70% of the average house cost in the relevant area.

So if house prices rise, villa prices increase and the major village operators, Ryman, Summerset, Metlifecare, BUPA and Oceania will enjoy greater profits.

However the factors that drive villa prices are greater than just local house prices.

A couple buying into a villa today are likely to be in their late seventies.

They will agree to pay a price for their shelter (villa) but their willingness to pay will also relate to their perception of the value of guaranteed geriatric care, available if needed.

As the perceived value of that care rises, the higher price they will pay.

That mindset is likely to grow unless the Crown or anyone else, ever offers to provide a similar level of access to a high standard of geriatric care.

My view is that the current estimate of price (say 70% of the local average home) may easily become 80%, as demand continues to exceed supply, providing the reputational issue is favourable.

There is one other factor that never seems to attract discussion.

Until two years ago, geriatric care was offered at a price set by the Crown.

The price set would protect the Crown as it pays the cost of a high percentage of all those who receive geriatric care from villages and rest homes.

Two years ago, as a bargaining tool to encourage more rest home beds to be built, the Crown agreed that operators could charge willing financially independent clients much more per year, if the rest home room was of a ‘’premium’’ standard.

In effect, this meant anyone who had the money could be asked to pay much more for a room with a view, or an ensuite bathroom.

Rymans immediately added close to $20,000 per year on to ‘’premium room’’ charges, snaring additional profits of tens of millions, without more cost.

Indeed all providers reviewed their prices upwards.

The likes of Oceania Healthcare, selling apartments in Lady Allum in Takapuna, began to build luxury (but small) apartments and sell them for more than a million.

Monthly charges had the potential to boost their already huge profits.

House prices in the area helped them sell for the obvious reason that a couple selling a house in Devonport for $2 million could afford a $1.5million, 80 square metre apartment, and would do so if high quality geriatric care would be provided if required.

Retirement villages with a high weighting to villas or apartments, and with presentable rooms for those needing care, will make much more money than the fund managers forecast, providing demand exceeds supply, providing no one else offers geriatric care, and providing the sector is not regulated. Any under-performer needs to be assessed by its standards.

After 30 years in the sector, with twenty as chairman of Parkwood Retirement Village, I would have been asleep at the wheel not to observe these changes.

Parkwood, run by a community charitable trust, is a quite different model, with no vision of massive profits, but it was the first village, it remains one of the biggest (300 residents) and by most external assessments remains an example of a well-managed village. (I retire from the board in a few weeks, to create time to write a book – or at least a manuscript!).

_ _ _ _ _

On March 27, the Christchurch branch of its NZ Shareholders Association have kindly asked me to speak on the subject of changing Strategies for investors in the 2018 financial markets.

The NZSA have offered to host at that meeting any of our clients, or indeed any who regularly read these weekly newsletters.

The meeting will be at 7pm at St Cuthberts Hall in Avonhead, Christchurch.

To ensure there is appropriate seating, any client or reader planning to attend is asked to email or ring Penelope, Sue or Tania at our office and record their planned attendance number.

 _ _ _ _ _ _ _ _ _ _ _ _

TRAVEL

I will be in Christchurch on March 27 and 28.

Michael will be in Tauranga on 5 March.

Edward will be in Auckland (Remuera) on 10 April and Albany on 11 April.

Kevin will be in Christchurch on 22 March and Ashburton on 12 April.

David Colman is planning trips to Palmerston North, Whanganui and New Plymouth in March.

Our future travel dates can also be found on this page of our website: https://www.chrislee.co.nz/request-an-appointment

Any person is welcome to contact our office to arrange a meeting.

Chris Lee

Managing Director

Chris Lee and Partners Limited


This emailed client newsletter is confidential and is sent only to those clients who have requested it. In requesting it, you have accepted that it will not be reproduced in part, or in total, without the expressed permission of Chris Lee & Partners Ltd. The email, as a client newsletter, has some legal privileges because it is a client newsletter.

Any member of the media receiving this newsletter is agreeing to the specific terms of it, that is not to copy, publish or distribute these pages or the content of it, without permission from the copyright owner. This work is Copyright © 2018 by Chris Lee & Partners Ltd. To enquire about copyright clearances contact: copyrightclearance@chrislee.co.nz