Chris Lee & Partners Ltd

TAKING STOCK 27 OCTOBER

CONVENTIONAL wisdom drew a picture like this last week.  The US would soon lift its cash rates by a quarter of one percent, New Zealand would lower its cash rate by the same amount, the US dollar would be relatively more attractive, and the NZ dollar would fall a little, as the divide in rates narrowed.

Overseas investors would pre-empt these moves by selling down some of their NZ sharemarket exposures, having captured good dividends, nice profits, and a currency gain over the past months and years.

New Zealand corporates would exploit the lower interest rates by soaking up retail money with low-yielding bond issues.  The NZ equity market would be weak, for weeks.

Property syndicators would obtain options to buy and on-sell to retail investors, keeping the management contract, if investors allowed.  Property is still seen as a lesser risk than other sectors.

Then Xmas would come, and we would start again next year.

Conventional wisdom is generally what the media picks up from those fund managers who benefit from helpful publicity, so it is usually widely circulated.

In reality, all these logical and sequential incremental changes might be put aside by the resistance of retail investors, and by the nervousness of banks, which might result in remittances from outlying NZ branches of the large Australian banks.

We have seen investor resistance with the failure of two trusted corporate entities, Air New Zealand and Z Energy, to raise money they sought with bond offers, both falling a third short of their targets.

We might have seen this even more obviously with the ASB’s proposed subordinated Tier Two issue, had it not, in quest of $400 million, recalibrated its margins and offered a rate that compensates investors for accepting a flexible maturity date, and a tiny but still real threat of participation in capital write-downs, should ASB ever stumble (an improbable event, in my view).

Conventional wisdom looks to have been overtaken by market realities.

The US dollar has not risen inexorably.  The US might not increase its cash rates (by the unterrifying amount of 25 basis points).

The Reserve Bank of New Zealand may not cut our cash rates, and is very unlikely to cut them twice, as some expected.

Some foreign capital has left our equity market but may flow back as quickly as it departed, providing the global score is not turned on its ear by a calamitous event.

Fund managers with short positions will continue to ‘’talk their book’’.  Talk means nothing.

About the only outcome one can predict confidently is a continuing rash of property syndicates, and possibly a new listing of a couple of property trusts within the next few months.

It will be interesting to see which property syndication is the next to push too hard, perhaps trying to raise money at yields too close to those offered by listed property trusts.

Investors give up liquidity, diversification, transparency and some regulatory oversight when they contribute to almost any syndicate, a rare exception to the liquidity problem being solved by one syndicator, The Wellington Company, which guarantees some liquidity by agreeing to buy back units once a year, at par, for those investors whose purchase is subject to a put option we arrange for our clients.

My view is that every syndicator should offer that put option but few syndicators have the resources to make such an offer, or perhaps are still believing it is a seller’s market.

Conventional wisdom now looks far from sagacious, with growing doubt that this sequence of events will produce predictable outcomes.

It is entirely possible that NZ will lower its cash rate yet fail to reduce the value of our currency.

Our corporations are producing robust profits and dividends but it is entirely possible that share prices will fall until foreign money, chasing yield, returns.  KiwiSaver money pours into the market, inexorably.

Foreign investors own less than 20% of our equity market, though perhaps nearer twice that level, if you deduct those shares that are held by major owners and are not regarded as purchasable.

Milford Asset Management recently quoted some Forsyth Barr research suggesting foreigners own about a half of our equity market but I think they may have meant to qualify this by defining our equity market as the ‘’free float’’, or the shares available to be purchased.

For example the Crown owns more than 50% of Air New Zealand, Mercury, Genesis and Meridian and is committed to retain these holdings so the holdings are not in the ‘’free float’’.

Perhaps Forsyth Barr was either misquoted or was confused when it made its ‘’50%’’ assessment.

Nevertheless it is true that our banks, our government bond market and to a lesser extent our corporate bond and equity markets, are dependent on other people’s savings.

Conventional wisdom may as usual be of little real guidance but there are some signals investors can look for, in the 40 shopping days before Christmas.

If Clinton’s presumed US presidential victory is not accompanied by a Wall Street burst of optimism, that response would be scary.  (An opposite result would surely have been dreadful.)

Watch for a stable US dollar, with little or no cash rate increases.

Now that ASB has recalibrated its Tier Two bond rate, watch for good response to its search for $400 million.  A new (and overdue) review of credit margins on corporate bonds might take its lead from ASB’s example.

The compression of rates, with virtually no extra margin for additional credit risk, was what led to the public overusing the non-bank lending sector in the period 2005-2008.

In that period, simply toxic organisations, like Blue Star Print, raised money with offers that were unfair and, as Blue Star Print proved, cynical and mis-described.  Blue Star Print was as poorly governed and managed as Bridgecorp, Money Managers, Strategic Finance or Lombard. (That is saying something!)

Investors should receive significant rewards for more risk and lack of liquidity.

ASB’s proposed Tier Two issue, priced at 5% or more, is likely to attract large sums, but any attempt to squeeze the rate to a significantly lower figure would have been a costly mistake.

Of course we all watch the changing values of dairy exports, still an easily identified factor in our currency pricing.

Any more failures to fill debt issues might also discourage the proposed listings of some aspirational companies, a notable proposed listing, like Perpetual Guardian Trust, being one that will be hoping for a surge of confidence from investors if it is to attract the money its vendor will use to settle bank debt.

PGT, I expect, will be considering a listing with the help of Forsyth Barr and Goldman Sachs, possibly aiming at raising money in New Zealand and Australia.

It has clearly not succeeded in finding a trade buyer, an outcome much more to my liking, as trade buyers in my opinion are the right people to assess PGT’s future, and its current value.  I think that retail investors will struggle to assess accurately PGT’s real value.

The group started with George Kerr’s Perpetual Trust being transferred to the British visitor Andrew Barnes, like Kerr an ex-Macquarie man.  Barnes was once a manager at Macquarie, Kerr, once a large borrower.  It is surprising that they never met prior to the Perpetual sale.

Somehow Barnes and Kerr disagreed over an alleged arrangement to reward Kerr/Perpetual should Barnes succeed in listing Perpetual, Kerr claiming a $22 million additional payment, Barnes denying that such a deal was unconditional.

Kerr and Barnes both filed for High Court hearings but my understanding is that the threatened actions have been discontinued, as I expected to be the case, having forecast this as a fairly obvious outcome.

Barnes may have spent around $80 million putting PGT together, and adding Covenant and other minnows for perhaps a few coins.  The BNZ funded most of this.

The British entrepreneur will have found some synergies, removing duplicated costs, and has promoted the idea of using the ‘’cloud’’ to store wills, hardly a stratospheric change.  He will hope to exit with a sale at least matching his cost.  I doubt that investors are queued up to buy PGT.  Clearly trade buyers were not.

Forsyth Barr and Goldman Sachs will be busy if they are indeed to list the company.

The best people to value PGT’s prospects would have been an industry player, perhaps like Perpetual in Australia, but no sale has been achieved, so a listing is likely, in Australia and New Zealand, as Barnes retreats from his leveraged position, a wise action in an uncertain world.

If the listing is cancelled, and Barnes retains his ownership, that might signal that the retail investors wallets are opening only if there is a bargain to be had.  That would be a signal to be recorded carefully by all retail investors.

An ASB Tier Two bond rate at 5% might be a fair buy.  At 4.60% it would not have been fair.

A PGT sale price of $81m might be seen by investors as a logical price.  A figure of $100m or more would need a buoyant underlying market, and would imply enthusiasm for a business model that does not appeal to me.

My own guess is that investors will not be buoyant again until they see a restoration of fair credit margins, and until they see the American response to Clinton’s expected landslide victory.

The response might be best assessed after a few months, not in the days after the election.

Conventional wisdom says that corporates should hurry to get their issues completed before Xmas.

Retail investor wisdom is sometimes best analogous to Boxing Day sales.

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THE Financial Market Authority’s civil action against Milford Asset Management’s star fund manager, Mark Warminger, finished last week.

The judge appears to have signalled that several of the 10 charges alleging market manipulation have not been presented convincingly, but the overall verdict is scheduled to be released in April 2017, or thereabouts.

The case is of great importance for it sought to establish a decision, and thus a precedent, on common fund manager practices, said to be based on gathering market intelligence in order to make simple transactions.

Cynical investors, like me, might regard some fund management behaviour as ‘’ window dressing’’, to bump up returns on relevant dates, though this practice is fading, and perhaps was not as prevalent as suspected, in recent years.  Window dressing often aligns with bonuses, as we saw recently with CSFB in Switzerland, fined $90 million for playing dress-up games.

Buying and selling tiny volumes of shares, followed by much larger transactions later in the day, sometimes selling millions after buying hours earlier in small sums, is sometimes described as a ‘’fishing expedition’’ to draw out potential big buyers (or sellers).

It must be very difficult to prove intent, or even question the motives of these transactions, as there might always be explanations with at least a modicum of credibility.

The Warminger/FMA trial may have tested the FMA, raising questions of the difficulty it will have in proving allegations of poor behaviour.

Capital market participants who are expert at their craft very rarely volunteer to switch employment to the market regulator.  One obvious inhibitor is the chasm between incomes of skilled traders and Crown-paid regulators.

A quick glance at the ‘’experts’’ who testified in the Warminger case highlights how difficult the task was for those seeking to put binary interpretations on a trader’s actions.  It seems even the experts could not find common interpretations of various odd transactions.

The transcript of the trial should be available at some stage.

If I can acquire it, I will list it on our website.

The only certain outcomes of this trial are that it has been an unwelcome, career-stalling event for 41-year-old Warminger, expensive ($1.5 million) for Milford (his employer), and a huge point of relief for a wide range of bucket shops and poorly-governed fund managers, all delighted it was someone else in the dock!

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MY suggestion in Taking Stock last week, that New Zealand badly needs a non-banking lending sector to be reinstituted, led to a range of interesting responses from market participants.

In effect New Zealand has no such sector now, its surviving non-bank lending participants being Liberty, General Finance, Asset Finance, Geneva Finance, Instant Finance, Gold Band Finance and one or two low-yielding illiquid mortgage trusts.  None are regular lenders to property developments, nor should they be.  Property development lending requires a fairly permanent, unimpeded access to stand-by facilities.

I regard UDC Finance as just an arm of a bank, funding from the parent, and lending only to those who meet bank criteria.  Anyway, UDC Finance is possibly to be sold, maybe to Asian buyers, though in my view the real synergy would be with Heartland Bank.

There are private lenders to property development people, but there is no scale, no lender of any significance, offering fair return for risk, in my view.

Perhaps what New Zealand needs is the involvement of its biggest construction company, Fletcher Building, once part of the Fletcher Group that long ago owned Broadbank.

Fletchers, as a conglomerate, was dreadfully governed at different times, confused by the difference between ego-driven projects and commercially-sane projects, Hugh Fletcher now seen, in hindsight, to have been a very poor guardian of the family fortune, remembered for the errors, not any achievements.

Its behaviour with Broadbank highlighted Fletcher’s erratic governance.

Broadbank, an early trader in foreign exchange after NZ floated its dollar in 1985, once gambled on a fall in the NZ dollar against the US dollar and made a million over a weekend.

Fletcher’s Head Office responded with delight, sending crates of champagne to the Broadbank staff, even though the gamble was against rules spelt out in its manual, prohibiting open-ended contracts.

Sometime later Broadbank broke its rules again, shorting the NZ dollar.  This time its luck ran out, and it lost an eye-watering $23 million in a very short period.

Fletchers responded by sacking the staff and soon after closed down its finance company/ investment banking arm.

Had Fletchers behaved professionally it would have sacked the staff when they made the illicit profit.  Rule-breaking is either an offence or not.

I guess that today, nearly 30 years later, Fletcher Building is a more focussed company and has a better culture, though I doubt everyone in Christchurch would be whole-hearted in their agreement with this.  Certainly the sub-contractors there would have their own opinion.

But Fletcher Building is exactly the right company to commit to fund and often build the tens of thousands of apartment units needed to meet the demand in Auckland, Wellington and Christchurch.

We need Fletchers to commit to well-built, high quality apartments, built one after the other, for many years.  The demand for the product is undoubted.

Given Fletchers is vertically integrated and can profit from the acquisition of land, construction, the use of its brand of building materials and has the balance sheet to support the funding of such projects, Fletcher Building might be the right corporate player to ramp up the process, beginning by forming a financing arm.

In its own right it could today issue senior bonds at 5% and raise whatever was needed, and it could equally set up a finance company, offering co-investment from mezzanine funders willing to share risk, with retail investors providing the low-risk end of the funds.

If investors had Fletcher Building as a major shareholder in a finance company, perhaps the public with a minority shareholding, offering two types of investments, a problem would be solved.

It could offer mezzanine finance for each project, with a low coupon but defined share of a profitable project, and offer secured debentures at a lower rate, for those without taste for risk.

Throw in Chapman Tripp as the trustee to supervise the trust deed (the deed approved by the FMA), maybe even list the mezzanine and debenture securities, and you would have a structure that might shanghai our property stock into a supply/demand equilibrium.

If at the same time the Housing Corp funded and bonded young people into trade education, and committed to build social housing, progress would be rapid.

Perhaps the Housing Corp could gear up with a Housing Corp bond, just as it did in the 1980s, when it raised hundreds of millions with a listed bond, at a rate that was fair.

Some respondents to last week’s Taking Stock item claimed that councils should solve the supply problem.  That also could work, while borrowing costs are low, though labour looks like being an issue.  Councils are rarely good employers

Every respondent acknowledged the paucity of young, trained tradesmen.

Those problems can be solved.

We just need the drive to get started.

Surely the ridiculous queues at open houses in Auckland and Wellington (and Queenstown) can provide the impetus.

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THE failure of the security and crime analytics and software company Wynyard reinforces the reality that risk grows when small companies seek to take on big contracts in foreign jurisdictions.

When those big ‘’contracts’’ rely on sheikhs and emirs or kings, guided by their own rules and culture, the risk multiplies.

It is unlikely Wynyard will tell anyone, but the reason it has lapsed into a form of receivership is that it geared up and incurred massive costs in the belief that two Middle East contracts would produce tens of millions of dollars of revenue for Wynyard.  Not a dinar was received.

For months, the lure of the contracts was probably dangled in front of Wynyard, if the past performance of the kings and emirs there continues to be mirrored today.

Very likely Wynyard thought that hiring dozens of expensive people, and adopting the culture of the Middle East, would be amply rewarded when the value of Wynyard’s software was recognised.

Unless there has been radical change the likelihood is that the unspecified Middle Eastern leaders viewed the signed contracts as an ’’option’’ rather than a commitment.

Very likely bigger forces in the world of terrorism, money laundering, crime analytics, and perhaps warfare had no sense of duty to a tiny company based thousands of miles away.

Wynyard probably burnt many tens of millions, convincing itself that riches were within reach.

Some will see Wynyard, born out of Jade Corporation, as another one of Ruth Richardson’s errors.  She chaired Jade.

It is true Richardson has been yet another politician who has not made a seamless transition to commerce.

She is on our never-again list, after her dreadful connection with Roger Moses and the IP Mezzanine Finance farce, where she was absurdly overpaid while investors were well and truly rorted.

But Wynyard’s demise is most unlikely to be connected to her failings.

Unless I am sadly mistaken this is a failure caused solely by spending far too much on two projects that have produced no payment.

Wynyard does have some cash-producing contracts and it has zero debt, having decided not to draw down on a facility offered by one shareholder, and having failed to attract bank loans.

If the voluntary administrator (VA), KordaMentha, finds a buyer, the Wynyard shareholders might get a return.

By calling in the VA, Wynyard can reduce the costs of farewelling contracted staff and might get out of other obligations.

My guess is that KordaMentha will find a good solution.

What a grave shame it is that when KordaMentha was called into South Canterbury Finance in 2009, neither its directors, not its corporate advisor, Forsyth Barr, accepted the insightful conclusions KM reached.

One hopes Wynyard will be better served by its directors and advisors.

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Travel

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington - by appointment please.

Edward plans to be in Auckland on 15 November (on Queen Street), Auckland on 16 November (in Albany), Blenheim on 5 December and Nelson on 6 December.

Michael will be in Auckland on 22 November, Tauranga on 28 November and Hamilton on 30 November.

Kevin will be available in Christchurch on 17 November.

Investors wishing to make an appointment are welcome to contact us.

I hope soon to have dates for visits to Invercargill, Dunedin, Timaru, Christchurch, Nelson, Wellington, Kapiti, Auckland and North Shore.  Before settling on those dates, I need to know the outcome of our application to fund a civil compensation claim against various parties who presided over the collapse of South Canterbury Finance.  I hope to be more specific soon.

Chris Lee

Director

Chris Lee & Partners Ltd

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TAKING STOCK 20 OCTOBER

 

BY the time this Taking Stock is circulated, the subject of Australian property development failures ought to have been fully covered by every NZ media outlet.

It ought to have been on the front page of every newspaper and if the National Business Review in fact has any business focus it ought to have been the subject of a special edition of the NBR.  (It is more likely to offer Donald Trump as a columnist, than any in-depth capital market analysis.)

The news has been dramatic and the implications are alarming, in Australia.

In essence, Australia has copied the failed American model of 2004-2007 by building dwellings for ghosts to inhabit.

Supply of apartments has well exceeded demand, leading to phoney sales, often to offshore punters, particularly from China (and Macau?).

The punters have put up 10% deposits, almost as though they were options to buy apartments, in the hope of on-selling, rather than deposits on their intended residence.  They have abandoned their deposits when the market supply proved to be excessive.

Belatedly, the banks, having agreed to fund the developments, are now aware that they are carrying the risk, for totally inadequate reward.  Major bad debts lie ahead.

So the banks are withdrawing in Australia and are now in a panic wondering whether within two years they will own developments perhaps totalling $20 billion that are uncompleted and have no real prospect of being owned, or priced fairly.

Given that the Australian banks are capitalised in total at low hundreds of billions, but not trillions, the threat that the unwise bankers will be feeling, is intense.  Australia is in panic as it contemplates this.  (Expect some rights issues, soon.)

Historically, foreign owners of New Zealand’s banks (and assets in general) focus first on their own countries, often switching their resources to save the home base.

The fear here will be an unreasonable, illogical even, withdrawal from funding what in New Zealand is a property shortage, rather than the undefined but likely surplus of property that describes the situation in Australia.

Here, as we all have known and the media is at last observing, we have faced a shortage of property, in part thanks to the duopoly that Fletcher Building and Carters enjoy, giving them, in effect, pricing control of building materials and building costs.

We have a problem with constraints on land zoning.

We also have a deep and chronic shortage of construction workers - builders, steel workers, electricians, concrete workers, sheet pilers, plumbers etc.

Despite those skilled workers having an ability to earn handsome wages, and despite the certainty that skilled tradesmen will be in demand, effectively forever, we have a miserable record of converting young people with problem-solving skills into highly-paid, highly-admired tradespeople.  Our education system has failed, in this respect.

The evolving Australian disaster, which may lead to abandoned sites and may have a painful impact on New Zealand, might just provide the adrenalin to push us into addressing underlying problems here.

Possibly there is little we can do to solve the cost of building materials.  The scale of our demand and our distance from global suppliers may mean that we pay a premium that seems extreme to what some might call the ‘’robber barons’’.  Perhaps we need a new building supplies chain to import product and challenge the status quo.

The second problem, of labour shortage, might ironically be solved because of Australia’s errors.

Will we soon be campaigning in Australia to lure construction industry people to leave their shores and head for ours?  (How will we house them?).

The really difficult problem to solve is how we will fund the projects designed to solve our housing shortage, which rolls into a shortage of apartments in the most work-centric and desirable locations.

We do not want to address the problem by building multi-storey residential property in Wairoa or Huntly.

We do not want to generate living quarters for people who can afford them but currently are the habitual tail-runners at every auction of property in the most desirable locations.  That is not a social problem.

We need more developments and we need them to be built well, funded sensibly, priced properly and bought by users, not speculators who buy off the plans and seek to arbitrage their purchases, and not by investors who leverage their other assets to buy and then rent out, to service their own debt levels in a tax-subsidised manner.

For some time I have been discussing with other capital market participants, the need to re-establish a non-bank property lending sector.

We need a sector that will bear no resemblance to the motley, often dishonest, exploitative, greedy or weak people who in an unplanned way ended up owning the non-bank lending sector prior to 2008 when their lies, greed or incompetence became public knowledge.

Before I record my thoughts on this rebirth based on the right structures and people, we need to identify where the problem lies.

Cheaper, social housing at affordable prices, in areas where there is infrastructure suitable for a young family, might be left to the Housing Corporation, which can borrow at very low rates, and can benefit from access to public sector knowledge, and political cooperation.

Emergency shelter for the dysfunctional or desperate is rightly a social problem, for solving by the Crown, perhaps with Housing Corp involvement.

But new housing, built for those who have a choice, and designed to bring supply and demand into equilibrium, needs private sector funding.

It can be taken almost as a certainty that land developments and multi-storeyed developments are going to encounter nervous and reluctant bankers, if nothing is done now, because of what is happening in Australia.

At very least, the cost of such funding will rise, and will often be set at levels that might deter sensible property developers, and sensible property seekers.

How do we get tension into the pricing of property development funding if there is effectively only one source of lending- the Australian banks, in blind panic over their own failure to discern their over-supplied sector?

What we do not want are the sort of dishonestly-described offers that plagued us a decade ago.

We do not want mortgage trusts that lend to serial defaulters or lend to related parties, and regularly defy their own rules, covenants or promises.

Many will recall the frozen funds of the likes of NZ Guardian Trust, AMP, AXA, Tower etc. which promised investors to repay at call, and then froze investor money for many years, repaying less than was owed.

The Canterbury Mortgage Trust was another example of this model but NZGT was arguably the ugliest of all.

It had control of investors’ money through control of estate and money held in trust.  It pretended that its Mortgage Trust fitted the definition of a ‘’cash’’ fund and it pretended that the other people’s money needed an allocation to ‘’cash’’.  So it poured other people’s money into its ill-described Mortgage Trust, calling it a ‘’cash’’ fund.

It then lent some of the money on property developments and when they failed it then froze the trust, and was unable to meet client requests for their ‘’cash’’, for many years.

How it escaped prosecution, I will never understand.

What its behaviour caused was my conviction, shared by many, that no one should ever allow a trust company to have control of trust or estate money and be permitted to use its own brands into which these funds could be placed.  The conflict is obvious.

Indeed I would argue no one should let a trust company write a trust deed or a will, and be allowed to have any role in managing the money at all.  I have seen no ability to attract the sort of excellent staff that these functions require.

So that model is broken- mortgage trusts are not the solution.  They were the problem.

The same can be said in spades for the model followed by the property development lenders like Hanover, Strategic, St Laurence, First Step, Orange, Totara, Lombard, MFS (Octavius), Bridgecorp and South Canterbury Finance which collectively lent several billion in the period 2000-2007.

The flaws in that model were uncovered in the period 2008-2010 and must be recorded before we contemplate a new model.

As we all know, the flaws began with the people, many of whom were opportunists, greedy, dishonest and/or incompetent.  Many lied when under pressure.

A small number went to jail, far too small a number, in my view.

The other flaws included;

* A lack of real capital (are tax credits for application to possible future profits, ‘’real capital’’?).

* A focus on ‘’getting money out’’, rather than on wise selection of good projects run by honest developers.  (For stupidity, think Fiji, Brooklyn Rise, Queenstown, Baring Head!).

* Exploitation of ridiculous accounting rules - IFRS.

* Appalling audit inspection.

* Fee-chasing credit rating agencies with no accountability for unprofessional work.

* Childishly naïve and ‘’cooperative’’ Trustee supervision.

* Grossly under-manned regulators, with inadequate market intel.

* Dishonest selling to retail investors, one problem being the misleading and incomplete information provided, another being the commission and incentive-based rewards provided cynically to ‘’financial advisors’’ more interested in revenue and free golf/holidays than in sustainability or reputation.

* Related party lending or use of ‘’conduits’’ to disguise related party lending.  (Hanover, the worst).

The new model must address all of these shortcomings.

My view is that the shareholders of the lenders should have real substance, take a long-term stance, put up real capital, and should surround themselves with excellent people, with their own money backing their performances.

Accounting rules need to change.  No uncollected fees or interest should be displayed as revenue, lending to dividend and tax obligations, prior to the fees/interest being collected, and leading as it did in 2008, to grossly over-stated profits, and revenue reserves, and to dividends paid out with investor’s money.  (Hanover, Strategic).

Auditors should be paid fully and should assign mature, wise managers to any such client, not youngsters with no insight.

None of the existing trustee companies should be licensed to supervise or oversee trust deeds on behalf of investors.  Trustees should be specialist law firms or perhaps divisions of a bank and should have new powers to prevent poor behaviour.  They should be accountable for their behaviour.

Trust deeds need to be approved by the regulators, not by directors, owners and trustee companies, who all have an incentive to create ‘’flexible’’ deeds.

The new property development lenders I envisage would be supervised by the Reserve Bank and the FMA.

New law needs to be quite specific about what makes up ‘’fit and proper’’ executives and directors, and quite specific about minimum penalties (including jail) for offences.  Failed finance company treasurers, lenders, executives, directors should be excluded, forever.

Shareholders, directors and executives should have defined financial responsibilities for breaches of the trust deed.

Information documents must be developed that prevent the sort of cynical behaviour designed to mislead, as was so obviously exhibited by so many such lenders a decade ago.

For example, South Canterbury Finance, Bridgecorp, Strategic and many others borrowed money for, say, a year, and lent it to a developer for a project that might take several years to complete, sell, collect the sale proceeds, and repay the lender.

Yet SCF and others might set up the loan as being rolled over (or repaid, a euphemism) every six months and then display its liability (the deposit) as being repaid in 12 months, but the asset (the loan) as being collectible in six months (rather than several years).

The resulting table displaying asset and liability maturation would deceive an investor into believing that the loan and borrowing schedules were matched, and that there could be no liquidity crisis.

That sort of cheating was never litigated.  Don’t ask me why.  (Bad law, a hopeless Commerce Minister, or too much worse crime to investigate?)

New Zealand needs to ensure that we continue to build our property assets to match demand.

We need a new financing structure that ensures funds are available and fairly priced and that no one who provides the money to the lending company can later show that he was deceived, or that his money was used improperly.

I envisage a company formed around genuine capital market specialists, genuinely committed and wealthy shareholders, and controlled by expert independent directors.

I see that company raising mezzanine finance from wholesale or eligible investors who would be attracted by high returns that acknowledge high risk.  The wholesale investors would rely on no one else to assess risk and return, but they would rely on the company behaving honestly and legally.

I imagine the retail market would then be approached to provide money that would earn a return that well exceeds, say, bank rates but was genuinely protected to an extent that is assessable from the time of investment.

Ideally I would expect bank lending, if any, to sit alongside retail investors, with no prior security to the bank.

I imagine the property funder would not accept deposits unless it had sane projects that it sought to fund.

The property funding entity would disclose fully any brokerage to sharebrokers it authorised to distribute its securities and would not allow the ‘’bottom-feeders’’ to represent it.

There would be no ‘’special’’ brokerage deals, such as Bridgecorp specialised in providing (free trips to the RWC, paid golf subscriptions etc.).

There would be no related party lending unless approved, by exception, by the trustee and the regulator.

Could such a tightly-controlled company achieve a fair return for risk, for its shareholders?

Property developers expect to earn a 15%-25% return on the full sale value of a development.

If a development total costs are $20 million, the developer expects to nett, before tax, at least $3 million, hopefully $5 million.

That rarely happens.

A shareholder in a lending company expects dividends, and expects higher dividends when his obligations are as potentially severe as I would want.

A mezzanine financier expects a high, double figure return.

The retail investor expects the rules to be applied, expects expert and optimal management, and expects a return of, say, 3% more than a bank deposit.  He/she expects risk to be low, those earning higher returns to be taking the higher risk (unlike the case of Strategic Nominees).

Ironically the greatest amount of ‘’fat’’ in a development currently might be available to the vendor of the land, the contractor providing labour, and the supplier of the building materials.  Should their ‘’cream’’ be paid only if the project succeeds?

These are the people with the least risk, especially the land vendor, and the supplier of building materials.

Do we need the land vendor and the materials supplier to endure some hard lessons to get them into a more realistic mind-set?

And of course we have not addressed compliance, Health & Safety, and the whole consenting process, where often skills are not visible, and where attitudes can be those of the small men with a rare opportunity to exercise power, or exhibit their skills (or stupidity).

Importantly we do not want accidents and we do not want building failures, leaky houses, land collapses etc.

We do want more houses and apartments.

Do we need some available, honest, capital market experts to be brought together in as small a group as possible, with the task of ensuring that property developments can be chosen wisely, funded well, overseen properly and on-sold realistically?

I suspect what is happening today in Australia must lead to the sort of response described.

The alternative is either an end to immigration (reduced demand) or ever-increasing prices (lack of supply).

 _ _ _ _ _ _ _ _ _ _ _ _

PERHAPS, the man who might be available, wise and experienced enough to attract cooperation from the right people, and kind enough to act in the national interest, is the departing NZX executive, Tim Bennett.

Somebody like him will be needed to find the way forward to bring property demand and supply into equilibrium.

Unlike his predecessor, and many others in property markets, he has ample emotional intelligence.

His departure leaves the NZX with a significant problem.

Its governance over decades has been erratic, its leadership often self-focussed, its tasks potentially conflicting.

For example it runs the sharemarket but regulates itself and those for whom it acts.

In my opinion it needs refreshing at the board level.

I would hope that Bennett’s successor comes from within current executive management, from a clever succession plan for its executives.

If that is not possible (i.e. no suitable person wants the job) I hope the NZX again selects someone with no history of self-service, no history of condoning illegal or bad practices, and no history of compromising the standards that would attract the confidence of New Zealand and foreign investors.  I can think of plenty of people who should not be Bennett’s successor!

I hope that the NZX incrementally improves and becomes much more willing to suspend trading in shares of companies which have disclosed major but unspecified problems.

An obvious example today is Intueri, a recent listing of a company that wants to provide tertiary education funded by the Crown.

Its concept, to use the internet as a teaching forum and to focus on skills and trades (like the hospitality or food industry) is clever (very little competition in that area of education) and is cleverly focussed on immigrants.

But Intueri’s shares in my view should have been suspended weeks ago, when it was revealed that both in Australia and here, there are investigations into how students are recruited.

The investigations, I infer, might look at whether the ‘’students’’ are genuine, and whether the immigrants are wanting to study, or are simply wanting an easy pathway to residency, maybe citizenship, and access to health services, while the Crown pays the education bill.

Intueri’s share price, from a high of more than $3.00, is now at seven cents.

I have no wish to deny those with a different ‘’guess’’ as to the ultimate outcome of the investigation, and to the subsequent recovery or destruction of the company, but I do not accept that these shares should be trading when there is a great deal of knowledge in areas of the market that is not being universally disseminated.

We are being told headlines but not details.

The NZX will rid itself of potential litigation when it eventually realises that it is safer to suspend than to allow an unevenly-informed market to operate.

 _ _ _ _ _ _ _ _ _ _ _ _

NEWS that several well-known overseas retailers are to make the plunge into opening stores in New Zealand might be interpreted as an indication that their pursuit of the disposable dollar for retail expenditure is not finding much joy in the decaying retail models being used in Britain, USA and Australia.

New Zealand may be seen, rightly or wrongly, as a market of people with disposable money but inferior clothing choices.

The likes of Top Shop and Zara might indeed find enthusiasm here but if they are to succeed long-term they will need to display excellence here, not just promise it.

They will need to build slowly a skilled, trained, well-paid staff.  They will need to develop a culture of quality and excellence, and they will need to be patient.  New Zealand’s record in retail staff excellence is at best patchy, to be polite.

If the newcomers expect to earn high margins by under-staffing or by using ‘’average’’ staff, their successes will be restricted to the honeymoon period (months, maybe weeks) and they will come to regret the set-up costs.

They will need to accept that NZ is different, and that a huge percentage of New Zealanders focus on price, rather than on superior brands unless they can see proof of superior products and service.

(New Zealanders are also, on average, of bigger build than, say, the Spanish.)

If the new retailers are aiming at the cruise ship market or the ‘’Auckland wives’’ they may encounter some fairly fickle support, fickle and feckless.

The newcomers may want some earthy advice; prepare the ground carefully, sow the best seeds, tender to the little things that protect the growing plants (staff and culture) and don’t seek to harvest too early.

My guess is that there will be great emphasis on short-term rewards and that the wailing wall will be often visited.

My next guess is that the winners will be those who have very long-term objectives.

 _ _ _ _ _ _ _ _ _ _ _ _

EMAIL (important)

If you have tried to reach us by email and not had a response (if sought), please call us directly to address your enquiry over the phone.

Spark’s migration from Yahoo back to local control is, we believe, causing a disruption of service for XTRA email users.

We are frequently having emails bounced back as ‘undelivered’ for clients using @xtra.co.nz email services.

Our normal behaviour is to respond to all emails in 48 hours or less. At the time of writing this note we had no outstanding emails to respond to, but are suspicious that we may not have received some emails that others believe they have sent to us!

TRAVEL

I will be in Nelson on Tuesday October 25 and Blenheim, October 26.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington - by appointment please.

Edward plans to be in the Wairarapa on October 27, Auckland on 15 November (on Queen Street), Auckland on 16 November (in Albany), Blenheim on 5 December and Nelson on 6 December.

Mike will be in Auckland on 22 November, Tauranga on 28 November and Hamilton on 30 November.

Kevin will be in Christchurch on 17 November.

Investors wishing to make an appointment are welcome to contact us.

Chris Lee

Managing Director

Chris Lee and Partners Ltd

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TAKING STOCK 13 OCTOBER 2016

 

WHENEVER one hears about the predicted consequences of unfettered carbon emissions, or the spiralling unaffordability of providing optimal health solutions to a population anticipating greater longevity, one then hears politicians and media commentators pass the solution to those who design new technologies.

Better technology will solve the problems.  By implication, inadequate technologies caused the problem, not poor policies or management!

Very rarely, using a style or language that is readable by the masses, does any politician or commentator outline the anticipated technology, and its brilliance.

Perhaps their proposed solution is that ‘’undiscovered’’ technology might solve the problems.

One might also infer from this that we must not expect politicians or indeed anyone that can be identified and is accountable, to address the problems.

So it was refreshing to hear on 2YA, or whatever its latest ‘’brand’’ might be, someone immersed in technology talk about the speed with which technology can bring about change.

He began by explaining the different ways the public digest binary issues, linear outcomes, and exponential outcomes.

For those who dislike mathematical concepts, I might record that a binary issue is one for which a solution is either right or wrong.

One plus one equals two.  Binary.  Right or wrong.

A linear outcome records a consequence of an action.

Throw a rugby ball into water and it gets wet.  A wet ball will not fly as far as a dry ball.  Linear.

An exponential outcome is neither binary nor linear.  It describes an outcome that expands uncontrollably and unpredictably.

The 2YA technology sector participant, whose name was unfamiliar to me, described with great enthusiasm the speed with which solutions are arriving, one being development of a possible solution to multiple sclerosis.  Changes were occurring exponentially as the new knowledge on MS also leads to potential solutions for many similar health matters.

I recall observing recent photographs of a quadriplegic whose spinal cord was repairing itself after stem cell treatment.

An accident victim unable to move had recovered well enough to lift weights above his head.  His spinal cord was regenerating.

I observe the recent breakthrough involving our own Orion Healthcare developers now involved in world-leading analytics.  Orion believes that information properly communicated has the potential to reduce health problems, obviously reducing wastage of health budgets.

One watches the development in education, where internet-based learning is now broadening the options for those who cannot or will not study in orthodox learning centres.

And of course information is now so easily accessible from the internet that in essence the dopiest husband has no excuse for saying that in his wife’s absence, there will be no home-made mint sauce!

It was fascinating to hear the specialist talk about access to health diagnosis and treatment from one’s computer, and to hear how rapidly, (exponentially) surgery is being performed by robots, with surgical processes being done so cheaply that health budgets are being positively affected.

In war zones, robots perform surgery guided by specialist doctors sitting safely in an office thousands of miles away.  (Perhaps there will be no remaking of M.A.S.H.)

We all know the progress being made with battery storage and its implication for the transport industry, and for electric cars, the hope being that a carbon footprint will be smaller, that man-caused accidents will decrease and that the dominance of individually-owned cars in our metropolitan areas will be addressed.

(Private cars are used for just 5% of the day yet car parking and roads occupy 24% on average of every metropolitan area.)

When one hears of despair about the global problems of food shortage, lack of access to health, education and water and the devastation of waterways and clean air, one can easily resort to despondency.  (On the subject of water, we have nothing to offer, it seems.)

Technology has the task of putting right those things that politicians, bureaucrats, and you and me, have fouled up.  (Can technology also resolve our shortage of tradesmen?)

Remarkably, New Zealand is a diamond in this pursuit of solutions, fighting as far beyond its weight as perhaps the All Blacks do in sport.  (Dr Swee Tan in Lower Hutt is a health genius on any podium.)

What a great day it will be when others follow the lead of 2YA and expose us to the brilliant New Zealanders who are finding solutions to the big problems.

Message to all:  encourage your young ones to write code and to think laterally!

 _ _ _ _ _ _ _ _ _ _ _ _

ONLY a fortnight ago, Taking Stock wrote about the impatience of institutional and private investors with their holdings in companies which have strategies that require many years to succeed.

I think of companies like Xero, Orion Healthcare and ERoad, all of which believe that their software skills will add value to American clients, allowing the NZ companies to leverage their sales.

The market has been kind to Xero, recognising it as a significant company, a key component of Wellington’s transformation as an IT hub in New Zealand.

But it has been tough on ERoad.

ERoad produces software and puts it in a black box which is installed and tethered in a truck.

It measures everywhere the truck goes and correctly calculates its road tax obligation, and also captures data on the truck’s usage, recording fuel & oil usage, speeds and other maintenance information.

The US government, which has a problem with road tax cheating, introduces in 2017 a law making it compulsory to use a black box in all of its 5.5 million trucks.  ERoad expects its box to set the gold standard.

So ERoad, which has a most impressive market share in New Zealand and slightly less in Australia, wants to ramp up its success by leasing its black boxes to trucks in America in very large numbers.

As at March 2016, it had leases arranged for 32,452 vehicles in Australasia and 4,501 in the USA.

As at September 2016, the units leased in Australasia had risen by 17% to 38,129 and in the USA the number rose to 5,301, an 18% increase.

In Australasia the business scale already produces impressive profitability which is being used to part fund the US initiative.

If ERoad gains scale in the US its performance would soar.

If it first broke even in the US, its Australasian successes would fund a dividend.

The market price seems to indicate its progress is too slow.

Its share price this year has slumped by a third, though ERoad itself might be best not to be distracted by the valuations others ascribe to their company’s plans.

Are we just an impatient lot or do the sellers believe that the progress is not rapid enough or certain enough?

Orion has announced a series of partnerships and new relationships and targets 2019 as its breakthrough year.  By any normal standard its progress has been stellar.

Its share price is off 20% from just weeks ago.

Impatience or loss of hope?

 _ _ _ _ _ _ _ _ _ _ _ _ _

OF course what every genuine investor wants, and every genuine company strives to do, is to profit by sharing in added-value.

A company that simply allowed gamblers to bet against each other on a corporate platform, and clipped the ticket from the gamblers might argue that it created value by providing the platform, or by guaranteeing to collect from the losing punter, but in terms of our globe, no value is added by shifting money between two private punters.

You might construct an argument that much of today’s derivative trading activity is equally as futile.

Nearly all derivative trading is simply another form of gambling.  No one is likely to convince me that there is added value in day-trading of shares, based on the milli-second advantages created by accessing a faster fibre optic network cable, an activity that is now enormous in the USA.    

Such people have drilled holes through mountains to shorten the route of a cable, so that the length of time that electricity, at 186,000 miles per second, is reduced by a millionth of a second, enabling those with the fastest cable to intercept and exploit those whose cables take a few milli-seconds longer.

Value add?

Can you imagine a more useless purpose in life, if your job is to intercept other people’s business and force a re-pricing of their transaction so you can make a living!

I guess you could argue that hacking into someone’s database and blackmailing him with the threat of destroying the database if the ransom was not paid, might be an example of a valueless occupation.

The Auckland court hearing involving Mark Warminger, Milford Asset Management and the Financial Markets Authority is in full flight, and not yet suitable for comment.

But the underlying theme, involving alleged market manipulation is another example of a practice common overseas that strips value from one party and hands the benefit to another.  Value add?

Such practices as we observe overseas also produce one other result- they often result in individuals falsifying fund performance either to please their boss, or to optimise the crazy bonus systems that lead to such disrespect for the sector.

Fund managers are really well paid.  The best of them are clever, committed, hard-working and worthy of high pay if they can engage in legal, ethical investment practices that produce honourable results for those whose money they manage.

What is it that makes it necessary to pay a bonus based on returns?  If there is a bonus, why not base it on the number of new clients?

Perhaps if they were underpaid, but then rewarded when they achieve successful results, there might be some sympathy for them.

Successful results come from three main directions.

1.  The market generally rises.

2.  Stock Picking is excellent (or asset allocation).

3.  Luck (i.e. takeovers emerge, a technology take off etc.).

If only one of these factors involve skill, why does a bonus follow in a linear manner from the results?

Indeed, if a manager is well paid, why is there any bonus for a year in which investors do well?

Whose money is at risk?

Can you imagine a sharebroker recommending a new share issue and demanding a bonus if the share price rises?

Now if the fund managers in the USA, UK or anywhere are actually manipulating market prices to reach budget targets, in pursuit of a bonus, surely the concept of a bonus, as well as dishonesty, is the cause of the problem.

Might you not argue that the only real bonuses should be relative success, leading to a bigger fund and more clients, leading perhaps to a bigger base salary?

One hopes that the FMA v Warminger case will lead to discussions about how much it is reasonable to pay a fund manager, and why such people need ‘’incentivising’’.

Would we ever argue that a fund manager refused to do his job properly because he was not incentivised?

 _ _ _ _ _ _ _ _ _ _ _ _

OF course, market manipulation is despicable, though I would say even worse is the behaviour of those who indulge in front-running, which seems to me to be simple theft.

Front runners are people in a position of power who KNOW that the market is about to change, and intervene by buying or selling to exploit that knowledge.

Imagine a young idiot, quite unsuited for any role in financial markets, who has been instructed to buy a large number of shares to meet an institutional order.

So this despicable, weak, greedy person buys for himself before buying for the client.

As the institutional order forces up the price, the gutless wonder sells his shares acquired a few minutes earlier, and steals a profit.  Value add?

Is this any different from an ambulance driver stealing from the purse of an accident victim?

How is it that any organisation would employ such a weak man?  Surely no reputable organisation would employ such a thief?

And if an organisation employed such a person knowing of their weakness should that cynical employer be exposed?

Such a person, or organisation, has no defence, when criticised.

If you have no reputation worth protecting, you have no valid complaint when eventually exposed.  On a global scale, Lehman provided ample proof of this.  Cheat.  Fail.  Linear.

 _ _ _ _ _ _ _ _ _ _ _ _

THE ongoing struggles for one of the world’s most important banks, Deutsche Bank, has not reached crisis point but has now escalated well beyond an issue of poor profitability.

DB, present in New Zealand as the beneficial owner of half of retail broker Craig & Co, has been fined by American regulator US $14 billion, for its role in selling toxic sub-prime securities in the lead-up to 2008.

Presumably the fine will be payable at an affordable annual rate for many years, if any such payment is ever affordable.

The Europeans, particularly the German politicians, are linking the size of the gigantic fine to the tax claim the Europeans have imposed on Apple, a similarly enormous sum.

Some German politicians and market regulators are claiming the fine is almost tit-for-tat between the Americans and the Germans.

What struggling bank can cope with such a fine?

Worse, DB is yet to hear how many billions it will need to pay European regulators for its outrageous role, via its Moscow branch, in allowing the Russian Putin and other oligarchs, to mirror trade tens of billions of shares, effectively enabling them to shift their securities into a ‘’safer’’ economy and currency.

That behaviour defied the European sanction on trading with Russia, after the Russians had strengthened their control of Crimea and the Ukraine.

The European fine may also be elephantine.

Bankers worldwide are on edge, concerned that were Deutsche Bank to be in poor health, there would be inevitable reactions, probably over-reactions, to what is not known about the biggest and oldest bank in Germany, with a massive counter-party liability in derivative markets.  (Some say with trillions of liability.)

For example, banks might wonder some of the following

- How much exposure does each bank have as a counter-party to derivative transactions?

- What is a bank’s nett exposure to inter-bank lending?

- Is a bank able to stage a huge rights issue at a discounted price, and would any party underwrite such an issue?

- Is Angela Merkel serious in saying that Germany would not respond to a special need of any of its biggest banks?

- Is any bank not clear of unidentified problems?

- What would be the wider consequence if a bank was left to solve its own problems?  Would it affect banking globally?

Readers may recall that during a trip to Europe, two years ago, the market participants I met were signalling unresolved issues in DB.  Taking Stock has discussed this regularly, over a long period.

Subsequently DB has moved its relatively insignificant NZ operation back to Australia, leaving it with minimal NZ involvement, principally its holding of 50% of Craigs, a holding that enables Craigs to enter large transactions, assuming it has a giant shareholder to assist if needed.  Craigs is our leading retail broker/funds manager.

First NZ Capital has a back-up with Credit Suisse, and of course UBS and Macquarie have access to substantial offshore parent balance sheets.  They all need grunt to be credible, as investment bankers.

In a world which, as always, seeks to assess unquantifiable risk, such as the North Korean nuclear weapon behaviour, Russian/American/Syrian fallout, Middle East perfidy and the South China Sea tensions, the restoration of Deutsche Bank is a front-page item yet to be addressed.

My own guess is that DB is too important to Germany to remain weak for many years.

My guess is that the DB subordinated debt-holders might be in a slight sweat till there is certainty about the second fine, and about the recapitalisation of DB, if it is required.  But I expect German tax-payers will already be sighing.

How many more corporate or sovereign problems will they be expected to underwrite?

 _ _ _ _ _ _ _ _ _ _ _ _

TRAVEL

I will be in Christchurch next Tuesday and Wednesday, October 18 and 19, and in Nelson/Blenheim, October 25 and 26.  I will be free to see clients in Blenheim on the morning of the 26th, and Nelson clients in the afternoon of the 25th.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington - by appointment please.

Edward plans to be in the Wairarapa on October 27, Auckland on 15 November (on Queen Street), Auckland on 16 November (in Albany), Blenheim on 5 December and Nelson on 6 December.

Mike will be in Auckland on 22 November, Tauranga on 28 November and Hamilton on 30 November.

Investors wishing to make an appointment are welcome to contact us.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

---

TAKING STOCK 6 OCTOBER 2016

 

IT can be repeated that Taking Stock is not a travel guide but in recent weeks our Prime Minister John Key visited Sri Lanka and in turn Sri Lanka is leading a high-powered trade delegation to New Zealand.

Once Ceylon, Sri Lanka is lined up as an important trading partner, and possibly an entry point to India, with whom Sri Lanka has its major two-way trade.

Penelope Christoffel is one of our key staff.  She heads our database hub and client communication centre.

A former journalist, later a librarian, Penelope joined us three years ago.  With her husband Patrick, a news editor at Fairfax, she holidayed recently in Sri Lanka.

Her picture of the growing trading partner of New Zealand follows.

Penelope writes: -

YOU would be mad to drive in Sri Lanka.

This island country has a land area a bit bigger than Scotland, but is home to at least 15 million more people – around 20.7 million at the last count.

The main roads are good, and improving, with a nice, clear centre line that every motorbike, three-wheeler (tuk-tuk), bus, van and truck ignores.

A single-lane road quickly becomes six lanes when a van or bus overtakes a tuk-tuk, which is overtaking a motorbike – and the same thing is happening the other way.  At times during our two-week stay, I could have sworn our van had Harry Potter Knight Bus properties – it seemed to squeeze through gaps much too small for it.

The amount of traffic – or perhaps widespread ownership of motor vehicles - seems to be a good indication of a country with a reasonably strong economy.  At around NZ$6,000 new, a tuk-tuk is not a cheap purchase.

At the risk of sounding patronising, I thought most people appeared to look healthy, well fed and virtually all busy.  We saw few beggars, and street hawkers were apparent only at the most popular tourist sites.

However Janith, our (extremely calm) driver for two weeks, was scathing about what he called the government’s lack of policies to help the poor.  They were getting poorer, he said, and the rich were getting richer.

No different from the rest of the world then.

The Tamils, brought by the British from south India to pick tea, are probably among the poorest in the country.  Tea is still picked by hand, mostly by women, so just like our seasonal pickers their wages and conditions are probably varied.

Some of their houses are provided by the tea estates and look substantial, with million-dollar views over the endless tea-covered peaks of the central hill area.  Other workers live in tiny tin huts, squeezed together to form a tidy, but ramshackle, shanty town.

We went into only one real home (as opposed to the Airbnb holiday homes we rented).  Janith invited us to dinner at his parents’ house, where he lived with his four adult brothers (all employed).  The house felt small for so many adults, but was clean and well-furnished and the food was excellent (as it was everywhere we ate).

We noticed sacks of rice stored in the rafters.  Janith explained that the house floods roughly once a year and they then had to sleep in a nearby temple.

Regular flooding is all too familiar to many New Zealanders as well.

Like us, Sri Lanka is blessed with plenty of rain, and similarly it falls unevenly over the country.

Sri Lanka is hotter overall, however, with a temperature year-round in the high 20s, but the country could teach us a thing or two about water storage.

In fact the ancient kings began digging tanks, or reservoir lakes, around 400BC and irrigation is still a thing of precision and beauty.  Every spare piece of land is planted with vegetables, the soil dug neatly with irrigation channels between each row, which are flooded just once a day.  The produce thrives.

Sri Lanka grows enough rice for its population and exports very little.  The domestic-only use might explain some of the relatively old-fashioned harvesting methods we saw, sometimes even with yoked buffalo.  And we would often see rice spread out on tarpaulins or even on the hot road to dry.  Nobody would dream of driving over it.

The country’s main earners are tea (obviously), clothing, diamonds and rubber, though the rubber (painstakingly gathered from the sap of the tree), is gradually making way for palm oil.

The highest earner, however, is tourism.  In 2015, there were 1.8 million visitors, which is an enormous increase from probably an extremely low base in 2009, when the civil war ended.  New Zealand last year had 3m visitors.

Sri Lanka is well set up for tourists.   For a start it offers much better internet coverage, which is widespread, reliable and cheap.

To accommodate the rugby fanatics in our party, we settled in to one roadside restaurant in a small town and, after lunch, live-streamed the All Blacks vs South Africa test on a laptop.

There was barely a blip in the service for the entire two hours and no suggestion from the manager (a prop in his schooldays) that we were exhausting his data cap or that we should pay extra.  He was happy with our patronage, and especially with the gift of some AB playing cards.

This excellent wifi service is in sharp contrast to many New Zealand hotels and restaurants, where we have often experienced intermittent and expensive internet access.

Despite this widespread availability of wifi, and the proliferation of mobile phones (90% of the adult population have one), credit and debit card use is low and only 10% of transactions are done online.

Cash is king, which we didn’t find surprising, considering the abundance of roadside stalls and tiny shops lining the streets of every town and village.  It would be a tough job to install transaction machines in every one.

There are, however, 43,000 ATMs in the country and we found them readily available.  That figure equates to 17 per 100,000 adults in Sri Lanka.  The figure for New Zealand is 70 per 100,000.

Unfortunately, we had cause to use the health system during our trip.  A cat which had crept under our table during lunch took fright when we stood up to leave and sank its fangs into the nearest calf – not mine, thank goodness.

The hospital was efficient, the medical staff were very helpful and spoke excellent English and took no risks.  Although rabies is not widespread, especially in Colombo, it is always fatal, so our friend was pumped full of antibiotics and rabies vaccinations and released nine hours later.

Healthcare is virtually free to citizens; our friend’s visit to a private hospital cost around NZ$1,000 (including a delicious dinner).  The reception area was very well staffed, the walls were adorned with photos of all the senior medical staff, and there were numerous electronic signs advertising that the hospital had the latest CAT and MRI scanners.

Things are rather different in the north of the country, though, where the Tamil independence movement was strongest.

The military presence gets stronger and more overt the further north you go and, despite clear signs of government infrastructure spending, poverty is obvious.

A wonderful country, but it still has a way to go.

Penelope

 _ _ _ _ _ _ _ _ _ _ _ _

Chris Lee writes:-

A SAGACIOUS old boss of mine, many decades ago, told me that virtually every ‘’big idea’’ loses money for the fellow who had the idea.

The person who dreams of the monster sub-division in an area where he visualises a surge of public interest, might get the idea underway but usually underestimates the cost, and overestimates the speed with which the public want to buy into the idea.

My old boss told me that the fellow with the idea usually has to resort to second tier financiers, who themselves fail when times are tough.

This often leads to receivership, and one conclusion we are all allowed to reach is that most receivers are hopeless at selling assets at fair value during periods of market downturn.

The person who buys from the receiver also often fails and often it is the third owner who completes the project and makes it viable.

The Wairakei Golf course, a marvellous advertisement for New Zealand, provides an obvious example.

Developed on a shoestring by the poorly resourced Tourist Hotel Corporation in 1970, it was scruffy and grossly underfunded, and finally was virtually given to a Japanese company, EDC.

The Japanese spent multi millions putting in better facilities and giving it an international feel and then they went broke.

The new owners, very well-heeled New Zealanders who had banked hundreds of millions from successful business or property ventures, bought the course for a song, maybe even just a verse of a song, and then spent tens of millions building a truly great international golf facility, on a par with any international course.

Just down the road at Kinloch, some bright fellows persuaded the golfing great Jack Nicklaus to design an international course in a lovely holiday area, but in an area which was well off State Highway One.

Just as my old boss would have forecast, this expensive development fell into the hands of the likes of Bridgecorp and Hanover, and has failed to achieve what any Nicklaus course should achieve- a mass of visitors bearing fat wallets and an insensitivity to travel and golf costs.

It remains to be seen whether an ultimate buyer with very deep pockets can rescue this project.

I was reminded of these projects when I was in Queenstown last week and witnessed the astonishing growth of suburban housing in and around the Five Mile village that had been created by the failed Christchurch property developer, David Henderson.

Well before the 2008 global financial changes, Henderson with virtually no capital, had the vision to get this development drawn up.

The likes of Hanover Finance helped him to get cracking, lending other people’s money to him, but after 2008 his project died, Hanover died, and his involvement ended.

I guess he will get a little satisfaction from watching others now create the suburbs he envisaged.

By contrast consider the Wellington suburb of Whitby, which must have taken a decade or more to achieve enough sales to make the project viable.

Its backers included two deep-pocketed shareholders, Fletchers and Todd Corporation, so it survived, and now is, a thriving suburb, still growing, and probably shedding regular returns to its shareholders.

The difference here was that the dream was held by people with the wherewithal, the experience and the access to bank debt, even in bad years.

In a Taking Stock soon I will offer thoughts on how developments can be funded reliably and why New Zealand needs a non-bank lending sector that can survive market downturns.

It is inevitable that the sector will return.

It is essential that the sector does not in any way embrace all the design faults of the 1996-2008 non-bank sector, and that it does not attract the sort of weak, greedy people it attracted in that period.

 _ _ _ _ _ _ _ _ _ _ _ _

THE difficulty in advising on, or managing other people’s money is highlighted by the collapse of the share price of Tower, an ugly duckling for at least a decade, often poorly managed and over-influenced by its previous shareholder GPG.

Indeed at least 15 years ago I criticised Tower for the wide range of mediocre performers who were paid at what I described as ‘’Prime Minister’’ levels.

When it spun off some of its divisions, to the likes of Fisher Funds and other insurers, Tower was left with a rump that was to be averted by all sensitive eyes.

Its earthquake liabilities after 2011 were undefined but scary.

Yet it attracted as Chairman Michael Stiassny, a thick-skinned fellow with a good level of experience and energy.

I was gobsmacked when Tower decided two years ago to use its dwindling resources to buy back its own shares at a price north of $2.00.

And I was also amazed when at least one broking firm, and several fund managers, were attracted to its prospects, believing its dividends were sustainable and made the shares a good buy at prices around $2.00.

All of this just goes to show how foolish one can look a year or two later.

The Tower share price is now less than $1.00, still not stable, and the dividends are suspended.

Insurance claims have still not ended.

I see no competitor in sight, looking to reverse the state of what is now a very small company with a dwindling market share and no obvious solution.

My dislike of share buybacks is long-standing, and does not rest solely on my memory of the ANZ Bank, which bought back shares in 2006 for more than $30 and then needed to discount a rights issue in 2008/9 to a figure nearer half of that, to re-raise the capital it had depleted.

All my career I have regarded real capital as precious, something to provide stability and calm during inevitable bad years.

I have watched countless times good companies squander their good years and then founder in bad years, because they focussed more on share price rises, than underlying performance and ability to survive the unexpected.

If directors can get it so wrong, and fund managers fail to apply caution, and financial advisers feel free to make optimistic recommendations, what benefit does the public have, from following the leaders?

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THE retirement of Tim Bennett, after his five-year stint as the head of the NZX, might have been expected but is still to be regretted.

Bennett, after a distinguished career had every right to seek a quieter life when he returned to New Zealand, but opted for the tough role of sorting out a largely dysfunctional NZX, which had endured poor leadership and erratic governance for many years.

The most senior leaders of NZX broking firms had ceased to engage cooperatively with each other, their disrespect for the NZX leadership was highly visible, and the staff of the NZX had a turnover rate that reflected incompetent leadership.

I recall reading that the NZX staff turnover was higher than in any other NZX-listed company.

Bennett, mature, affable and in no hurry to be wealthier, has brought cohesion to the NZX, has overseen a broadening of its offerings, including an increase involved in exchange traded funds, and he has brought calm and inclusiveness to the exchange’s relationship with the senior leaders of the three significant NZX broking firms which account for the bulk of the daily share trading.

His successor will inherit a very much happier work force, more functional relationships, and a broader revenue base.

Bennett is still relatively young and hopefully will find a slot that allows him to contribute further to capital market improvement, without an over-commitment.

One hopes his successor will also focus on the development of the capital markets, and on patrolling the members who use the NZX platform, to ensure we never revert to the previous decades when morally bankrupt people indulged in front-running, insider trading, market fixing and ‘’client-last’’ behaviour.

The global markets are in an environment that might easily be spooked, without any fuelling from greed and self-interest.

Bennett’s legacy might be the cleanest NZX environment in our history.

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Travel

 

I will be in Auckland on Monday October 10 in Albany (Aroma Café) and Tuesday October 11 at Waipuna Lodge.

I will be in Christchurch (Chateau on the Park) on Tuesday October 18 and Wednesday 19.

I will be in Blenheim on Tuesday October 25 and Nelson, October 26.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington - by appointment please.

Edward plans to be in the Wairarapa on October 27, Auckland on 15 November (on Queen Street), Auckland on 16 November (in Albany), Blenheim on 5 December and Nelson on 6 December.

Mike will be in Auckland on 22 November, Tauranga on 28 November and Hamilton on 30 November.

Clients and investors are welcome to contact us to arrange meetings.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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