Chris Lee & Partners Ltd

Taking Stock 30 November 2023

IT IS likely that the entire adult population of New Zealand is now aware that the property syndication sector is in survival mode.

The conditions that led to many dozens of people becoming syndicators and fund managers have gone. The greener pastures they spotted over the past 10 years were fed by a mix of warmth, water, and nutrients.

The pastures looked rich when these conditions were optimal.

The “warmth” came from economic growth, pre-Covid, driven by population increases. Tenants paid their rent reliably in a growing economy.

The “water” came from the money available to be invested without much guidance, “wholesale” offers sidestepping the focus of regulators. The rules were absurdly loose. Investors were over exuberant.

The “nutrients” were artificially low interest rates, banks loading up on short-term loans that were in effect underwritten by the capital of extremely optimistic investors.

In effect any commercial property not wanted by the pension funds, listed property trusts, or wealthy investors, would end up on the scrap heap from which syndicators would choose the properties easiest to sell to unadvised investors.

While the economy chugged along, the interest rates were very low and the regulators were uninterested, the syndicators enjoyed a path to rapid, short-term riches.

In fairness there have been syndicates that have worked well, largely because the properties, unwanted by the rich or the large fund managers, sometimes proved to benefit from new trends. For example, the growth of Albany richly rewarded those who anticipated that growth. Institutions did not.

The most resilient of the syndicates focused on industrial properties for logical reasons. That sector thrives because the business owners must make long-term commitments, normally backed by real capital. By definition, the tenants had long-term commitments.

The business owners often spend large sums on improvements, adapting the premises to meet their unique needs. For example, panel beaters must build a spray room, transport companies created access for big vehicles, labour-heavy businesses built a cafeteria, and growth businesses wanted to sell spare land for future development.

The funding was relatively straightforward.

A $20 million building in Petone might be bought at a yield of 7.5%, meaning rent was $1.5 million, outgoings paid by the tenant.

If the bank would lend 50% at 4.5%, taking the dominant security, there would be a surplus equivalent to 10.5%. A syndicator might offer a “target return” of 9% and make himself rich pickings from the surplus.

For some years, the syndicates thrived. Rent reviews were incremental but added to the “value” of the building.

Investors thought they were getting a decent cash return and would ultimately make a real gain when the building was sold at the enhanced value.

You could have said, in 2019, so far, so good.

Then came the government’s flooding of the market with money.

Robertson and Orr convinced the market that “negative” rates might be imminent. Property valuations soared.

For a brief period the unthinking syndicators might not have seen that the flood of money would lead to a reversal of the benign conditions that had been lifting their returns.

Inflation came, accompanied inevitably by a sharp reduction in bank lending, tougher covenants, more threats of business failure and unemployment rises, a contracting economy, and, of course, higher interest rates eating more of the rent.

Nobody needs me to point out that the subsequent reversal in “valuations” and “cash returns” have led to grief for investors.

Most of that grief was caused by the undisciplined way the funds were marketed, hopelessly inept governance (no plan to cope with the market reverses) and, sadly, poor decision-making processes by the investors.

The fund managers had been allowed to feast at a level of gluttony, grasping the returns, while the investors were left with all the risk that was feeding the syndicators’ returns.

In most cases, this was the result of the use, I would say abuse, of poor regulatory supervision of what the sector called “wholesale” investment propositions.

In 2019, the “wholesale investor” proposal accepted by regulators was that anyone with some wealth (a million or two), or anyone who claimed they were an “habitual” investor, or was used to investing large sums, could ask a professional to issue them with a certification that could provide them with access to “wholesale” products.

A farmer who sold their farm, a grocer who sold their business, the beneficiary of an inheritance, or even a bus driver who won Lotto could find an intermediary who would sign the wholesale certificate.

In one case a South Island lawyer was paid a secret commission of $100 (and more) for signing off anyone who asked him to do so.

In another case the syndicator had in his offices a woman who signed off anyone who wanted access to a wholesale product.

Given the shortage of staff, and the over-stretched budget, it was easy for the Financial Markets Authority to prioritise retail investors, not those “wholesale” people who were certificated as not needing the protection of very specific rules and a strong regulator/enforcer.

Well, the “wholesale” certification must now be under scrutiny, even after the improvements made since 2019.

I hope the FMA requires existing wholesale issuers to forward every investor’s wholesale certificate and closely examines who signed the certificate, investigates whether a secret commission was paid, and then interrogates the investor.

Many investors will now be seen to be total amateurs, clueless about such matters as balance sheets, cashflows, constitutions, covenants, and fund managers’ small print powers.

The climate is now right for investors to be honest, as many will be stuck in illiquid syndicates, receiving no or pitiful returns and panicking when the syndicator asks for more capital from investors, threatening that the banks will foreclose if they do not pay up.

The truth is that only a tiny percentage of investors are truly meeting the criteria of significant wealth, genuine investment experience, and genuine investment expertise.

When the tide goes out, we see all the rubbish on the sea floor that was previously submerged. The tide will come in again one day, but the policing of flotsam and jetsam should mean we have a much more friendly and sustainable environment.

The next item discusses Provincia, an industrial wholesale fund, marketed six years ago.

I know nothing about its wholesale certification process and do not imply it has insurmountable problems.

But if its founders ever market another fund, the investment processes and management must have a more modern and meaningful manual.

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MARKETED in 2017 to “wholesale” investors, Provincia promoted a 6% targeted return with some emphasis on growth.

It wisely targeted industrial properties in and around Auckland.

Wisely, it sought diversification by targetting relatively small, well-tenanted properties, perhaps in the $10-$30 million range.

Cleverly it sought advice from the well-known Auckland property enthusiast, Olly Newland, a man who had often held seminars teaching people the rudiments of property investing. Newland, now in his 80s, for a very brief time guided Provincia in its formative year.

Years ago, he retired from his role there, wisely, in my opinion.

Provincia engaged with Malcolm McDougall, long ago a director of the impressive, listed property trust, Property For Industry.

Its founder Carl Burling comes from a family well known in yachting circles.

Newland was the face well known to Auckland investors.

McDougall and Burling controlled the fund manager company with the mandate to manage Provincia.

Provincia’s model was to raise investor money, leverage it, buy small industrial properties, and thereafter continue to buy more, paying for each new property with a mix of debt, vendor finance, and share issuance, often to the vendor.

Hopefully the share value would rise meaning the vendor, when he became an investor, did so at a price reflecting growing share value. That is, he accepted shares at the share value calculated by a valuer.

The funds management company would be paid 0.75% of gross assets (at valuation) and 6% of the price of each acquisition (at cost), capped at $2.5m per acquisition. As you can imagine, the fund grew quickly, the managers incentivised to grow the number of properties, and paid fees on the revalued portfolio.

Pause here. The fee and the bonus would be greater when “valuations” were higher. The fee and the bonus were paid in cash and ranked ahead of shareholder distributions.

Every industrial property seller to a fund like Provincia wants the best price they can get.

If the private wealth, listed trusts, and pension funds were not accepting the sale price, a syndicator might be the best bet for a vendor.

Imagine the vendor asks $20m. A private offer comes in at $18m. But imagine a syndicator agrees to pay $20m providing the investor leaves in some of the money, either at nil percent or at a cheap rate, and agrees to accept as part payment, say, $10 million in Provincia shares, based on their asset backing (which is based on the “valuation” of their other properties).

Good deal for all?

Well, this would be a very good deal for the fund manager, though I make no suggestion the fund manager exploited the deal.

You see the fund manager receives 0.75% p.a. on gross assets, and a 6% bonus on the $20 million purchase.

If the price paid was $18 million, the annual fee and bonus would be lower.

My point here is that there is a risk of disalignment. In my view the fund manager contract was poorly drafted, the investors not prioritised unless the valuations constantly increased.

The fund manager in 2023 can genuinely claim that at the fund valuation accepted, the fund had an asset backing of, say, $1.60, sixty cents higher than the original $1 per share price.

He could then show investors that their “return” on their investments includes a 60c “gain” implying the fund has done well, even if the cash return is just 1% (because of the higher cost of debt, inflation etc).

A six-year fund that has returned 1% and had a 60% valuation gain could arguably allege it has had in rough arithmetic a 10% annual capital increase and a 1% cash return.

The “valuation” in Provincia’s case is not easily substantiated, the buildings being saleable only at a large discount to valuation.

The shares are virtually unsaleable, one large holder unable to find a buyer at 90c, so the $1.60 value would seem to be detached from market prices.

The company had originally hoped that anyone wanting to sell could do so whenever a new capital raise was over-subscribed. Such an oversubscription did happen, pre-Covid. Recent capital raises at heavily discounted prices were significantly undersubscribed. So, there is no liquidity.

Earlier this year the company failed to attract widespread shareholder interest at $1.10. A “kind” person took up this shortfall, the money raised being used to buy an interest rate swap from ASB, as a reaction to rising interest rates. What this tells us is that the real value of the fund is certainly less than $1.10 so the alleged 60 cent capital gain is somewhat mythical.

So, the shareholders today have an illiquid investment, not returning anything like 6% cash, and appear to have a problem in changing the “growth” ambition, which is fuelled on acquisitions funded by vendor finance and the willingness of the vendor to accept shares at a price unrelated to any market-based transactions.

In a fortnight, shareholders will meet to discuss proposals that include sale of property to reduce debt, total liquidation, and more board control of strategy. One imagines a competent chairman will encourage lengthy discussion, yet the manager estimates the meeting will not exceed 30 minutes. That sounds as though discussion on the proposals will be stunted.

The board now comprises some investors. It was previously chaired by McDougall. The new chairman is not in the fund management ownership structure.

My involvement is simply the result of an approach from an investor, previously unknown to me or my business, who confessed he had no clues about a solution, and was not an obvious candidate for the recently-improved definition of a wholesale client.

If I was voting on his behalf, I would vote for liquidation.

In my view if the buildings have a real value equal to 90c per share (i.e. the real market is nowhere near the claimed asset banking), if the distribution is some years away from being at a higher rate than bank deposits, if the shares have no real liquidity, and if the fund manager is being incentivised to grow the portfolio while the investors really want income and liquidity, then the fund has been created by the wrong sort of money, the wrong sort of people, and should be liquidated now at whatever real value it has. Circumstances have changed. Close the fund.

This would be even more urgent if the fund manager fees and bonuses over the history of the fund were greater than the returns paid to investors, whose capital is at risk.

There is nothing untoward in this as the investors accepted, by majority, this unintended outcome when they allowed the constitution to be accepted.

Growth is a legitimate aspiration. It may be that the investors as they aged, and faced inflation, have changed needs. That is why you need liquidity. Maybe it is why Provincia needs a different type of investor.

A tiny compromise could be reached by paying the fund manager’s bonuses in shares, not cash, using the fund manager’s acclaimed value of $1.60 when calculating the number of shares needed for the bonus. Cash should not be dispersed as a bonus in any fund which is clearly cash-strapped.

I dislike bonuses. I dislike funds that have no effective liquidity. I dislike funds that have no provision for changing the fund manager (at minimal cost or effort).

With sadness, I expect the vote in a fortnight will support management. In my view most aging investors cling to the hope that “all will come right at some distant time” and most aging investors have good manners, dislike confrontation, and want to believe that their original investment was wise.

My view is that 90c today, reinvested more certainly, is a much better proposition for aging investors than waiting for an unknown time for a questionable structure to deliver superior returns in a difficult world.

Footnote: There is apparently a Christchurch based syndicator known as Provincia. As far as I know there is no link between the two funds.

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THE noticeable fall in long-term bond rates, here and globally, combined with a fall in the more sensitive swap rates, is likely to send two important signals to investors.

1. There will be a rush of new bond issues in the New Year, corporates willing to pay the new (lower) rates to backstop their bank loans.

2. The interest rate sensitive stocks like the listed property trusts and the retirement village stocks may have been discounted too much. Their share prices in 2024 may be firmer, though not by so much that they will reach the highs from the era of “free money”.

Other obvious concerns are the lack of growth in the economy, the certainty that fiscal deficits will be greater, before they respond to tighter government spending, and the probability that unemployment will rise. Housing unaffordability remains a problem.

One must hope that rising unemployment will not lead to higher mortgagee sales, social dysfunction resulting. Mortgage delinquency is rising. Many face higher debt levels when their loans are reset in 2024.

For investors, all of this probably means that those who filled up on 6.5%-7.5% long bonds will be pleased to enjoy those returns. Bond values rise when interest rates fall.

Edward will write our confidential client newsletter, which will be circulated at the beginning of December, spelling out what we have learned.

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On 7 December I will publish my final Taking Stock for 2023. Fraser Hunter will write Taking Stock for 14 December. I am on leave from December 11- January 16, but available by email.

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Chris Lee & Partners Ltd

Taking Stock 23 November 2023

THERE will be at least 100,000 New Zealanders who will have displayed interest in the appointment of Simon Power as the new head of Fisher Funds, a private company.

Fisher Funds is the fund manager that followed the play book of Doug (Somers) Edgar’s Money Managers in the 1990s and 2000s. It now has control of a six-figure number of those people who have enrolled in KiwiSaver and collects hundreds of millions each year in fees.

It also collects fees from a probably dwindling number of people who use its various other managed funds.

One must acknowledge its founder Carmel Fisher who, like Edgar, is now retired, enjoying a fortune she created through her personal selling, her hefty use of advertising, her impressive energy, and her development of a personal brand.

Unlike Edgar’s, her empire has survived, now given a new level of respectability by its acquisition from Kiwibank of a bank KiwiSaver database (Kiwi Wealth) and by its link with the TSB, its major shareholder, though TSB is more of a figurehead owner then an active owner. The American group TA is now responsible for strategy and culture, despite its minority shareholding.

When Fisher had finished and cashed up, Fisher Funds (surely in need of a name change) came under the leadership of Bruce McLachlan, relatively a banking journeyman, having emerged from Westpac to take the helm of the old PSIS bank, now called Cooperative Bank. He left Coop bank to head Fisher Funds.

It was McLachlan who integrated Kiwi Wealth with Fisher Funds, paying a king’s ransom for the acquisition, but such is the value of the long-term licence to manage other people's KiwiSaver money there seems little doubt Fisher Funds will recoup the $310 million it paid to take over these captive clients.

McLachlan would not have seen himself as a fund manager and probably displays decency by recognising the need for Fisher Funds to transform now that it is an industry leader. It must have an appropriate culture, modern investment standards, and long-term sustainability.

It is now NZ’s second largest KiwiSaver manager, behind the ANZ bank, implying a level of respectability and devotion to best practice that comes with being a giant.

So along comes the former politician Power to bring about necessary change.

Simon Power, but for a massive error in 2010 when he was in Key’s National cabinet, might today be Prime Minister, instead of running a cobbled-together fund manager.

He was Key’s logical successor, a young lawyer who impressed many, including me, by making much needed changes as soon as he achieved Cabinet status 15 years ago.

He became Justice and Commerce Minister, earning admiration for the way he regulated financial salesmen many of whom were hiding behind the title of “financial adviser” without evidence of knowledge, experience, or long-term commitment. 

Some 22,000 so-called advisers were selling investments during the reign of his predecessor, Lianne Dalziel, who in Clark’s government had been an utterly inept Minister of Commerce, ignoring all the evidence of the rotten practices in property management, contributory mortgage trusts and finance companies.

Perhaps she was preoccupied with much lesser issues but under her reign, some hundreds of the 22,000 advisers around the country pillaged investor money.

We know the number of those who were inept because when Power rapidly introduced the Financial Advisers Act requiring advisers to pass relevant exams and commit to a code of ethics, some 20,000 of the 22,000 simply vanished, unwilling or unable to achieve relevant standards.

For his singular achievement in executing this plan Power emerged as an intelligent action man, able to cut through all the blockages that intimidated lesser politicians. His political destiny seemed predetermined.

Sadly, Power undermined his achievement in just one weekend in 2010.

You could argue that it was not all his fault, but he took the blame and unexpectedly retired from politics.

The error related to the late Allan Hubbard, the founder and CEO of the giant South Island finance company, South Canterbury Finance. 

Hubbard was a stubborn old timer. For years he had irritated Wellington public servants by behaving as though he had more respect for a greater authority than for the laws created by parliament.

Hubbard believed his guide was the Lord and believed that his morality and commitment to underwrite his clients with his extreme wealth, meant that Wellington’s laws were aimed at lesser people, not him. Effectively he declared he had no respect for laws.

Ironically, left alone, he might have had an argument. He really did foster his investors.

But Wellington discovered the multiple laws he broke. Off was sent public sector and private sector officials to examine a fund he was managing and to discover whether he was adhering to the investment laws.

Hubbard had a fund comprising other people's money, known as Aorangi Securities. It was imperfectly structured and occasionally made lending or investment decisions with other people’s money that seemed more in keeping with Hubbard’s charity than with commercial standards.

Hubbard compensated for these indulgences by committing to use his own funds to underwrite all of the commitments he had made to his investors, to pay 10% interest and to return capital.

Eventually he had to front up. He did so. He injected into Aorangi some $60 million of value he held personally in various farms. He did this to meet his promise to underwrite the fund and to avoid any losses for investors.

His injection worked. 

Ultimately, no investor lost.

But Hubbard’s unique Christian moral commitment to “put things right” did not alter the fact that the fund was operated illegally, in its final years.

So Wellington sent to Timaru the team of people to investigate.

Within hours they reached a totally false conclusion.

They thought that Hubbard was illegally lending Aorangi’s publicly-funded money to himself, to buy into farms. That would have been fraudulent.

The reverse was true. The error was inexplicable, oafish, in fact.

Hubbard was injecting his interest in some farms into the fund so that his bad lending practices would hurt nobody except himself and his wife Jean.

The Wellington party scurried back to Wellington with their clunky conclusion.

The message was passed up to the Minister, Power, that Hubbard was defrauding investors. The group recommendation was that Hubbard be placed into statutory management by government decree, thus labelling him a thief and alerting all the parties trying to solve Hubbard’s troubled South Canterbury Finance that he was, in effect, a common crook, his empire implicitly founded on jelly.

Power, a lawyer, had to call together a group of cabinet ministers and consider the group view before recommending that the Governor General accept a proposal to appoint a statutory manager (akin to a liquidator).

So Power recommended Hubbard be placed into statutory management, a state similar to home detention, effectively isolating and stigmatising Hubbard and denying him access to his own money and to any involvement in his companies.

Egregiously, Power made no effort to consult relevant people before committing to this drastic action, wrongfully judging Hubbard.

Power did not check the facts with the directors of Aorangi, he did not ask Hubbard, and he did not ask competent people to review the accounting transactions that so clearly were misconstrued by the group who visited Hubbard’s office, with what seemed a predetermined conclusion.

Power took his decision in haste, an odd error for a trained lawyer.

Hubbard was banished, astonished by the error.

There was thereafter no possibility of accepting the offers to buy out South Canterbury Finance. The error cut off any hope of a solution.

Indeed a stupidly managed liquidation of SCF and its various lending and investing entities, and a greedily-managed statutory management of Aorangi (and others) left investors unnecessarily shortchanged. The value of some of those flogged-off assets have matured, with values sometimes 50 times the fire sale price, the Xero shares an obvious example.

Worse, the taxpayers who had guaranteed SCF lost more than a billion dollars. This was a dreadful and unnecessary outcome, Key dismissing the loss as Hubbard’s fault, when the loss in fact was caused by the public sector and political errors.

An ugly by-play was that some dozens of wide boys were able to buy Hubbard’s and SCF’s assets for barely a shilling in the pound, effectively a transfer of taxpayers money to a range of opportunists and wide boys.

All of this stemmed from Power’s failure to interrogate the hasty and ultimately discredited allegations of a Wellington group, which exercised insufficient care, and reached a conclusion that third form accounting students might have corrected.

How do we know these conclusions were utterly false?

Because Justice Helen Cull heard evidence in a subsequent court case where the errors were acknowledged.

One of the errant inspectors of Aorangi was Graham McGlinn. He became the statutory manager, days after Power’s error. Within a week he discovered the journal errors that had been so misunderstood by the group of which he was one.

In a report on the statutory management, a few days after his appointment, McGlinn identified the transactions that had been so carelessly interpreted.

Hubbard's career ended in disgrace.

Taxpayers lost a billion.

Power, for whatever reason, retired from politics.

SCF preference share holders lost $120 million, unnecessarily.

The vultures moved in and feasted.

Yet the National Party, and later Ardern and Robertson, steadfastly declined to put right the extreme injustice served on those investors who suffered write-offs because of the crass error. The politicians carry that legacy of having pretended that the error never occurred, leading to huge financial injustices, especially for the taxpayers.

You see, at least one credible buyer undertook to pay out an amount to the Crown that would have largely offset the Crown guarantee. He offered to pay interest while he was paying that money in instalments. He would have shared his gain with the Crown. The gain would have been in billions.

There would have been no destruction of public or investor money.

The most credible potential buyer offered to protect the investors.

Cruelly, flogged off by incompetent liquidators, the assets of SCF and Hubbard within a few years were shown to be worth far far more than was needed to repay the Crown and the investors.

All that was needed was time and intelligence.

Precious little of the latter was ever evident.

New Zealand bonfired a billion plus, unnecessarily.

NZ lost a man who might have been a good Prime Minister.

Power is now an experienced corporate manager, having worked for Westpac and TVNZ in senior roles, since his political retirement.

He will now have the experience to sharpen up Fisher Funds.

I would bet he will never make the 2010 mistake again.

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One of life’s greatest mysteries stems from the question of why television and/or film producers have neglected to create a film or even a drama series based on the life of the late Allan Hubbard.

He was unique. Are those creative people asleep or just tired? Surely they cannot be unaware of Hubbard’s extraordinary life.

Those who read The Billion Dollar Bonfire, of which only a handful remain unsold, will have read of a man who began life in the most dysfunctional setting and was heading down the path to a life of petty crime and misery.

Thanks to the Boy Scouts and a mere handful of good people he traversed the tracks and based on some improbable events became an immensely wealthy and powerful man whose influence on South Island commerce was extraordinary.

A workaholic (and thus a pretty average father of six girls), an accountant, an entrepreneur and later a philanthropist, Hubbard ultimately ruined his legacy, perhaps unbalanced by health issues and by his error in surrounding himself with goofy advisers and people whose own wealth depended on Hubbard retaining control of his fiefdom but exercising that control with minimal interest in the input of others. He thought it was cheaper to surround himself with goofs, with only rare exceptions.

He believed he talked with God while on the operating table with cancer, and believed God told him to follow his principles and ignore the selfish and often stupid expectations of politicians, bureaucrats, and regulators.

He was unique in that he was the only fund manager, probably ever, who fabricated high returns for his investors BUT then used his own assets and income to deliver the falsely high returns.

He preferred to pay extreme amounts to mostly distinctly average people - directors, executives and advisers - exercising the right to ignore them, rather than broaden his horizon and learn from the much better qualified support he could have hired.

He helped large numbers of people exercising his Christian principles. He saved lives, literally preventing suicides.

He was a hopeless driver. Local panel beaters bought spare parts in multiple numbers. He rarely used a seat belt. 

Hubbard annoyed all the process driven people in Wellington, breaking laws at will, but genuinely underwriting all his mistakes so that no investor had reason to complain.

That worked till his underlings exploited his decay and left losses that were beyond his underwriting capacity.

Then, his cheating emerged, panic setting in.

Finally, on the day the receiver moved in and the locks were changed, he went for a drive with his wife, who was driving. Parked on the side of the highway, the Hubbard car was wiped out, Hubbard dying hours later, on the day the company was closed down.

No filmwriter or TV series producer could imagine such a man so conflicted, with such a contrast of strengths and frailties. To imagine his life, and create a script, would need genius. The script just has to trace his real life.

Yet none have sought to tell the story, with a full-length film, or a TV series.

Within another few years memories will have faded.

I could imagine Timaru’s movie theatre having a queue all the way to Winchester if the film was ever on show in Caroline Bay.

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NEXT week I will describe the issues around Provincia, a $100 million property syndicate which owns several small industrial properties around Auckland.

The fund is at crossroads, not delivering credible returns, yet amply rewarding its fund managers.

My analysis suggests the fund should be liquidated, proceeds returned to investors. It has not come near to achieving its original sales pitch (6% returns).

The investors will vote at a special general meeting on December 12, on several issues, including a liquidation of the fund.

I will explain next week why I think the fund is not structured suitably, why it should be liquidated, and why changes are needed to ensure any future such fund needs to offer better protection for investors.

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Travel

I will be in Christchurch and Timaru on December 5 and 6 with a single appointment left available in each city.

Our advisers have no other travel planned for 2023.

Chris Lee

Chris Lee & Partners Ltd

Taking Stock 16 November 2023

IN 2008 the world’s investors finally woke up to the chicanery of banks, stock exchanges, greedy entrepreneurs, dozy auditors and trustees, self-serving directors, incompetent market regulators and deceitful valuers.

Global markets crashed when investors finally saw through the veneer.

Liar bank loans, undocumented loans, deceitful finance company directors, global credit rating agency frauds (cash for high ratings), incomprehensibly stupid fund managers, and crooked financial advisers were all in the spotlight.

Massive institutions like the Royal Bank of Scotland, Lloyds Bank, Goldman Sachs, Merrill Lynch, Lehman Brothers, and Deutschebank were guilty of abject stupidity and dishonesty.

Taxpayers rescued some of them from bankruptcy; too big to fail.

The most rotten of those rescued used the bail-out to pay millions in “bonuses” to the knuckleheads in charge, Merrill Lynch a sickening example.

It could never happen again, we all hoped.

Better rules would stop “valuers” from cheating, law firms from producing dishonest investment statements, bankers from gambling blind with other people’s money, and straight-out thieves from selling mountain oysters as health food.

It could never happen again, least of all in transparent markets such as the New York Stock Exchange seeks to run. Surely it could not recur.

Well, listen up.

Corruption is part of a cycle, driven by the extreme greed of stupid people.

The 2008 crash was a reaction to corruption.

We thought we learnt from that debacle that better rules and better enforcement would disincentivise those who figured they had the key to vaults of other people’s money.

At very least now we can say with certainty that the USA, where all fund managers like to invest (Silicon Valley Bank etc), shows no signs of breaking the greed/corruption/crash cycle.

Below is the story of one company founder/chairman/CEO.

It reminds me that corruption is endemic in the USA.

The story begins in 2019, just four years ago, by which time Adam Neumann had created a company to provide workspace for the new world, beginning in New York.

The investment statement that the big law firms created spouted this nonsense: -

“We are going to have to excise the extensive technology infrastructure because what we are really talking about is not Silicon Valley breakthrough technology but jazzing up often drab offices with beer taps, micro-brewed coffee, fruit-infused water, and wifi, the latter of which you can get free at Panera’s, along with a table and chair, for the price of a cup of herbal tea.”

Neumann set about creating workspaces in the USA’s big cities so that his company WeWork could list on the NYSE.

Secretly he had personally borrowed to buy buildings. Four of them he then leased to WeWork, not exactly at his cost or a loss. He held the majority of the voting power and made the decisions at WeWork, which was funded by Softbank and other venture capitalists.

According to the investment statement WeWork had the right to buy a further six buildings from Neumann’s stable.

WeWork’s future undiscounted minimum lease payments to Neumann would be approximately US$236.6 million. Hmmm.

Now read on.

In 2019 as he and the venture capitalists prepared to offer WeWork shares to the public, Neumann’s company, WeWork, was valued by venture capital geniuses at . . . drumroll please . . . US$47 billion.

US$47 billion!  Venture capital fund managers in places like Softbank who were using other people’s money said so!

JPMorgan Securities, incidentally for 15 years the funder of the paedophile Jeffrey Epstein, planned to share the underwriting of the proposed issue with their Wall Street rivals, Goldman Sachs.

Some people regard JPMorgan Chase (parent of JPMorgan Securities) and Goldman Sachs as being amongst the universe’s most credible investment banks. This article may cause one to pause on that thought.

For organising this proposed nonsensical deal JPMorgan Securities and Goldman Sachs were ready to charge $122 million in fees.

Praise be for an intervention by a New York University professor.

He killed the first absurd IPO. The 2019 proposed deal was cancelled.

Thankfully, the US does have some university professors whose commercial and social knowledge is based on previously working in the real world. (I wish we had some of these people.)

The NYU professor began to write skeptical articles when the IPO was being prepared.

Another credible researcher described the proposed IPO as “hype wrapped in subterfuge”, pointing out that WeWork had never displayed the ability to make a profit and in the first half of pre-Covid 2019 had somehow managed to lose US$900 million. (For the whole year it lost $1.9 billion.)

Recall that venture capitalists in 2019 valued WeWork at US$47 billion.

Discouraged by these interventions, Neumann withdrew his planned listing.

According to CNBC, Neumann received US$1.7 billion to walk away from WeWork, when WeWork was finally listed in 2021.

Softbank paid him $970 million for his shares and paid him a special US$185 million consulting fee AND lent him US$500 million to repay the banks which had funded his building purchases. Softbank  had originally invested $18.5 billion of other people’s money in WeWork, prior to the failed IPO.

Neumann’s bankers were JPMorgan, UBS, and Credit Suisse.

The IPO, cancelled in 2019, reignited in 2021.

WeWork was backdoor listed then for what seems like a “bargain” price of not $47 billion but $9 billion.

The listing was achieved by buying a special purpose acquisition company (SPAC). These are often called “backdoor listings”.

So where are we today, in 2023, just two years after the $9 billion capital raising?

On August 8 this year WeWork advised the Securities and Exchange Commission that “as a result of its losses and projected cash needs, combined with increased member churn and current liquidity levels, substantial doubt exists about the company’s ability to continue as a going concern”.

A little earlier the wizards of Wall Street had observed the growing losses and responded with a share reconstruction, replacing 40 old shares with one new share.

This helped the WeWork share price rise from three cents to $1.11, but investors had had 97% of their shares cancelled.

WeWork had issued bonds to raise debt. Banks would no longer provide debt.

On October 2, 2023, WeWork cancelled the interest payment to its bondholders.

On October 5 its bonds were rated as “junk”, selling for a few cents in the dollar to the sort of distressed bond buyers who play with other people’s money, gambling on miracles.

On November 3 the Wall Street Journal recorded that WeWork was filing for bankruptcy.

Yet the share price last week was still around 87 cents. The price might as well be $87 million. Only a fool would buy.

Who were the suckers that paid $9 billion for what within two years has proved to be virtually worthless? Fund managers, venture capitalists and the painfully naïve may raise their hands.

Consider this: -

Neumann, with his billion-dollar payout, has not broken any rules. That is clear. He has not been prosecuted. He is another billionaire regarded as a celebrity, probably advising governments on how to make money.

The New York Stock Exchange, the Senate Banking Committee, New York’s (ugly) law firms and the US market watchdogs have NOT done anything wrong. Pristine. Pure. Lovely people.

None have been implicated in this catastrophic transaction. None have had their competence or diligence questioned. Business is as usual.

Perhaps investors will just look at Sam Bankman-Fried, the man with the most prophetic surname in world finance.

He is adjudged to have stolen billions of other people’s cryptocurrency money and awaits his sentence which, if it rivals that of Bernie Madoff, will mean his best case for a cheerful life depends on reincarnation.

I guess he might be coming back as a toad or some sort of rodent.

He has been prosecuted, as a thief.

In summary, greed produces absurdity, if not wanton corruption. Ultimately corruption destroys confidence and creates catastrophes. I am not sure what motivates anyone to pursue useless riches by exploiting others.

Do not kid yourself that NZ is free of nonsensical valuations, greedy practices, revolting lawyers, falsehoods, and predators.

Corruption leads to crashes, as we saw in 2008 and in 2001 and in 1987. A few people will be caught, and will go to jail.

Do we have to live with these cycles?

Might we ever revert to a day when wealth equated with value add?

_ _ _ _ _ _ _ _ _ _

THE current relief displayed by markets stems from its habit of believing that what it wants to happen is about to happen.

The phrase self-fulfilling prophecy comes to mind. Prophets live dangerously.

Globally and here the markets want to believe that inflation has been cured and that we can revert to our preferred state. If not an imminent return to Zero Interest Rate Policies (ZIRP) prophets are urging a return to lower, more affordable debt-servicing costs.

Their logic is that if mortgage rates fell to 5%, house prices would be less unaffordable and more of the middle-income households would revert to spendthrift habits; consumerism reignited.

Behind all this hope is the tea-leaf reading of what the US Federal Reserve will decide when it next reviews the overnight cash rate in the USA.

If it simply leaves the rates at current levels, this non-decision will be met with great cheers from those who sell real estate, shares, bonds, and particularly those who carve out excessive fees by managing other people’s savings and pension funds.

At the risk of being a naysayer, may I point out that there are more adult ways in which to judge the world’s appetite for more investment risk.

The ten-year government bond rate, here and in many countries, is now 10 times as high as it was just 18 months ago. Ten times! This week our 10-year Local Government bonds with a coupon of 4.5% were selling at a discount, to yield 5.51%.

Ten-year bond rates are much more accurate signals of global appetite for risk than central bank decrees on the overnight rate.

No sane lender would lend on house mortgages except at a rate much higher than 10-year bond rates.

In NZ our 10-year rate is around 5.0%.

Any pragmatic investor or lender will have that return as his benchmark for no risk; hence 8% mortgage rates, perhaps 7%. Westpac in Australia last week issued long-dated capital notes at rates that might approach 7.5%.

My conclusion is that the desperate market traders and financial salesmen are not the earthly representatives of The Oracle.

As many experienced financial sages have noted, there has been no genuine progress on addressing the troubled aspects of global conditions.

Wily investor Warren Buffet has sold down tens of billions of dollars-worth of shares, ploughing money into cash, waiting for fire sales. He is not guided by traders or salesmen. He waits patiently.

George Soros’ famed long-time investment manager Stan Druckenmiller has lashed at the US Fed for failing to issue extreme amounts of bonds when interest rates for 10-year bonds were virtually nil. How stupid could you be, he asks.

Here, most of us are too polite to discuss the abysmal decisions of our 2017-23 Finance Minister, Robertson, for his goofy blundering.

Like his US counterpart, Robertson was sufficiently inexperienced and unconnected that he overlooked the opportunity to cover the next decade of (expensive) borrowings when our 10-year bond was 0.5%, not 5.0%.

Had he borrowed $50 billion in that period, NZ would have saved an eye-watering two billion every year till 2023, a total of $20 billion.

Of course, his bigger error was to fund the banks by buying their long bonds at a yield of one percent yet not entering into an agreement to sell back those bonds at the same yield.

That error will cost NZ at least another $10 billion.

We will all now see the results, which must be an ever-greater chunk of our taxes being wasted to patch up these errors.

The USA will attempt to constrain its re-sale of their bonds, planning to dump US$60 billion every month on the US market, a small fraction of what it stupidly bought.

Of course that puts upward pressure on rates. It will be a buyer’s market. Last week US tenders received low levels of interest from investors, insufficient to meet the government’s demand.

NZ, with a new finance minister, will want to publish its loss and link it to Robertson’s incompetence. One expects the cost will be higher interest rates for longer. Fairy dust will not make the problem go away.

Market excitement might lift share markets, creating trading anomalies, but one cannot ignore simple arithmetic.

A mix of unprecedented, enormous debt levels, and a need for even more debt does not look like the foundation for imminently lower government bond rates.

A sharemarket with a nervous tic seems to be a possibility, spooked by rising debt levels and prolonged high interest rates, not to speak of horrific wars (or weather events!).

Expect markets to be paranoid. Not just nervous.

_ _ _ _ _ _ _ _ _ _

Travel Dates

Our advisors will be in the following locations on the dates below:

21 November – Napier – Edward

5 December – Christchurch – Chris

6 December (am) – Christchurch – Chris

6 December (from 2pm) and 7 December (until 10.45am) - Timaru – Chris

Over the next fortnight our advisers will be available to all Kapiti and Horowhenua investors.

Fraser and David will be available each day, Johnny Wed-Fri, Chris Mon & Tues, and Edward, by arrangement.

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Taking Stock - 9 November 2023

Fraser Hunter writes:

AT our seminars earlier in the year, we discussed the long-term returns of different types of long-term investment strategies. 

Taking a longer-term view has historically been a good way to consider financial returns – for today’s exercise we’ve used five years as it’s close to a full economic cycle (the US business cycle is approximately five and a half years) and it’s often the minimum time frame you would want an investor to consider when making an investment plan, perhaps a bare minimum. 

It can also lessen the impact of returns due to valuation changes (i.e. PE expansion and contraction), which can vary from week to week, or month to month, but over time should be less of a factor, with the main drivers of share returns being dividends and growth in earnings.   

_ _ _ _ _ _ _ _ _ _

In the past five years, overall returns have been weaker than historic long-term performance, but by no means the worst ever. Volatility has been perceived as high, or higher than normal, but it was also absurdly low in the decade leading to the Covid pandemic. 

Again, by historical measures, the volatility we are seeing is not crazy by any means. The average intra-year decline in the S&P500 over the past 40 years is approximately 15%.

The pre-Covid years marked the end of a 40-year decline in interest rates, which were distorted by ZIRP (Zero Interest Rate Policies) and “Free Money”, a term to describe very low-interest rates.

Declining interest rates also meant that returns could be enhanced by leverage as asset bases grew, while debt servicing costs fell, making growth via acquisition (corporate roll-ups) and speculative investment (growth at any price) appear a valid short-term strategy.

The quick shock to interest rates has forced markets to re-price risk – in the form of risk-free rate assumptions, bond rates, and share market valuations. At a company level, companies have had to adjust their capital management strategies to reflect the higher cost of debt and much tougher ability to access capital.

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

To date, listed companies have adjusted better than expected. While debt costs have sharply risen, they again are not extreme by any means. Companies are growing the revenue line and passing on price adjustments, as they have in the past. A lot are still very profitable.

Valuations are still expensive (NZ in particular), but have come back a long way from the extremes seen during Covid, which removes one of the potential headwinds for expected share price returns (high valuations typically lead to lower future returns; low valuations typically lead to higher future returns). 

There will undoubtedly be future company failures, and locally this has been seen in the lift in companies entering Voluntary Administration in recent months. This is a healthy thing for markets and is less of a problem for the larger, listed companies due to the disclosure requirements and in-depth scrutiny of their annual accounts.

Global earnings growth for the next 12 months is currently forecast to be 10% higher than the current year. This is well below historic expectations, which tend to be overly optimistic, but also well above the 3% growth forecast at the start of the year. This is a sign that the market, rightly or wrongly, has become more optimistic or bullish. 

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

Investment class performance 

A lot has happened in the past five years. Consider that the Covid pandemic didn't break out on New Zealand’s shores until February 2020 (3 and a half years ago).

One of the key changes in investment markets since the pandemic is risk and how markets reflect it in their pricing of assets. Prior to 2018, the world was theorising how to value assets using a 0% risk-free rate, whereas now markets are using interest rates not seen since pre-GFC.

In November 2018, the RBNZ had just kept the OCR on hold at 1.75%, where it expected to maintain it for the foreseeable future. Inflation was just a smidge under 2% and a one-year mortgage was just over 4% per annum. By 2021, the Reserve Bank and the Finance Minister were both warning of “negative rates” being a possible outcome. Some of the banks and fund management administrators had to hurriedly upgrade and ensure their software could handle calculations involving negative rates.

Cash and Term Deposits

The importance of cash has been underpinned over the past five years due to its defensiveness, but also the higher low-risk return it is providing. A six-month TD is currently providing an interest rate above 6%, after dropping as low as 0.8%. A rolling TD strategy would have delivered a risk-averse investor a return of 2.8% per annum (pre-tax) over five years. 

Investors should also be conscious of the impacts of inflation, particularly over longer periods. Since 2018, inflation has averaged 4.1% per annum, or put another way $1 in 2018 has lost 18.3% of its purchasing power over the past five years.

Bonds

Investment grade bonds averaged 2.1% per annum over the past five years. Since the pandemic, bond returns (on average) have been close to zero as the existing bonds in the market were devalued in the face of rising interest rates. Over time, bonds will return towards the prevailing issue rate, as the low coupon issues mature and are reissued.

The yield on the New Zealand Investment Grade Corporate Bond index got as low as 0.70% in late 2020 and was 6.26% at the start of this month.

International and Australian Shares

Returns in Australian and International shares have been relatively good over the past five years, with the ASX200 returning 7.2% per annum, whilst international shares returned 8.3%. 

Global shares have been lifted by the US, with the S&P500 delivering 11% per year over the past five years. 

The recent performance of the S&P500 has been lifted by the "Magnificent Seven" (Apple, Alphabet, Amazon, Meta, Netflix, Nvidia and Tesla) which make up nearly 30% of the market. On an equally weighted basis the S&P500 is down 4% for the year to date.

Over the longer five-year period, every global sector has been positive. The Information Technology Sector has been the strongest, both globally and in the US, with Real Estate unsurprisingly the weakest. Quality and Growth are the two thematics that performed best globally. 

The Australian share market has been lifted by commodities and the banks, which have performed relatively well during a higher inflation and interest rate environment. 

New Zealand performance 

The performance of the New Zealand market has been a lot more modest than most globally and it is important to note that past performance does not necessarily predict future performance. We assume that the key drivers of return in shares are dividends, growth and change in valuations. If we assume that changes in valuation tend to normalise, share market returns in their simplest tend to reflect dividends and the underlying growth of a business. 

New Zealand has historically been a defensive market. It pays comparatively high dividends, is highly concentrated by defensive companies (Utilities, Infrastructure and Property), and the consequence is fewer growth opportunities than most share markets. 

Over the past five years, the best-performing companies in New Zealand are those that have been able to deliver growth. 

Infratil (return 27.3% per annum) – Over the past five years, IFT has grown its asset base from $6.6bn to more than $10bn (more than 9% per annum). The bulk of this was due to its well-managed investment in growth industries such as Renewables and Data Centres, while the company also successfully raised nearly $1bn dollars (at a narrow discount) via an equity raise to acquire the remaining 50% of One NZ (previously Vodafone), highlighting the willingness of investors to deploy capital to companies with a proven track record. 

Mainfreight (return 17.7% per annum) – Mainfreight's last five years have seen exceptional growth, growing revenue at 17% per year, and earnings at 30%. While some of this can be credited to strong company performance, Mainfreight (and freight companies in general) benefitted from abnormally high shipping rates post the pandemic, which are still being driven down as prior levels of activity and competition return.  Postscript: Mainfreight has today announced its latest results which showed a 21% reduction in revenue, and a reduction in net profit of 42%.

Ebos (15.7% per annum) - Ebos has consistently grown its business via a combination of organic growth and strategic acquisition. While the impact of the Chemist Warehouse contract being won and lost in the past 5 years does have a big impact, excluding the contract, growth in the remaining business has also been strong.

Fisher and Paykel Healthcare (12.7% per annum) – FPH was another company that benefitted from a “one-off” lift due to Covid, which brought forward huge demand for its products. Like Mainfreight, its current share price reflects a more sustainable growth expectation. 

Mercury and Meridian (16.2% and 14.4% per annum respectively) - perhaps two of the more surprising strong performers, both Mercury and Meridian have been able to grow revenue over the past five years, Mercury significantly due to the acquisition of Tilt Renewables, and the retail book from Trustpower. 

Mercury and Meridian trade at a premium to other major electricity providers partly due to their renewable energy portfolios, making them attractive to offshore funds seeking Sustainable Investment Opportunities (an area of investment growth over the last 5 years). 

_ _ _ _ _ _ _ _ _ _

OF our top 20 largest companies, only four had negative returns over a five-year period and all four of those have had well-documented issues over that period. 

A2 Milk (-59%, or -16.3% per annum)

The last five years have been tough on a2, which had previously been the market darling and at one stage the NZX’s largest listed company. During this time, it has had to change CEOs and also the strategy of the company after its key Daigou distribution channel into China effectively shut down during the Covid era. A2 has continued to grow revenue and its cash pile, but at margins far lower than in its heyday.  More recently, a2’s relationship with key supplier Synlait has been played out in the public arena, with a2 looking to exit its exclusive supplier agreement with Synlait.

Ryman (-45%, or -11% per annum). 

Ryman’s decline has also played out very publicly over the past year, concluding in a heavily discounted $902m capital raise in February this year to pay down debt and penalties entered into during the pandemic, thanks to a misguided entry into the US private placement market, a mistake also seen with South Canterbury Finance before its collapse. 

SkyCity (-7.2% per annum)

SKC was severely impacted by Covid-19 lockdowns, with 2022 revenue -33% below its 2019 levels. It has since done well to bring its 2023 revenue to new highs, however profits have been almost non-existent due to provisions and impairments relating to potential fines regarding breaches of its AML obligations in Australia. The regulatory requirements for casinos and the penalties for non-compliance appear to be getting higher and higher, impacting profits in the form of higher staff costs (compliance) and fines. 

Fletcher Building (0% per annum)

Fletcher shareholders have had a wild round trip, with the company reaching nearly $8 in 2021 before falling back to its current levels of $4.50. FBU had suffered a series of downgrades due to impairments and cost blow-outs from its the Convention Centre completion, as well as a weaker housing market and wet weather. More recently, the FBU share price has been impacted by its ongoing lawsuit with one of its building customers with disputes over the quality of its pipes. FBU has provisioned A$15m for the cost, while the building firm wildly speculated the potential cost to be close to $2bn.

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Underpins our preference for quality

The performance of NZ and global companies continues to underpin our preference for high-quality and well-governed companies, which over many periods has been a successful way to pick investments. 

Investors with a long investment horizon, wanting to grow their asset base and protect against the impacts of inflation, might continue to complement defensive assets with exposure to high-quality growth companies both locally and internationally. 

Historically, such a strategy has worked, however, nobody knows if history will continue to repeat itself. 

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Travel Dates

Our advisors will be in the following locations on the dates below:

20 November – Christchurch – Edward

21 November – Napier – Edward

5 December – Christchurch – Chris

6 December (am) – Christchurch – Chris

6 December (from 2pm) and 7 December (until 10.45am) - Timaru – Chris

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Taking Stock 2 November 2023

IF your knowledge of ERoad was gathered only from reading newspaper comment, or from its formal stock exchange releases, you might conclude that its Albany headquarters resembles a funeral house, gloom prevailing.

In short ERoad shares have fallen by 90% as it has continually reported that it needs more time to achieve its global goal, and has continually attracted scorn from random media commentators.

Its New Zealand business is undoubtedly a stunning success, having captured around 80% of the truck market, achieving very positive cash flow and profit. Its value is undoubted. Its users rate the products highly.

Though there have been no reports from ERoad, its investment bankers quietly acknowledge that its NZ business would attract buyers at nearly double the current market capitalisation of the whole business.

The market doubt has stemmed from the slow progress in getting its various hardware products into trucks in Australia and the USA.

Slow progress is not no progress. I will outline progress in the paragraphs below:

Despite its NZ success - undeniable - it has had bad press and endured comment that could be described as ignorant. Much of this press behaviour is understandable.

ERoad handled the long-threatened exit of its founder, Steve Newman, very poorly, virtually dumping the surprise exit on the investment world with far too little explanation and with no comforting strategy to replace him or retain access to his input.

Some of this was Newman's fault. He effectively tossed his rattle, though not selling his shares, because his board was not enabling him to back off his commitment to his own plans.

The company’s chairman at the time behaved as though he was unprepared for the event and its acting CEO, now the CEO, behaved in keeping with his legal training, as though he was dear old Jack Sullivan, chairman of the rugby union in the 1960s, who would continually parrot the words “no comment” to any passing newspaper reporter.

The media attacked. I, too, was very critical of ERoad’s response. The share price tanked.

The next controversy arose when a Canadian investment fund sought to take over the company for a price roughly double what the price had been months earlier.

ERoad’s board dismissed the offer, declined to allow the Canadians access to the business, loftily saying the bid undervalued ERoad but unexpectedly declining to explain why the bid for the underlying business was at an unacceptably high discount.

The explanation was simple. Others would pay for the NZ arm alone more than the Canadians would pay for the whole business. Why did ERoad not disclose this?

Furthermore ERoad was observing real progress in Australia and the USA,  given the enthusiasm of trucking companies for the new hardware ERoad had developed.

The NZ business was and is still growing. The Fleet Day that two of our advisors attended provided ample evidence of customer support.

Yet none of this has been well articulated by the ERoad chairperson or chief executive.

The CEO, Mark Heine, is running an impressive, progressive business and is a thoroughly decent, likeable fellow but his commitment to communication has been inadequate. Lawyers are trained to be furtive.

Susan Patterson, the chair of the board, caused a third issue when she advised ERoad needed no new capital, just a few months ago.

But when the company's advisers, Craigs and Goldman Sachs, later promoted to the board the idea of a new fee-heavy rights issue, ERoad accepted the idea, contradicting Patterson's previous statements. Perhaps ERoad accepted that in a deteriorating global economy, capital might be harder to find.

The media waded in, unaware of the underlying business, obviously sensing blood.

None visited the company. None appears to have penetrated ERoad’s apparent dislike of communicating. Is this a commentary on the media or on ERoad?

The board and the CEO hunkered down, focusing solely on progressing sales, cutting costs, and accelerating the day when ERoad will stop burning cash and will begin to eliminate debt.

New Zealand business media is not exactly the equal of the best of the Financial Times people, whose credibility and experience gets them into boardrooms where they are treated respectfully, and given detailed insight into the sector and the business.

Indeed many of NZ’s best business leaders simply do not talk to the media except at superficial levels, some preferring to avoid the risk of being misunderstood or misquoted by media people with little or no experience in the real business world, there being very few exceptions.

As an example, Infratil, an outstanding performer in a narrow range of business activities, for many years would not invite the media to analyst days and spoke mostly at headline level when answering media enquiries. It sticks to platitudinous stuff when briefing the media.

In very recent years it has relaxed its stance a little with no apparent damage, though naturally it never discusses sensitive subjects until they are executed.

The unwillingness to educate the media is understandable but the consequences have been unhelpful, as ERoad’s media relationships have illustrated.

The truth is that ERoad now has a range of hardware products with at least one piece of hardware in at least 100,000 US trucks.

The hardware is leased for monthly amounts, varying from a few dollars to tens of dollars. Hardware is rarely returned. The vast majority of leases continue indefinitely. The software behind the hardware does its job well, a credit to its designers.

ERoad’s hardware includes a computer that calculates road tax, its original product. Other hardware items report on maintenance, another observes the driver behaviour and offers live reports on the driver for safety purposes. The latter technology is well endorsed by market regulators.

Other hardware produces live footage of road traffic and this is used to report definitively on any collision.

Hardware monitors the conditions of sensitive goods; for example, food refrigeration and the rotation of the barrel of a cement truck (cement rotation to avoid solidification is sensitive and needs monitoring).

Other hardware provides live advice on optimal routes for trucks, with deadlines and penalties for late delivery.

You can also assume that the inevitable shift to road taxes for motor cars will be relevant to ERoad.

The company does have a story to tell, and it is a story that is backed by product development and sales successes, albeit at a moderate pace.

ERoad expects that by 2026 it will be significantly profitable, reducing and gradually eliminating debt, funding its hardware from sales rather than from bank debt. It should be cash-flow positive.

It is not a cot case, as the irritated, and often under-informed, media is likely to suggest.

It needs to do two things urgently.

It needs to communicate with its shareholders, including the institutions, and display its progress. If it does not want to be pestered by exploitative takeover offers, it needs to get its share price lifted by achievement.

The other need is to be avuncular to the NZ media, at very least tolerating them, and teaching them about the sector and its planned, profitable future in that sector.

It could make one further concession, showing investors a way to profit from the progress.

I will leave its CEO and board to discuss a suggestion that might help.

ERoad does have some smart people and it does have clever software. It is growing its client base. It needs time.

And it needs to learn how to communicate with the media, even with people not obviously relevant to its progress.

_ _ _ _ _ _ _ _ _ _

THE collapse of a Christchurch retail centre-based property syndicate is going to test the skills of the Australian bank which funded the deal.

A bank had put up $26 million of a $60 million purchase to buy a retail centre based on a cinema hub, surrounded by restaurants. (The figures quoted were provided by an investor.)

The transaction was completed just before Covid arrived, a sad piece of timing, which effectively wrecked the syndicate before it could get started. Lockdowns were not negotiable. Revenue ceased.

Today cash flows have improved but penalty rates and compounding interest, coupled with a slowdown in the centre’s food shops, have wiped out investor equity.

The current valuation of the whole complex is $20 million, sadly less than the debt, so the bank, not guaranteed by investors, is set to lose some money. Investors would lose all their capital if liquidation occurs. 

Of course the bank’s hope was that investors would contribute another few million of capital so that the bank’s debt could be reduced and then fully serviced at a penalty rate.

The bank may also have asked the tooth fairy to buy out their loan, with just as much success.

So we will now discover whether bankers have learned anything in the past two decades.

Think back to the early 2000s when the owner of farmland at Albany sold the land to a group of investors (Cornerstone) who in turn created a lease over the land and sub-let to others. The new lease owners proposed to convert the land into a huge shopping and retail centre, anchored by supermarkets and a retirement village, which would lease rather than buy the land. The concept today sounds fanciful.  The lease seems like an unnecessary structure.

Today Albany is a thriving, enormous, town centre, with a very large number of shops, offices, supermarkets, petrol stations, and fast food outlets, a shopping mall and there are various warehouses retailing goods. 

It has achieved all of its objectives. The original freehold investors will have been greatly rewarded by the success of the project.

Sadly two other principal sources of funds were slaughtered in the process, one, Westpac bank bringing down the guillotine on its own neck, the other, retail investors ranked behind Westpac, drowned by the consequence of Westpac's suicidal behaviour.

Westpac had lent around $135 million for the leasehold development.

The looming 2008 crisis generated nightmares for Westpac which at that time was badly governed, badly led, and had a gung-ho attitude towards commercial lending, made worse by an urge to panic when plans needed reassessment.

The panicking mentality prevailed.

The project was abandoned, Westpac taking a $135 million hit, at that time a contender for New Zealand's largest ever single banking write-off.

It seemed that no one in Westpac could look past the troubles of the day, sadly a rather typical Australian banking mindset.

Had Westpac accepted a compounding return on its loan for some years, or bought the freehold and retained the project, the ultimate success of Albany’s centre would have been Westpac's reward. A loss would have become a monumental gain, a reward for thinking beyond the next quarter, or year.

Such wisdom might also have thrown a lifeline to the retail investors who were victims of Westpac's decision.

The invincible Westpac commercial bankers would have had some work to do, but over time Albany’s value has grossly surpassed anyone's estimation. I guess it is fair to question whether commercial banking teams have real skills to justify their salaries and bonuses. Are they just lenders or are they specialists?

Was any lesson learned?

The property syndicate in Christchurch will lose all of its capital if the bank pushes the syndicate managers into calling in a liquidator and cutting off the investors.

Typically liquidators rarely have the skills to arrange any long-term solution. Typically the potential buyers will hear an auctioneer cry out “must sell, owners insist”.

Typically the potential buyers will structure offers that exploit the ignorance of the bank and the liquidator, probably obtaining expensive short-term funding from a private equity lender planning to reboot the project and refinance with a cheaper loan a year or two down the track.

There would be a fair chance that the refinancing would be with the same bank that writes off some of the existing loan.

The current little Christchurch case will tell us the answer to a question I hesitate to ask, as I think the question is rhetorical.

Do banks ever learn from their past mistakes?

_ _ _ _ _ _ _ _ _ _

ONE issue that arises from poor banking behaviour is the issue of accountability, as the following narrative implies.

At a time when two Australian banks were chasing every commercial deal they could find, grabbing high fees and high margins (and paying the commercial bankers ridiculous bonuses), one slimy crook in a bank was approached by a developer to fund a residential development.

The grubby little banker secretly negotiated a free 10% equity holding in the development in return for his promise to shepherd through the loan application, which was marginal.

The equity was given to the cheat. The loan was approved.

The development collapsed.

The bank demanded more capital from the developer.

Not unreasonably, the developer advised the bank that its grubby lender owned 10% of the capital and thus he would also need to put in more funds as he had taken a 10% shareholding.

The bank was somewhat bemused. It had no record of such a holding. No bank allows such conflicts of interest.

But the bank then displayed its own miserable standard.

It allowed the cheat to resign rather than make this behaviour public, the cheat not disgraced and named. He survives to this day, often in prominent roles requiring trust.

The bank believed it was better to hide the behaviour than to stand tall and display standards to its staff, its clients, its investors, and to the public.

I could write a book about the behaviour of Australian banks in NZ. Of course, a Royal Commission in Australia wrote what was virtually a book on the behaviour of Australian banks in Australia.

I live in hope that the good people I know in banking will one day prevail and convert banks into social and commercial leaders, with a focus on fiduciary and ethical standards.

_ _ _ _ _ _ _ _ _ _

THE growing corporate habit of sidestepping the media may imply disrespect, or it may just reveal careful selection of which of the media can be regarded as careful listeners and likely to report the news with accuracy.

Perhaps the media's lack of budget to spend time and money on travel and on research is behind that disrespect. Very few journalists ever appear on site.

Perhaps NZ lacks a sponsor to teach financial journalism, though my personal opinion is that our academic institutions have very little relevance to the private sector, there being far too few people teaching who have actual experience in creating and developing wealth. The late Brian Gaynor tried to address this problem when he funded Business Desk.  I doubt that he intended BD to be bought by the “Granny Herald”.

Our new Prime Minister, Christopher Luxon, has shown his corporate training by declining to discuss strategies until they are finalised as he forms his government.

Personally I hope he also brings an end to the theatrics and shallowness of recent governments, where the importance of an appearance masked the unwillingness or inability to discuss important detail, preferring almost daily television appearances.

Luxon, with his business training, is hinting that substance matters more than style, and more than audience applause. He might want to reduce time with show pony TV people.

He will know that there is a reason to conduct business behind closed doors, and that there is ample evidence that “gotcha” and “activist” journalists are, like much in social media, a hazard to be avoided.

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New bond issue

Channel Infrastructure New Zealand (CHI) has announced that it plans to issue a new 6-year senior bond.

Channel Infrastructure is responsible for importing, storing, and distributing 40% of New Zealand's total liquid fuel demand and 80% of its jet fuel demand. The company also owns the 170-kilometre pipeline connecting Marsden Point to Auckland.

It has long-term revenue contracts with BP, Mobil and Z Energy and is forecasting demand to remain at approximately 3,500 million litres of fuel for the next decade, dropping to approximately 3,000 million litres by 2050.

As at the end of September 2023, there were 63,000 fully electric light vehicles in New Zealand, up from 47,000 in 2022. There are currently over 4m petrol and diesel vehicles in New Zealand.

The bonds have a minimum interest rate of 6.75% which will be fixed for the 6-year duration.

CHI willbe paying the transaction costs for this offer. Accordingly, clients willnot be charged brokerage.

We have uploaded the investment documents and a presentation to our website below:

https://www.chrislee.co.nz/uploads//currentinvestments/chi030.pdf

If you would like a FIRM allocation for these bonds, please contact us promptly, with an amount and the CSN you wish to use. 

The offer is open now and closes at 9am tomorrow, Friday, 3 November.

Payment would be due no later than Friday, 10 November.

If you have any questions in relation to this offer, please contact our office and we will assist you.

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Travel Dates

Our advisors will be in the following locations, on the dates below:

9 November – Auckland (Albany) – Edward

10 November – Auckland (CBD) – Edward

17 November – Arrowtown – Chris (one appt. left at 2.45pm)

5 December – Christchurch – Chris

6 December (am) – Christchurch – Chris

6 December (from 2pm) and 7 December (until 10.45am) - Timaru – Chris

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd