Chris Lee & Partners Ltd

Taking Stock 25 March 2021

THE comfort level of investors in the past decade has improved, though it might be optimistic to describe that level as restored.  The next year may well bring change.

As we saw last year when Covid appeared, extreme volatility can arrive overnight.

The fear of that unacceptable loss of value remains present for many investors whose savings have been capped by retirement, yet investing in NZX-listed shares is rising significantly.

One reason – the main reason – for improved comfort levels has been the performance of economies and markets.

Since 2011 inflation has been low, unemployment low, failure rates of listed securities extremely low, and the glow that many will have gained from the rising value of their property portfolio has been constant and reassuring, in NZ and elsewhere.

The market has fuelled confidence.

Adding to that confidence has been the reduced number of false prophets or, if you like, rip-off merchants, who prospered in the 1990s and the 2000s.

Far too few of these ugly cheats ended up in jail but we can all celebrate the current invisibility of many of those people who destroyed wealth.  They ''retired'', without dignity.

I refer here to the types who furtively promoted the likes of the ponzi operator David Ross, to those who created selling chains, blitzing the media with phony promises and, especially, those who created finance companies and built trust while treating the money of investors as their own.  (One wonders how their parents would feel about their progeny.) 

Comfort levels in investors bottomed out when those grubby merchants, after stuffing ill-gotten assets into family trust structures, declared themselves ''bankrupt'' and prepared for a period of comfortable invisibility.

What had allowed all of this despicable deception to blossom was a period of lazy, uncaring government, most notably in Helen Clark's tenure as Prime Minister, and an inexplicable era of dreadful regulatory laziness, resulting from regulators without social and governance intelligence.

One could argue that the recovery of comfort levels has occurred since the Financial Markets Authority replaced the Securities Commission in 2011.

The Minister of Commerce at that time was Simon Power, then a bright young man with a background in law, often thought to be a future Prime Minister, till a massive error with South Canterbury Finance changed his horizon.

Power had tackled what earlier politicians had neither the wit nor energy to address, introducing new law that chased away about 10,000 exploitative financial salesmen, bringing in laws and penalties that altered the return/risk equation for incompetent financial advisers, and the finance company cheats.

The FMA was given a much larger budget, sufficient to incentivise the likes of Sean Hughes, and a team of largely female lawyers, to pursue those who were cheating investors.

Hughes, from a banking background, bristled, and for a few years was brave enough to endure the personal attacks that were being used to undermine him by those who feared being revealed.  He was greatly helped by Liam Mason, who remains the FMA's respected counsel.

When Hughes' energy had been sapped the FMA found Rob Everett, a British lawyer who had market experience gained with international firms like Merrill Lynch, where he would have mixed with people, many of whom were exploiting poor practices.  He knew where to look.  He was not as visible as Hughes but oversaw continued improvements in regulatory supervision.

Last week Everett announced his retirement, leaving the FMA to find someone with similar skills, energy and motives.  Everett has led the FMA with dignity and skill for roughly seven years, and has had a hand in creating a more comfortable environment for investors.

The task of replacing him should prompt his governors and the Government to analyse what the FMA needs to do differently, and to consider how to remove any hurdles that Everett has successfully negotiated.  Definitely the FMA needs a larger grant from the Crown.

It is the Government that appoints the board that governs the regulator.

Governments have the habit of rewarding political friends with appointments to such roles, and often make soft appointments, using people who meet social objectives rather than best practice.

The current Government is painfully inexperienced in financial markets, has an amiable but naïve commerce minister, and is not greatly helped by a public sector that is strong only in a few areas, business and financial markets not being one of those few areas.

The public sector plays a role in advising on these FMA appointments, but this task is not one that the public sector handles well.

Perhaps now is the time to reassess what one wants from the board of such an agency.

There have been too many incompetent appointments in the past, and too often the competent people, whose personal politics should be irrelevant, have found the environment not conducive to effective governance, so have resigned.

A review now might look at the type of skills needed to advance the FMA, given that Hughes and Everett have created a regulator that has won respect from many quarters.

Does the task of its CEO now best suit a trained lawyer, or a person with wide financial market experience?

Do we want a New Zealander, or should we import someone from another jurisdiction?

Do we need to be concerned about the frequency with which FMA executives use a short stay with the regulator as a career move to be followed by private sector plum jobs, achieved by selling the notion that the new private sector employer will benefit from ''inside'' knowledge of FMA plans?

This type of issue is debated loudly in the USA, where Goldman Sachs has benefitted greatly by encouraging crossovers between their company and the public sector.  Goldman Sachs almost owned the public sector in some eras.

It is much easier to avoid regulatory intervention if one knows the weaknesses of the regulator.

The exit of Everett ought to prompt a review of governance and executive appointments to enable the FMA to maintain the momentum that has improved the environment here.

Investor comfort levels have definitely improved in the past decade, despite some examples of political appointments designed to impress voters, rather than to oversee effective change.

Across town the other regulator, the NZX, is now providing proof that led by the right man, it can restore investor faith.

Obviously, the performance of markets, and the relatively benign economic environment, would be a major factor.  But in my view significant credit should go to those who have tidied up the NZX and what was the Securities Commission, both of which deserved their poor reputation in the 2000s.

The current NZX chief executive, Mark Peterson, would be an excellent candidate to run the FMA.

Given that he is busy now, and must enjoy his role, his availability is doubtful but if the FMA could find such a thoroughly decent, experienced person from a banking and financial markets background, investors would benefit.

Comfort levels would stay on a rising trajectory.  And we might never again observe such dreadful law as the recently enacted Insolvency Practitioners Act, a law which brings shame on the receivers and lawyers who helped to concoct it, in my opinion.

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ONE most important issue that Everett could help resolve, by combining with Reserve Bank governor Adrian Orr, would be the defining of what constitutes a fit and proper person.

Anyone who had investigated the failures of listed property companies, unlisted property syndicates, investment companies, and finance companies would have identified literally hundreds of people who were neither fit nor proper and should never have been in control of other people's money.

Currently no organisation is effective in ruling out unfit and improper people.

One of our country's best and most socially aware legal people explained to me that the failure to exclude unfit and improper people came down to a lack of agreed criteria to use as a base measuring tool.

If Orr or Everett ruled that someone was unfit or improper, an appeal to the High Court would focus on the criteria applied in reaching this decision.

Obviously someone who had criminal convictions or was accountable for previous corporate failures would be excluded, and the court would support the ban.

But how does one judge immoral behaviour, or anti-social tendencies, or greed, or inappropriate experience?

If I were the judge, I would probably regard a career in politics as a significant negative, given the prevalence of failures of companies' window-dressing their image by seeking out ''names'' rather than substance.

Should there be a matrix that might rule out someone whose point score reached 10?

Previous convictions for crime - 10 points

Previous governance failures - 10 points

Irrelevant experience - 10 points

Previously bankrupted - 10 points

Anti-social behaviour - 10 points

History of lying - 10 points

No doubt there would be other criteria.

Some might allocate demerit points to retired politicians.

Were the Reserve Bank and FMA to publish such a matrix the outcome might be far fewer of the old boys' network appearing in positions for which they were clearly inappropriate.

My own hobby horse is the great value on boards of people from engineering, science, and rural backgrounds, people who have been business owners and been accountable for paying their bills, people who are truthful and analytical, and are not motivated by greed.

Might Rob Everett's parting gift to the public sector be a contribution to building a matrix, aimed at excluding unfit and improper people from governance and executive roles?

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Johnny Lee writes:

ONE of the concerns that weighs on the minds of financial advisors today, and indeed the financial community at large, is the sheer volume of money entering financial markets, especially from the younger generations, as asset prices continue to hover near-record highs.

Across the spectrum – from property to shares to cryptocurrencies – prices remain at highly elevated levels.  The dearth of competitive offerings from the term deposit sector has led to many re-engaging with higher risk products, chasing an improved rate of return for their accumulated savings.

The shift has been remarkably fast paced.  Just five years ago, the suggestion that an invented cryptocurrency would have a market value equivalent to the entire New Zealand housing market would have elicited scepticism from all but the most ardent of believers.  Meanwhile, on the sharemarket, some share prices have doubled or tripled over this timeframe (Mainfreight has quadrupled).  Property values have also seen astonishing gains.

As the Government debates efforts to rein in this house price inflation, the combination of low interest rates, the growth of Kiwisaver and increasing access to sharemarkets has helped lead share prices higher, while risk and volatility have increased alongside it.

Those with the benefit of financial advice – qualified, not social media – have been able to boost income while remaining within the sphere for credibility, investing carefully into companies with either an essential product, a dominant market position or a major competitive edge.  While there is no hiding from risk, the risk of total failure from these companies is remote, short of a truly calamitous event.

Other companies have also benefited from this general re-pricing of risk.  Across the globe, companies are seeking to capitalise on this by listing their companies on the sharemarket.

In some ways, this shift along the risk continuum is a huge positive for the country.  Businesses seeking capital to fuel growth (more on that in a moment) can enjoy more competitive pricing, and upscale ambitions.  The recent Contact Energy issuance, funding the construction of more geothermal electricity generation near Taupo, is a good example of the benefits associated with a deeper capital market.

However, it does expose us to additional risk.  Regulators will, hopefully, detect and punish any outright cheating.  But regulators do not normally intervene to stop investing into assets that are perceived to be overvalued.  Investors take this risk, and with the aid of financial advice, must make these determinations.

The right balance must be struck.  If we are going to see the expected raft of new issues over the next year or so, investors will need to be diligent in ensuring that these opportunities are fit for purpose within their portfolios.

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THREE important announcements of note this week:

Oceania Healthcare (OCA) has announced a $100 million dollar capital raise, to aid in the acquisition of a retirement village in Auckland and its adjacent land.

The $100 million will be made up of an $80 million dollar institutional placement (already completed) and a $20 million dollar retail placement.

The registry is currently advising shareholders regarding the retail placement.  The offer will give existing shareholders the opportunity to buy up to $50,000 worth of stock at a price of $1.30, or a lower price if it falls closer to the closing date.  Scaling will apply if the small offer closes oversubscribed.  The recent Contact Energy offer, many times larger than this, closed more than three times oversubscribed.

Scales Group (SCL) confirmed its interest in acquiring a shareholding in the well-named Villa Maria Estate in Marlborough.

This transaction is still in a preliminary state, and as such, details are scarce.  However, early indications suggest that if the transaction did proceed, the cost would necessitate the company raising additional capital. Existing shareholders, typically, would be invited to such a capital raising, meaning current SCL shareholders may want to maintain a slightly larger than usual cash balance in the short term.

Presumably, investors could also expect a sudden willingness for analysts to increase coverage of the company, and conduct ''research'' on its products.

Lastly, Westpac Bank (WBC) has indicated it is conducting a review of its New Zealand assets and considering a ''demerger'' of its New Zealand arm.  There is no indication on how such a demerger may take place, or if the intent of the review is even genuine, or simply gamesmanship following its ongoing issues with the Reserve Bank.

Nevertheless, if the demerger does proceed, and Westpac decides to proceed with the long-rumoured IPO of its New Zealand arm, it would mark by far the largest IPO in recent memory, dwarfing the size of the electricity generators when they listed last decade.  Such an IPO would be among the largest companies on our exchange and require an enormous effort from capital market participants.

We will continue to advise as the situation develops.

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Travel

Edward Lee will be in Nelson on Wednesday 14 April (morning only) and in Blenheim on Thursday 15 April.

David Colman will be in Palmerston North on 21 April, in Kerikeri on 6 May and Whangarei on 7 May.

Kevin will be in Timaru on 27 April.

Please contact our office for an appointment.

Chris Lee will be undertaking no further travel for several months.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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Taking Stock 18 March 2021

AS the National Party struggles to develop a pathway returning it to power, the somewhat undistinguished co-authors of its secret review ignore one episode that encapsulated a reason for its electoral failure.

The reviewers hardly represented medal standard in governance.  Yet they needed to perform no more research than read chapters 10 and 11 of the book, The Billion Dollar Bonfire, which chronicled the empty-headed behaviour of many people and organisations.

The emptiest heads were in John Key's National government, whose vanity and chicanery threw petrol on what might have been reduced to a harmless backyard fire.

I offer this heads up to those party reviewers not to sell the small number of unsold books in our office or with the distributor.  Indeed, whatever is unsold I plan to offer to universities, maybe Victoria, but maybe any university, perhaps for use in any business course investigating politics, business ethics, leadership, or competency.

My suggestion to the National Party is to read at least chapters 10 and 11, and then reflect on the sort of people National needs to seek out to ensure it never again disgraces itself in public.

If the party could attract people who would forget about petty, selfish politics, and focus on a SWOT analysis of New Zealand, followed by a detailed strategic plan aimed at pursuing an intelligent pathway to improve outcomes for the people and the economy, then we might recapture some hope that the democratic process has a value, and that National could offer progressive leadership.

The chapters politicians (and students) should read refer to the schoolboy-like errors that led to the wrongful stigmatising of Allan Hubbard, all preventable if New Zealand had had competent leadership.

The awful behaviour of politicians, public officials, underpowered financial advisers, selfish lawyers, and grossly inadequate insolvency practitioners, cost New Zealand a billion dollars, cost the South Island a source of investment support, and brought great shame on New Zealand.

Perhaps, from what Key once said (''a hundred million is chump change'') one might infer political indifference to the outcome.

A range of hitherto electable politicians were left with a legacy no dignified person would want.

The errors began in February 2010 when an unsigned letter posted to the Securities Commission made the observation that one of Hubbard's lending vehicles (Aorangi Securities) was breaking the law.

The letter observed that Aorangi should have attracted funds only after presenting a registered prospectus and investment statement.  It went on to allege that Forsyth Barr, the financial adviser to Hubbard's main vehicle (South Canterbury Finance), had so much client money invested there that its ability to do its job was ''conflicted''.  (My own opinion is that the letter-writer should have assessed competence rather than conflict.)

The author of the letter was a supporter and friend of Key, and the National Party.

Prompted by this letter, the inept Securities Commission, by then in its most vulnerable state, selected an investigative team to head to Timaru and examine Hubbard's Aorangi moneylending business.

The team comprised two experienced forensic investigators, John McPherson and Denis Parsons, the then head of Grant Thornton's receivership division, Graeme McGlinn, and a young lawyer, Sarah Burnett.

In June 2010, they arrived in Timaru at Hubbard's office, seeking and being given a complete list of Aorangi's assets, comprising mostly loans and a few dairy farms assigned to Aorangi.

Hubbard and his wife Jean, and in one case their family trust, had injected their interests in these farms to offset any doubtful loans, thus honouring their commitment to use their own assets to protect Aorangi investors.

The investigators proceeded to make a series of schoolboy-like errors, an astonishing situation given that McPherson and Parsons were both admired for careers where thoroughness was essential.

The team discovered that Hubbard had part-owned the farms and could find no evidence that the farms owed Aorangi money, so they assumed he had personally borrowed from Aorangi to buy into the farms.

The reverse, of course, was true. He had long owned the assets and had transferred his equity in them by journal entry to bolster Aorangi.

The investigative team made the unforgiveable and crass error of making assumptions, then failing to validate them.

All they needed to do was to check the cash book, or the cheque books, or the bank statements, to discover whether Hubbard had ever borrowed money from Aorangi.

It seems that the apparently competent, experienced team failed to do this.

As a consequence, a whole series of crass decisions were made, none of which were ever preceded by even the most basic research, by any party involved in the disastrous episode.

One might surmise that what the team thought they had found might have suited the mindset of Key's government, which by then could see the support Hubbard had in the South Island included many National supporters, whose loyalty might have been greater to Hubbard than to National.

Perhaps the looming 2011 election meant more than sound decision-making on matters like Crown money.

After the team had reached their false conclusion in Timaru, they must have asked Hubbard if he was aware that borrowing from Aorangi would be an act of fraud.

Grumpy, busy, and disrespectful of meddling bureaucrats, Hubbard could easily have nodded, maybe even adding that of course such behaviour would be fraudulent.

The team scuttled back to Wellington, met with the available people in the Securities Commission (its short-lived acting chair was out of town) and reported that not only had Hubbard committed fraud, but had ''confessed''.

This conclusion was not tested with Hubbard, the directors of Aorangi, or supported by simple accounting records.

From that dreadfully wrong information all hell broke loose, the public sector and Key's National government behaving like juveniles at a street party.

Within 24 hours, the Securities Commission had recommended to the National government that Hubbard should effectively be ''handcuffed'', subject to statutory management, a very rarely used response to fraud when public money was at risk.

The Commerce Minister Simon Power, and then a grouping of cabinet (Key was overseas watching football), chose to place the Hubbards and some of their companies into statutory management.

In doing so they speculated that tens of millions of public money would be lost, that fraud was alleged, and for the next six months they repeated these words, even publishing a flow chart that falsely depicted Hubbard borrowing from Aorangi (unsecured) to buy farms.

The flow chart was simply wrong, premised on incompetent findings.

Hubbard was thus sidelined, stigmatised, his supporters stunned to learn he had confessed fraud.

Hubbard had not borrowed Aorangi money.  He had donated assets and subordinated his gift to put investors first.  He had most certainly not ''confessed'' to something he did not do.  No investors lost money.  Assets exceeded liabilities.  It was the accusation that was scandalous.

Whether these initial errors were welcomed by the politicians to exclude Hubbard from the agenda before the next election is simply guesswork, but such a theory has at least a kernel of logic.

Here is the point that brings emphasis to the shameful decision-making and behaviour.

Within a week of being appointed, the statutory manager discovered the journal entries, discovered the origin of the farms, discovered Hubbard had not borrowed money, and must have known that the ''confession'' story was colourful but balderdash.

Yet the National government, having specifically stated that Hubbard was being sidelined because of these ''illegal'' borrowings, did not reverse the decision.  Perhaps somehow the news never reached the politicians, improbable though this seems.

Furthermore, National and Key in particular, went on to make a series of the sort of goofy errors that usually would be made only by people with shallow commercial acumen and a propensity to gloss over Crown errors, without any respect for transparency and accountability.

Key and his cabinet proceeded to make a series of appalling errors, clinging to the discredited notion that Hubbard was a fraud who had enriched himself with other people's money, invested in Aorangi.

The politicians declined an offer to sell Hubbard's assets to a buyer who offered a minimum price hundreds of millions more than a receiver would collect, as Treasury had correctly advised.

The offer included the prospect of a profit share.  Had it been accepted, South Canterbury Finance would either have been resuscitated, or the ultimate outcome would have been a minimal loss, possibly even a profit, for the Crown.

The politicians were strongly advised to supervise independently the inept receivers. Key vetoed that. Um . . . why?

The receivers, McGrath Nicol, perhaps not helped by some fairly limp legal advice, grossly underperformed, not prevented by the Crown from flogging off assets at fire sale prices at a time when everyone, including the National government, knew that markets were distressed, indeed disabled.

Public funds were incinerated, a billion dollars or more, unnecessarily tossed towards those who bought the assets at the fire sales.

Bill English said in public the receivers would be instructed to recover money over at least four years allowing the true value of the assets to be reached.

The receivers sold virtually everything within two years, at nonsensical prices.  The book spells out these follies.

The so-called businesslike National government's legacy for that appalling episode rightly condemns their people as inept, poor listeners, poor users of research and advice, perhaps, in my opinion, far more focused on a convenient outcome than on what I would call their fiduciary duties.

The behaviour exhibited would be seen by me as proof that the decision-makers had no rightful role in governance.

The facts, with supporting documents, many provided by the Crown itself, and later verified by a High Court judge, display a political party of people of no obvious merit, in that era.

If the National Party is to attract votes in big numbers again, its aspiring candidates should first read the chapters, re-examine their personal motivations to get into politics, brutally assess the authenticity of their personal governance skills, and only then decide whether they are fit to govern the country.  Key's government had shown it was not fit to govern.

That is not, of course, to say that any other political party should be exempt from such critical self-examination.  Democracy has delivered competence in recent decades but only on rare occasions.

The Hubbard/Aorangi/SCF debacle recorded in The Billion Dollar Bonfire was once described by Winston Peters as ''essential reading'' for all serious journalists.

I would have liked him to add all political aspirants to his list of essential readers.

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Johnny Lee writes:

Z Energy Limited shareholders received a brief moment of sunshine yesterday, with the company announcing a return to dividend payments.

Z Energy was heavily impacted during the Covid lockdowns last year, with movement restrictions and border closures having a predictable impact on fuel consumption.  With a month of virtually no cars on the road, coupled with an almost total reduction in jet fuel usage, the clouds over the company were darkening.

Following a period of negotiation with its nervous lenders and the raising of more capital, new terms were negotiated, and a restriction applied to distributions to shareholders.  Subsequent negotiations, the conclusion of which were announced yesterday, have brought these restrictions to an end, with a 12 to 14 cent dividend now expected in May this year.  The share price climbed following the announcement.

March last year saw many people exit the likes of Z Energy, Air New Zealand and Auckland Airport.  With fears around Covid at their highest point, and data from those countries facing the early onset of the virus looking particularly ominous, markets around the world tumbled.  None of these companies have yet recovered in share price, with Z Energy amongst the first to return to dividends.

Such a return to dividend payments would be predicated on something of a best-case scenario – a single, effective lockdown, the development of a vaccine and a successful rollout of such a cure to the current coronavirus, the absence of any errant variant, and the restoration of normal consumer behaviours and habits.  It remains to be seen whether this scenario plays out, but investors are clearly hopeful, and Z Energy is clearly confident.

This is the second announcement from Z Energy in recent times, the other being last week's announcement regarding its foray into the electricity market.

Z Energy announced a new product, in partnership with its subsidiary Flick Electric, selling electricity direct to retail consumers in competition with the likes of Mercury, Contact and Meridian.  Unlike these companies, Z Energy would be strictly a retailer, offering no generation capacity as yet.

Electricity retailing is a competitive arena.  Trustpower's recent announcement of a strategic review may lead to the company parting ways with its retailing arm, returning its focus to generation.  As one firm exits, another enters.

The announcement was perhaps a glimpse into the strategic direction the company is looking to move.  Fuel distributors face something of a dilemma in today's environment, with improvements in technology, and societal and Governmental changes, actively eroding their viability as a business model.  As transportation moves to a focus away from fossil fuel usage, these companies will need to adapt.  The speed at which this adaptation is necessary may be unknown, but it is undeniable that such change must eventually occur.

The company also hinted that it has ambitions beyond electricity retailing, suggesting it may seek a leading role in the home solar and battery market, perhaps even extending to a leasing service of electric vehicles.  Electricity retailing may be just a first step.

Z Energy's announcements over the past fortnight will provide some comfort to those long-term shareholders who perhaps invested with an eye towards long-term dividends.  While risks remain, the short-term picture is one of a profitable company paying dividends, while maintaining an eye towards the future.

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A RIDDLE: what do you get if you send a $1,400 (per adult and dependant) cheque to 159 million American households, regardless of financial need?

We should have an answer in the days to come.

The arrival of these funds will be welcomed by many, including those tens of millions struggling with job loss, ill health, or compounding debt.  As we have observed with previous stimulus payments, many recipients who have not endured such hardships instead turn to investment.

The renewed enthusiasm across stocks like GameStop, Blackberry and AMC Entertainment, as well as a spike in some well-known cryptocurrencies, will be spurred by a range of factors, including the stimulus package.  The Dow Jones has climbed 10% in the last week, off an already high base, indicating that enthusiasm for shares is widespread.  However, the continued outperformance in the rally across these stocks is surprising.

The sustained enthusiasm has been perhaps the most puzzling aspect of the climb.  Most would have assumed the rush would be short-lived, with momentum dying as attention turns to the underlying performance of the company and the likely evolution of the business model and the sector within which it operates.  Instead, the likes of GameStop have doubled again in ''value'', as buying continues to pour in, and new shareholders refuse to sell, draining liquidity from those trying to short the stock or buy back outstanding short positions.

Meanwhile, Bitcoin's total value has exceeded a trillion US dollars – $1,000,000,000,000 – and so-called ''crypto ETFs'' are seeking to capitalise on this enthusiasm, looking to raise money from the public to pour into the sector.  Meanwhile, the Indian Government is considering becoming the largest economy to ban ownership of cryptocurrencies.  The one certainty on offer seems to be that, in 12 months, there will either be some very happy holders or some very unhappy holders.  One hopes, to paraphrase New Zealand's leading economic author, that we are not about to witness a trillion-dollar bonfire.  (Bless you, my son – ed).

New IPOs are doubling in value, merely days after listing.  Companies are rushing to capitalise on this, seeking to raise capital or sell down holdings while market valuations remain at elevated levels.

In New Zealand, at least two further listings are expected within the medicinal cannabis space.  At the other end of the spectrum, Contact Energy's capital raising, seeking $75 million of investment, closed three times oversubscribed, forcing severe scaling on smaller shareholders.

It is clear that there remains an abundance of money seeking investment opportunities in both the retail and wholesale space.  While underlying swap rates have climbed over the past month, and opportunities in the fixed interest space have improved, the tide has not yet turned, and investor enthusiasm continues unabated.

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Travel

Edward Lee will be in Nelson on 14 April (morning only) and in Blenheim on 15 April.

David Colman will be in Palmerston North on 21 April, Kerikeri on 6 May and Whangarei on 7 May.

Chris Lee will undertaking no further travel for some months, details to follow.

Please contact our office for an appointment.

Chris Lee

Managing Director

Chris Lee & Partners Limited

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Taking Stock 11 March 2021

IF we believe the bankers in the USA, the world should be celebrating a new solution to hardship.

Print money; trillions of it.

Goldman Sachs has announced that by printing a further two trillion dollars the US will this year reduce poverty by a third, grow the economy by a stunning 7%, reduce unemployment and greatly reduce inequality.

The BNZ reaches similar conclusions, forecasting that the US stimulus (of trillions) will lead to growth, and even higher asset prices, in the world's biggest economy.

Perhaps the BNZ is recalling that Trump's stimulus package fell into the hands of people, 37% of whom used the money to buy more US listed shares.

If Goldman Sachs and the BNZ should prove to be insightful, the rest of the world should prepare to gear up their printing of money. We would have a simple solution for all our problems. Lower unemployment, growth in domestic production, reduced poverty, reduced inequality and growth in share indices would combine to please many people.

But among the issues not addressed are inflation, which might not hide forever, and the effect on the planet of exponential increases in consumption.

If, in the interests of a functional society, we want the less advantaged to have more with which to consume, some might argue that such a desirable outcome would be sustainable only if we have a matching reduction in the consumption of the rich.

Nevertheless, at least superficially, it is encouraging to harbour the thought that printing money might be a solution.

Naturally, not all agree.

The influential and widely-read economic commentator John Mauldin warns that the base statistics from which forecasts are made are horribly wrong. His analysis is that true US unemployment is roughly double the official figures, certainly in double figures.

He argues that the definition of unemployment – those who are actively looking for a job and cannot find one – misleads the nation. Millions of people, he estimates, are unable to look for jobs because of home circumstances, or have given up hope at a premature age.

He also notes enormous fraud in the unemployment claims, and alleges organised crime in the USA and in Russia is milking the unemployment budget.

Another to offer a different perspective is Jeremy Grantham, a respected fund manager (Grantham, Mayo, van Otterloo – GMO) now in his 80s, regarded, like Warren Buffett, as a sage.

He warns that the pricing of US assets – shares, property, cryptocurrencies, bonds – is so stretched that a savage correction will happen. (Sadly, he does not provide the timing of this event, but just notes it will happen.)

Buffett's own view is discernible through his investment decisions. He has stockpiled a mere US $130 billion, to be used when asset prices are fairly valued. He took that position a year ago, unconvinced that the damage caused by the Covid virus was being reflected in prices.

Might the key issue come down to this question?

Does the printing of money (stimulus) produce short-term sugar rushes, or does it simply further defer reality, taking away from future generations any hope of enjoying the living standards that people of my age (70) have basked in, for the past six decades?

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GRANTHAM and his fund management operation GMO may not be well known to New Zealanders whose experience has been gained only in recent years.

But in the 1980s, GMO was the centre of news here in New Zealand, having decided to take a huge stake in the recently-listed property company RJI, a company created by the property enthusiast, Jones.

Having made the investment decision, perhaps with insufficient due diligence if judged by today's standards, GMO then rapidly lost its love for the investment, ultimately taking a long-term unflattering view of New Zealand's capital markets in the 1980s.

Of course, these were the nascent years of today's markets, reflecting the period of idiotic Roger Douglas-inspired moves from a Soviet-style over-regulated market to an unregulated Dutch tulip bulb lookalike, the 1980s being an era of transition in regulations, accounting standards, and corporate mores.

The Jones company, of course, was an early pioneer of the Employee Unit Trust structure, which allowed companies to buy shares in itself, a previously debarred activity.  The company used this option enthusiastically, without any noticeable disadvantage to the company's share price.

It also was an enthusiastic user of bonus shares, but did not issue such shares except on application, leading to obvious anomalies, many shareholders left diluted and grumpy if they neglected to apply for these ''free'' shares.

It was to my knowledge the first, and only, company to buy assets (buildings) by using as payment its shares with a ''guaranteed'' future share price, the guarantee supplied by Jones' personal company.

Sometimes the guarantee was sub-underwritten by clients of Mouat Bolland, a tiny sharebroker in Lower Hutt.

The collapse of the share price probably cost the providers of the guarantee at least $75 million. The company's management contract, granted to Jones' personal company, paid fees based on gross revenues, not nett revenues, or nett profit.

Jones himself was new to NZ's sharemarket and enjoyed a colourful relationship with institutions.

He took time out to form a political party, which won no seats but attracted ample media attention.

Grantham Mayo van Otterloo's loudly celebrated entry into the NZ capital market was short lived, as, of course, was the listed company RJI.

It is not reasonable to assess GMO's due diligence failures with today's standards.

In 2021 the active fund managers often have high standards of research, broker introductions are cautious and usually are made only after thorough research, and the days when the likes of Carmel Fisher took large positions in new companies have long gone, even Fisher Funds themselves, now owned by the TSB, rarely holding a double-figure percentage of any company, let alone an embryonic company.

GMO has survived as a mainstream fund manager, entrusted with hundreds of billions of investor and pension company money, and is again an investor in New Zealand, its founder, Grantham himself, now quoted in our media as a sage.

New Zealand depends on accessing capital markets everywhere and so it is comforting to note that GMO's view of NZ today is not coloured by memories of the 1980s.

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Johnny Lee writes:

WHEN considering investing in a new or recent listing to the stock exchange, there are a number of factors a potential investor will consider.

Chief among them is the suitability of an investment.

Initial public offerings typically occur for one of two reasons – raising capital to fuel growth, or providing owners with a means of exiting their investment.

A mature, profitable company offers a different set of risks and rewards from one growing and offering new products in new markets.

A growing company, paying no or small dividends, is unlikely to appeal to the investor looking to supplement income, perhaps carrying a shorter investment horizon, and unwilling to wait for the trees to grow and fruit to be picked.

A mature, profitable, cash-generative business may hold less appeal to those to whom cashflow is less relevant, instead seeking growing companies with perhaps greater potential to outperform in the long term.

But one key consideration people should make is to evaluate the barriers to entry associated with a newly-listed company, and the impact of new competition on different business models.

Barriers to entry can include physical impediments – such as with the likes of Vector – or artificial, such as patents over intellectual property.  The biotechnology sector, for example, relies heavily on the latter to maintain an advantage.

Different sectors offer different risks in this regard. The likelihood of a major new competitor entering the market in say, the electricity generation sector, is slim.  Few would spend the billions necessary to construct a viable, stand-alone business in this sector.  Government ownership within the sector will also dissuade competition, reinforcing the current oligopolistic structure.

Conversely, competition within the medicinal marijuana sector is seemingly flourishing, with a large number of new participants entering the market each year.  Another new listing to our stock exchange is expected in this space soon, joining Cannasouth and Rua Biosciences.  So far, these listings have yet to produce stellar results for investors, although believers will no doubt be focused on the long term.

Most of these companies have their roots in Crowdfunding, having raised tens of millions from people willing to risk capital on an as-yet unproven business model.  There are virtually no institutional investors in this space, companies instead relying on retail investor participation to provide capital.

It seems improbable that all of these companies will succeed long term.  The barriers to entry are such that global competition is likely to eventually result in a clear market leader, with others struggling to carve a niche.

A similar effect is being seen across the beer market in New Zealand, with the low cost of market entry allowing competition to thrive.  While this is a fantastic environment for lovers of craft beer, it becomes problematic for investors, as evidenced by the recent sale of Moa Brewery by Moa Group (now known as Savor Limited).

Consumers, of course, welcome competition, as it tends to lead (initially) to lower pricing and an incentive to provide higher quality service.  However, this can prove to be a double-edged sword, as businesses fail and dominance is re-established.

One example of such would be the evolution of the increasingly fractured television and entertainment sector.

In the not too distant past, Sky TV's product was a household staple and the share considered a core part of most income portfolios.  The company was posting healthy profits and healthy dividends, maintaining a dominant position due to the restrictions afforded by the technology of the time.  Competition, for some of its content, was non-existent. It was comfortably within the sphere considered ''blue-chip''.

Now, of course, Sky TV exists solely in the portfolios of the long-term investors, who may believe the company might one day own a big enough corner of the market to produce sustainable profits.  Competitors such as Netflix are increasingly competing for viewers' leisure time, while giants Amazon, Apple and Disney, with seemingly limitless wallets, are happy to bide their time, accepting low margins or losses, knowing their competitors will not outlast them. The low cost of debt exacerbates this issue, allowing companies to survive extended periods of loss making in order to chase market share.

For the consumer, this fracturing of the industry affords greater choice – ''Why should I have to pay for channels I do not watch?'' – but one could argue that the resulting market carries significant inefficiencies too – as duplication in these businesses across marketing, billing, IT costs and other areas results in an overall worse position for both consumers and providers.

Competition was one of the key risks highlighted in the recent My Food Bag IPO. Its primary competitor, HelloFresh, has been described as ''ruthless'' in its willingness to subjugate profitability to growth, its dominant global position allowing it to effectively subsidise expansion efforts into new markets.

When making long-term investment decisions, investors should consider the likelihood and impact of competition.  While competition is generally positive for consumers, it erodes profitability and, especially in the case of global competition, it forces local companies to compete with overseas cost bases.

As the pipeline of new IPOs reach our market, investors can afford to be discerning and ensure investments are fit for purpose.

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A BRIEF update in regard to the Vocus IPO that was anticipated later this year:

Vocus New Zealand, a spinoff from the Vocus Australia group and best known locally as a broadband provider under its Slingshot and Orcon brands, has been put on ice following a takeover offer from a consortium led by Macquarie Group in Australia.

We will update clients as news of new listings continue to develop.

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TRAVEL

Edward Lee will be in the Auckland (CBD) tomorrow Friday 12 March, in the Wairarapa on Friday 26 March, in Nelson on 14 April (afternoon only) and in Blenheim on 15 April.

David Colman will be in Palmerston North on 21 April.

Chris Lee

Managing Director

Chris Lee & Partners Limited

 

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Taking Stock March 4, 2021

NO investor enjoyed being cuckolded by the sort of corporate gangsters we endured in the 1980s, or the ghastly people who held the reins in what I would identify as the Money Managers era, characterised by self-focused salesmen, pyramids, Ponzi schemes and so on, leading to the 2007-08 collapse in investor trust.

Being duped is demoralising, expensive, belittling and often life changing.

Sadly, the opportunity to rort investors has not been stamped out here, or in the regulation-heavy USA.

Like many, I need help to get my head around the failure to prosecute and jail people who make small fortunes by misleading inexperienced investors, often using the media, especially social media, to exploit the innocent.

To put this into context, imagine a media-exposed commentator (and the USA has many mediocre people as examples) publishing the loud view that a stock like GameStop will deliver riches to all.

Because of the ''credibility'' of the media (or political) background of the commentator, raw investors leap in, lifting the stock by the sort of ratio that GameStop achieved, (say from 10 cents a share to $20).

Perhaps as the stock is peaking, the commentator, having bought at the start, is dumping his shares onto the people he duped.

Once he has banked his pillaged loot, the commentator goes off air, finding another name behind which to retain his anonymity, or even quitting the game, hoping to avoid detection.

One person suspected of this sort of activity was spoken to by the authorities in the USA, but it would be widely anticipated that he would successfully argue that he had broken no law. He would claim he was not a paid adviser, so was not subject to regulations, a code of ethics, or even common decency.

He is granted freedom of speech by the constitution, he can offer up any opinion he likes, he is entitled to trade shares, and he is not accountable if others are moved by his opinions and push up the value of the shares he bought.

He might point to Trump, as a high-profile example of someone who can make up whatever he likes and gain a following without being accountable for the behaviour of the crowd he attracts.

If he were a real and credible person, like Warren Buffett, the public might argue that he should be held accountable but even then that might not work.

Here the issues are more subtle.

A well-meaning salesman, say, Sam Stubbs or Andrew Barnes in New Zealand, can send in articles to the media saying whatever they like without being accountable for any consequential behaviour from readers. They can promote their own businesses and ambitions, perhaps with little risk of causing offense.

The media itself is the only potential handbrake on such activity but it seems to have a better view of the accelerator than it does of the brake.

Any salesman is entitled to self-promote and to assert leadership status.

Stubbs is not a financial adviser, not a portfolio manager, and not subject to any code, though his KiwiSaver business is accountable to those who license such businesses.

Self-promoting journalists, like Mary Holm, carefully note that they are not advisers, not financial market participants, and not to be regarded as a source of advice.

Anonymous people on social media are even less accountable.  Any journalist or social media contributor can offer opinion. Indeed, these days many journalists behave as though they are commentators, rather than reporters.

Seasoned investors will take into account the market knowledge and experience of commentators before weighing up the value of the advice, but not every consumer of ''contributed'' articles is seasoned enough to avoid mistakes.

Of course the problem is now exacerbated by the emergence of asset trading platforms whose revenue is really from selling client data, rather than from providing the platform. This enables the uninformed to exploit other uninformed people. The law allows this. Social ''tips'' quickly gain followers.

Some four thousand New Zealanders lost millions of dollars by buying GameStop shares through no-responsibility platforms.  (The shares peaked around $350, and are now a still lofty price, but less than half that amount, indeed sinking to $30 just a week or two ago)

Ouch.

Like Lotto, blind gambling destroys the budgets of families or people with no or little ability to incinerate money.

Just as dangerously, crowd funders can behave like a town crier without accountability.

So our land is still seen as fertile by people who want others to take the risk, while they collect cold cash from the opportunities provided.

This may not be a case of a ''fool and his money is soon parted''.

This may be a case of disconnected lawmakers and regulators being swept up by arguments that lawyers will be creating, that there is nothing illegal about asking a fool to part with his money, or to believe in the material being presented by salesmen, pushing products or stoking egos.

The law seems to support that position; regrettably, in my opinion.

Our news media, happy to obtain ''free'' material, and demonstrably lacking good judgement, ought to think about this issue.

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THE listing occurs tomorrow of My Food Bag (MFB) which is now separated from the entrepreneurs who created and grew the company.

Its market value will be determined by its ongoing sales, not just of food, but perhaps of staple items like toilet paper, dishwashing liquid, and Lotto tickets.

MFB may well herald a new era of home cooking and grocery delivery.

Perhaps it may even convert to a green, sustainable delivery system, its deliverers arriving by bicycle, or its parcels by drone.

These issues may determine the value of the company but its share price risks being driven by the media.

Whatever one's view of this, MFB is a legitimate listed company, aspiring to gain scale in activities that are legal and sustainable.

How easy it is to recall listings in previous years that, by contrast, never had a show of being sustainable.

Recall the listing of Fay Richwhite's business, at a price reflecting the profits it made from tax structures in the Cook Islands, an exploitative activity that, when stopped, left Fay Richwhite with much more humble prospects.

What about the education provider Intueri, whose business model depended on unresolved anomalies in government funding for make-believe students?

Or the stamp shop Mowbrays, whose nett margin on tiny revenue rarely covered the annual listing costs, leading to the company being repurchased by the original vendor at a fraction of the original listing price? I recall describing that listing as having all the potential for shareholder gain of our local fish and chip shop, if it were listed.

Did not the financial broker, Roger Moses, sell his tiny company in the 1980s to the improbable Holdcorp, and then buy it back for a smile and a bow, when Holdcorp became Foldcorp?  Moses later was jailed over prospectus issues of Nathans Finance, which he chaired for John Hotchin.

Businesses in a sector that is moving from twilight to darkness should never be listed, in my opinion. Such listings favour the vendors and cuckold the investors.

The NZX is now better run than it has ever been – Tim Bennett and now Mark Peterson may be congratulated, as may its current directors, a far more impressive bunch than the NZX has ever displayed.

One expects that before MFB was listed, the lead managers of the issue, Jarden and Craigs, applied the sustainability test to the business model, and that the NZX also performed critical analysis.

One hopes these new, better standards will ensure that no new offerings collapse into a disgraceful heap, later to be seen as forecastable, or fall back into the hands of the original vendors, for a bag of peppermints.

We might not be able to stop the likes of Money Managers from selling poorly-designed products (First Step, anyone?), but we can prevent these products from being endorsed by the best informed in the sector.

To think that more than 250 of roughly 400 companies were listed in 1986 and gone by 1989. Lest we forget.

One can be confident that in our anxiety to increase NZX listings, that sort of blind oversight will not recur.

Our confidence would grow if the media refrained from publishing untested, self-promoting stuff, from people with self-described achievements.

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Johnny Lee writes:

THE RECENT FALL in global share prices has stoked discussion as to the short-term direction of interest rates, fuelled by concerns around inflation.

The Reserve Bank of New Zealand, which now has a number of tools at its disposal for achieving its objectives, released a statement late February addressing some of these concerns. The statement was considered ''dovish'', or supportive of a more stimulative approach, suggesting rates would not be hiked in the short-term. The statement was titled ''Prolonged Monetary Stimulus Necessary''.

The Committee highlighted the uncertainty it currently faces and stated that returning to the target of 2% inflation would ''necessitate considerable time and patience''.

Nevertheless, underlying swap rates and Government bond rates have continued to climb sharply. The Assistant Governor Christian Hawkesby later discussed options for more stimulus and utilising the Reserve Banks tools, which including bond purchases or lowering the OCR.

This is not a challenge unique to New Zealand. Globally, underlying interest rates are rising, as Reserve Banks around the world continue to plead for patience.

In New Zealand, pockets of inflation are continuing to be observed. Our councils are already being vocal about dramatic rates increases, with steep hikes planned as they look to fund infrastructure projects. Housing costs are also struggling to be controlled.

But the Reserve Bank’s Committee will be keen to avoid any financial instability caused by rapidly increasing interest rates. The recent update to the Reserve Banks remit, asking the Committee to consider the impact on house price sustainability, will muddy waters but is unlikely to have any dramatic effect, as Reserve Banks across the world insist that low-interest rate policies are here to stay.

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A POINT OF CLARIFICATION is needed for investors in Contact Energy's current off-market share offer.

The offer, to bid for up to $50,000 worth of stock, closes tomorrow at 5PM. The application process is simple, and Direct Debit facilities mean an application can be made in minutes. Even those less technologically inclined should find the process relatively straight-forward.

The price of the offer is not $7. The price of the offer is the lower of $7, and a 2.50% discount to this week's average price. If the stock averages a price this week of, say, $7.05, the shares will be allotted at a price closer to $6.87.

This automatic discount works in both parties' favour – early applicants have a guarantee that the price paid will not be worse than the market price, and Contact itself is not left short of its required amount if the sharemarket experiences a temporary fall.

The offer is likely to find strong support. Discounted share offerings have largely been oversubscribed in recent years, as investors – who by definition are generally favourable to a company's prospects – search for returns in a low-return world. Scaling will be made in reference to existing shareholdings, meaning that the shareholder with 100 shares will face harsher scaling than the one with 100,000 shares.

This approach was necessary after the inequities and inefficiencies produced during the Global Financial Crisis.

During this era, it was commonplace for investors to arrange affairs to maximise opportunities, producing undoubtedly inefficient (but incentivised) outcomes. It was not unusual to see Mr J Bloggs, Mrs J Bloggs, Mr and Mrs Bloggs, and the Bloggs Family Trust all own a small number of shares, to apply for large holdings of discounted stock offerings. Four holdings of 100 shares would be treated the same as the holder of 100,000.

A similar issue was observed during the Government floats, including that of Mighty River (now Mercury). With a guaranteed minimum allocation, infant children and grandparents found themselves in hot demand. Identification requirements precluded the participation of family pets.

Discounted issues, such as the one on offer from Contact Energy, give existing shareholders the ability and incentive to provide further support to the company. In Contact's case, the funds are being used to fund the construction of an electricity generation plant, promising to be one of the lowest-cost plants in the country.

Those interested in the offer should act now. It closes shortly.

Disclosure: I have participated in this offer.

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WITH My Food Bags imminent arrival to our stock exchange, 2021 has introduced three new equity listings this year, offering investors an expanding range of investment opportunities to consider.

My Food Bag (MFB), New Zealand Automotive (NZA) and Third Age Health (TAH) have all listed this year.

My Food Bag was the first true listing, raising significant amounts of capital to buy out its private equity owners, and giving New Zealanders a bite of the meal kit market that is expanding worldwide.

NZA and Third Age were both compliance listings, seeking no additional capital but providing a market for existing shareholders to de-risk and sell down holdings.

New Zealand Automotive is an importer and seller of used vehicles, as well as offering motor vehicle financing. The company makes a small profit and pays dividends based on these profits, forecasting a dividend in the middle of this year.

Third Age is primarily a provider of healthcare services to Aged Residential Care facilities, like Ryman and Summerset. The company is profitable and anticipates paying dividends to its shareholders in due course.

Outside of New Zealand, firms like Roblox and Coinbase are the next to capture (and perhaps rely on) American imaginations, as both companies seek to take advantage of high valuations by listing on the stock exchange.

Coinbase, a website that acts as an exchange platform for cryptocurrencies, is being valued at above one hundred billion US dollars, close to the size of our entire stock market capitalisation. Coinbase allows users to buy and sell Bitcoin and Ethereum, among other cryptocurrencies. The company charges a large fee (calculated in US dollars) for transacting the purchase and sale of these assets. Coinbase is currently riding a wave of interest in cryptocurrency transactions, as well-known figures and institutions tout the value of Bitcoin as a future form of currency.

Roblox, a video game company, is seeking a valuation of approximately thirty billion US dollars. The pandemic, and the US response to it, has encouraged this form of entertainment in children, leading the company to seek a direct listing.

The offers follow the success in recent months of Doordash and AirBNB, both of which listed at significant premiums, the latter tripling in price within two months of listing before retreating.

The pandemic and the consumer response to it has led to a number of companies seeking to ''cash out'', giving private equity owners a way to profit from sky-high valuations and de-risk. So far, investors have broadly won, as prices have moved from strength to strength after listing.

In New Zealand, three listings in three months marks the best start to a year the NZX has experienced in decades. More listings will come. Meanwhile, investors will need to be discerning, as owners of companies seek to capitalise on a high asset-value environment. Decisions should not be made on the basis of social media comment, or on the recommendation of self-promoting entrepreneurs.

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TRAVEL

Edward Lee will be in Auckland (Remuera) on 11 March, in Auckland (CBD) on 12 March, in Nelson on 14 April (PM only) and in Blenheim on 15 April.

Johnny will be in Christchurch on 11 March.

David Colman will be in Palmerston North on 21 April.

Chris Lee

Managing Director

Chris Lee & Partners Limited

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