Taking Stock 31 October 2019

IF there is one word that destroys investor confidence it is the ugly word ‘’corruption’’.

Corrupt practices transfer wealth furtively from rightful owners to those chosen by the corrupt. Because these practices are usually unforecastable, they negate the value of honest, intelligent research. Corruption destroys trust and undermines capital markets.

Ultimately it poisons the whole of society just as inequality might do.

New Zealand is often identified as among the least corrupt countries in the world.

Just across the Tasman Sea, Australia no longer enjoys this accolade, if it ever did, and now rivals some of the worst countries.

Malaysia would be one of the most corrupt countries, easily understood by those who read The Billion Dollar Whale, a non-fiction account of how crooked Malaysian entrepreneurs combined with corrupt political leaders to strip investors of billions of dollars, much of the money stolen from Wall Street and the Middle East.

The kernel of this event was a dishonest, nerdy drop-out who exploited investors by linking with the Malaysian Prime Minister to con Middle Eastern fund managers into guaranteeing Goldman Sachs-promoted worthless ‘’infrastructure’’ bonds. What a mix!

The money raised by Goldman Sachs – multi-billions – was actually spent by the Malaysians on nonsense; parties on yachts with bimbos leaping out of birthday cakes, the sort of childishness that appeals to Hollywood and Wall Street juveniles (and maybe those empty-headed lawyers who target university students on summer work experience assignments).

The Billion Dollar Whale was published just before my own book, The Billion Dollar Bonfire. When I read it, I imagined that I would not find more depressing evidence of the sort of greed and corruption that demoralises all decent people. Thank goodness it was in Malaysia, not closer to home, I thought.

Sadly, that book has been overshadowed by Banking Bad, a 2019 Australian book written by Adele Ferguson, a newspaper reporter, describing the effort to force the Australian government to appoint a commissioner to investigate Australian banking and insurance industry practices, and then recording the vile evidence heard by the Commissioner (Kenneth Hayne).

Banking Bad proved to be even more nauseating than The Billion Dollar Whale, for it revealed corruption in a stratum far more trusted than Malaysian politicians, Malaysian entrepreneurs, Wall Street idiots and Middle Eastern fund managers.

Those who read Banking Bad will be disgusted by the venal behaviour of people we know as banking leaders, and organisations which we implicitly trust, whether we are bank depositors or bank shareholders.

The book records the practices in Australian banks and insurance companies that illustrate how far the banks have distanced themselves from the days when bankers had a special status, as men (usually men) who had been trained to honour the trust of all bank clients.

Those men in those days would also serve as the honorary treasurer of the bowls club, or the Rotary club, and would provide sound advice on a wide range of activities. They were trusted and generally wise members of every local town. My uncle (Phil) was one of them, in his case for 45 years, at the ANZ Newmarket for most of these years.

Bank managers would be transferred around the country, learning about the people and economies of different regions, whether those towns relied on agriculture, industry, or tourism.

Bankers earned their privileged status because they were honourable people with good general knowledge.

Ferguson’s book Banking Bad has dragged us into today’s much less comfortable era. How did banking lose its way?

In the 1980s, the banking mantra began to switch from administrative excellence, carefully matching deposits with loans, into entrepreneurial organisations, measured not by their excellence and trustworthiness, but by the short-term earnings and their financial and political might.

Derivative trading, fee-earning activities (fund management, insurance selling etc) and risk activities, in good years lifted short-term earnings, leading to absurd salaries and bonuses, and higher dividends.

Consultants in this era were engaged to teach the administrative and frontline staff how to become aggressive salesmen, teaching staff that visits from depositors were an opportunity to ‘’cross-sell’’. Staff were expected to persuade depositors to take out expensive personal loans, or make more use of credit cards, or buy insurance, or other fee-heavy bank services.

Overselling became the norm. It was in the 1990s that Westpac in NZ was forced to rebate clients who had been lured into Westpac’s Superannuation Fund by the false claim that past performance indicated future performance, one of the great lies still perpetuated by managed funds salesmen.

Inevitably people of modest means were persuaded by bank staff to borrow massive sums (millions) to invest in high-risk, leveraged share funds, as the Australian commission has discovered.

If this sounds unbelievable, consider this documented case from the Haynes Commission.

A middle-aged single woman with a debt free house and on a modest salary ($60,000 pa) visited a branch of a huge Australian bank to renew a term deposit.

By the time she left she had been persuaded to borrow a sum equal to two thirds the value of her house, and to invest this in a share fund which itself borrowed to increase the risk in pursuit of higher returns.

Let’s put this into English.

She was persuaded to borrow hundreds of thousands, by putting up her house as security. The share fund then borrowed hundreds of thousands so that she was investing effectively a million, the bank holding her house to secure her ‘’investment’’.

If the fund fell by half, the amount of the extra money borrowed, she would lose her house.

Conversely, if the fund rose by a half, she would have made a massive gain. Either way the bank picked up hefty fees and had no risk.

The salesman pitched that the dividends and gains would exceed her borrowing costs, providing her with a ‘’free’’ pension of perhaps $50,000 after all her costs.

As well as charging a large fee for organising this, the bank naturally charged interest on her loan, and interest on the other borrowed money.  It paid bonuses to the teller who suggested the client talk to an ‘’adviser’’ and bonuses to the ‘’adviser’’ for sealing the deal and to the ‘’lender’’ for making a large loan.

Who cared about the lady?  Not the bank!

In her case the fund failed, share prices fell. As the woman could not meet her loan servicing costs from her modest salary, she lost her home. That is what the Australian banks were doing in the recent years all over Australia, to raise profits, to pay absurd salaries to its executives and revolting bonuses.

One recipient was Ralph Norris, once the NZ CEO of ASB bank, who could and does claim that in the 1990s he lifted ASB’s ‘’market share’’ by 60%, before becoming CEO of ASB’s parent company CBA. The CBA (Commonwealth Bank of Australia) was once wholly owned by the Australian government, but, like the BNZ in New Zealand, was sold to the public by the government.

Norris was paid $10 million in his later years, a nonsensical salary, unrelated to scarcity of willing, skilled people.

The Commission of Inquiry into Australian banks found dozens of examples of practices that would bring disgust to the real bankers who had enjoyed banking careers in earlier decades.

In the past decade banks overcharged knowingly, and did not refund promptly, if at all, when challenged.

Banks sold insurance products to people not entitled ever to make a claim. They did this to tens of thousands of people, knowingly.

Banks told their insurance divisions to take every possible measure to disallow claims on insurance.

Banks fired their branch staff who did not hit sales targets.

Banks lied to the Australian banking regulators.

Australian banking regulators allowed dreadful practices, inexplicably.  No evidence has emerged of ‘’brown paper bags’’ (a euphemism for bribery) but neither has there been a credible explanation for the extraordinarily slack behaviour of the regulators.

The insurance sector was just as rotten, as Banking Bad reveals.

Fees were charged for no service, dead people’s accounts were kept, fees charged, no attempt to notify the estate of the account. Companies trawled their clients’ medical records, seeking even the flimsiest excuse to deny a claim.

When did all of this rotten behaviour begin?

My memory of these excesses returns to an American, George Trumbull, who in one year in the 1990s, as CEO of AMP, oversaw a billion-dollar takeover of a reinsurance company that within months had been revealed as worthless. The AMP policy-holders’ money was sent to the sky as smoke.

Trumbull left after one year as an absurdly overpaid CEO.  Oh yes, AMP gave him A$10 million as a farewell bonus.  Presumably if he had lost ten billion, the gormless AMP board would have given Trumbull $100 million. No wonder AMP has been humiliated by the Hayne inquiry.

Rotten, corrupt practices grew like fertilised grass in the 1990s.

When AMP listed its shares in 1998, they sold for A$36. Today they are less than A$2.00. Greed comes at a cost.

Sadly, the Australian bank inquiry has shown us that greed and corrupt practices are not confined to Malaysia, South America, Eastern Europe or Africa. They were still taking place even in 2018. Place your bets if you want to believe that the Hayne inquiry has cleansed the Australian banking and insurance sectors of all their bile.

Just pray that the idiotic practices and self-focused mentality has not infiltrated our banks.

The rot will not go away if we sit silently, cosseted by any smug view of virtue.

The behaviour uncovered during my research of the South Canterbury Finance disaster (The Billion Dollar Bonfire) has left a most uncomfortable feeling. It is not going away. Perhaps our Reserve Bank Governor, Adrian Orr, will lead the inspection team in NZ.

The response of our own politicians to the SCF story increased my discomfort, though in fairness to Winston Peters, he has recommended during a radio interview that all of the media should read my book ‘’right till the very last page’’.

Two banks and a major public company bought multiple copies for their directors and executives.

But one pipsqueak voice is ineffective.  One hopes Banking Bad will raise the decibel level of the protest and that we will get fresh leadership in the banks to tackle the problem.

 _ _ _ _ _ _ _ _ _ _ _ _

ONE excellent response to uncomfortable corporate behaviour has emerged during the battle between the New Zealand Todd family company and an iron ore project it seeks to manage in Australia.

Todds has tried twice to privatise a public company (Flinders Mining) which has assets that the Todd project will need.

The minority shareholders of Flinders Mining mounted loud protests to Todd’s typically ‘’big brother’’ behaviour, succeeding in getting the Australian stock exchange to change its rules about the privatising of public companies. Todds had tried to privatise Flinders twice, to circumnavigate the minority shareholders.

Such a plan now needs consent of 75% (not 51%) of the shareholders before privatisation can occur. That Todd strategy failed. It deserved to fail.

The minority shareholders of Flinders clearly are not in the Todd camp, believing their company, controlled by Todds, has far better prospects than Todds is revealing.

Anyone interested in watching the Australian campaign to thwart the Todds will find this a fascinating issue to follow.

It seems a multi-billion dollar project will need to pay a premium to win the support of minority shareholders at Flinders, a rare outcome in a corporate world that not everybody admires.

Flinders’ minority shareholders argue that without their support the Todds’ massive project will be deferred indefinitely.

With ample access to sophisticated advice, Todds may have to move soon.

All investors might enjoy this battle. I will keep an eye on it, for our clients and users of our website.

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Johnny Lee writes:

LAST week’s comments regarding the Tiwai smelter prompted a strong response from readers, ranging from concerned investors to what I would summarise as readers less than impressed with Rio Tinto/Sumitomo’s behaviour.

Many noted that 2020 is an election year, and that certain political factions may have an incentive to boost their profile within the regions.  Initial comments made by the Deputy Prime Minister to the media seemed to indicate that the door to further assistance is not fully closed, while subsequent media speculation suggests that the door has been slammed shut by the Government.

The share prices of energy stocks continue to be volatile and have fallen further this week. Those companies with exposure to South Island generation look to be the most concerned. The fact that the share prices fell so sharply indicate that the market genuinely believes there is a possibility of a closure. As a point of reference, Meridian Energy’s 15% share price fall returned it to a point seen in August this year.

It is clear to me that there is little appetite for further taxpayer or shareholder contributions being gifted to the Australian and Japanese multinationals involved.

Rio Tinto intends to update the market early next year.

_ _ _ _ _ _ _ _ _

KIWI Property Group (KPG) has announced a retail offer, allowing existing shareholders to purchase additional shares at a fixed price of $1.58.  Shareholders of KPG can expect correspondence to be sent to them from the share registry today.

The offer closes on 15 November and represents a yield of approximately 5.75% gross, at current distribution levels.  KPG is forecasting a small increase in distributions next year.

The offer allows investors to bid for $50,000 worth of new shares per holding.  If scaled, it will be scaled in ‘’reference to existing shareholdings’’ – presumably to disincentivise shareholders from applying multiple times with different entities, a tactic commonly used during the flurry of capital raisings throughout the GFC.

The proceeds raised will be used to reduce debt levels, giving KPG headroom to pursue growth opportunities.  We do not expect Kiwi Property Group to require further AML documentation, unlike the recent offer from Goodman Property Trust.

The discount of approximately 5% is modest and is similar to the discount offered for the GMT issue. Investors sitting on surplus cash can take this opportunity to invest at a discounted level.

The driving force behind these capital raisings has been the apparent willingness of the market to value all shares, including the Listed Property Trusts, at ever-rising levels. The LPT sector is now trading at levels far above its Net Tangible Assets.

These dynamics are expected to continue. Advised clients should contact us if they wish to discuss an investment.


Kevin will be in Ashburton on Wednesday 6 November.

Mike will be in Auckland (city) on 7 November.

Edward will be in Nelson on 12 November and in Auckland City on Thursday 21 November and Albany on Friday 22 November.

David Colman will be in New Plymouth on 14 November.

Edward and Johnny will be in Christchurch on Wednesday 27 November.

Anyone wishing to make an appointment is welcome to contact us.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

Taking Stock 24 October 2019

The project that has preoccupied me in recent years has reached its final days.

Ever since South Canterbury Finance elected to mislead those investors with SCF listed securities I have believed that they were due compensation.  That aspiration has now ended.  I record below the email sent to those SCF investors who had helped to fund the compensation claim, and the rather unwise, petulant response of our current finance minister Grant Robertson, as well as my final email to him.

To be fair Robertson did not cause the problem, nor is his foreign affairs civil service background of even remote help to him in a current role for which he is probably ill-suited.  His error is nevertheless a defining moment in his career.

Nothing has been done to address the Companies Office's egregious error, when it wrongly advised its minister, Simon Power, that Hubbard was defrauding investors in 2010.

Surely a law firm and a litigation funder should be tackling this shameful cover-up that began with Key's government in 2010.

There were many victims, but none more obvious than the Hubbard family, which was forced to pay $22 million for the statutory management fee, but the real victims were the preference share investors, who were denied a recovery of capital, victims of decisions that followed the determination to keep the Companies Office error concealed.

Of course Justice Helen Cull accepted the Companies Office bumbling as a matter of fact in a court case in 2018.

Yet still the Crown and our government believe the error should be buried.


There is very little ground between incompetence, poor judgement, chicanery and the final, ugly condition of corruption.

One hopes we will hover above the ugliest of those descriptions.

My letter to SCF investors was forwarded to them last week.

The deluge of responses to this letter would not be linked to the recent political polls but certainly would not cause Robertson to believe there is goodwill towards him, or an understanding of his position.

The letter to investors included his letter to me. My response to his letter is at the end of this item.

The good news now is that the market regulators, particularly the Reserve Bank and the Financial Markets Authority, have taken action to reduce the chances of a repeat of the sort of poor laws and poor practices that led to the finance companies' collapse, and the destruction of Crown money totalling more than a billion dollars.

Laws are still not strong enough, but enforcement will be better.

We will tidy up trust deeds, supervise trust companies, license auditors and prosecute poor performers.

More effort will be made to exclude unfit and improper people, though in my view we need to be tougher in this area.

I want to see published a matrix that guides those who assess whether aspiring directors or relevant executives are fit and proper. I believe the decisions should be published and that the networks consulted to assist in providing relevant information should be widened.

The fit and proper person criteria should debar those who are so weak that they indulge in front-running, insider trading, false accounting, deceptive practices or immoral behaviour, such as we have seen in a law firm, adult men behaving without heed to any reasonable standards.

A matrix would make consistency achievable.

The other area which ought to be revisited but is being ignored by lawmakers is our lack of supervision of the country's insolvency practitioners.

The self-serving coalition between law firms, banks, trustees and insolvency practitioners naturally leads to self-applause when these people are asked to assess current practices with the MBIE law-makers.

The self-satisfied grouping reminds me of Mr Bean's mindset, when he sent himself dozens of complimentary birthday cards.

MBIE appears unable to respect the rights of unsecured creditors and shareholders, which sit behind the secured creditors, in any receivership or liquidation.

Put it this way: If a repossessed truck could sell tomorrow for a clean $20,000 to clear the secured creditor, who would fight for more time to see if the truck might sell over time for $40,000 and return money to the unsecured creditors or – gasp – the shareholders? The secured creditor will take the bid that clears his debt as soon as possible.

One sure way to get rich is to hang around insolvency practitioners with a cheque book looking for bargains.

The fit and proper person laws need to be better defined and enforced, and insolvency practitioners must be zealously supervised and prosecuted, by a simple, quick, cheap legal process, when their practices produce unfair results.

I am not talking about simple crime, such as occurs when a farmers' stock is stolen and reappears on the farm of a receiver's friend. The police should deal with that.

I am focusing on the vigour and intellectual rigour applied to ensuring best market prices are achieved with minimal process costs.

Anyone wondering why this is an ongoing issue should read the chapter in The Billion Dollar Bonfire on McGrathNicol's performance with the SCF receivership.

The letter to SCF investors and the correspondence between Robertson and myself follows:

17 October, 2019

To all contributors to the SCF Litigation Fund

The Minister of Finance, Grant Robertson, has written to advise that he has dismissed any thought of compensating SCF preference share investors.

My final approach had brought to his attention: -

1. That SCF preference share investors had been denied their legal right to full and timely disclosure of all material events that might affect investor decisions to buy, sell or hold SCF's preference shares.  A QC had proved that SCF’s directors (Baylis, Shale, McLauchlan), its shadow directors (Paviour-Smith, Borland), Treasury, the Reserve Bank, the Companies Office, The National government's cabinet, the Securities Commission, the NZX, its auditors (Ernst Young), its contracted CEO (Maier Junior) and its trustees (Trustees Executors), had all been aware of SCF's insolvency, or should have been aware of it. The law specifies that directors and advisers have a liability to ensure continuous disclosure.

2. That various incorrect statements had been left uncorrected by the Crown, in particular statements made by Maier and by SCF documents, published after Crown interrogation of SCF's true position.

3. That the Companies Office had made an egregious error in 2010 by falsely alleging that the late Allan Hubbard had committed fraud with Aorangi Securities Ltd, by lending Aorangi money to himself, unsecured. Astonishingly, the Companies Office wrongly recorded that Hubbard had agreed with this conclusion. A High Court confirmed these errors in a 2018 court case.

4. That Key's National government had concealed the Companies Office error and made a series of decisions that allowed the error to remain concealed until the High Court in 2018 forced the disclosure of the error. Subsequent National government errors flowed from the concealment and led to a decision to decline a secured rescue plan that, as time has proved, would have restored full value to SCF preference shareholders.

I asked Robertson to restore to investors the value of their SCF preference shares at the time these proven errors were made. Depending on the time that the different events impacted on the value of the shares, the compensation would have led to a payment of between 10 cents per share and 40 cents per share, costing the Crown between $12 million and $48 million.

On October 11, 2019, Robertson replied as follows: -

Dear Chris

Thank you for your further letter of 19 September 2019, regarding South Canterbury Finance.

You are welcome to hold the opinions (my underlining) that you do regarding the historical events surrounding SCF.  However, the advice I have received is that the facts do not justify the outcome you are seeking, which is payment by the Crown of significant sums of money to you (my underlining) and other parties (my underlining).

As I said in my letter of 18 September to you, further correspondence on these matters is unlikely to be productive and so I may not reply to any further letters you send.

Yours sincerely

Hon Grant Robertson

Minister of Finance

Please note I have never sought money for myself, having sold my SCF shares for 13 cents in August 2010, nor have I sought money for any ''parties''. I sought compensation for SCF preference share investors.

I shall reply to Robertson, noting his response was the final act of a concealment of Crown incompetence and noting his decision was neither “honourable” nor a decision based on ''values'', as his party had promised.

I will leave it to him to work out the cost of disrespect, and will publish his response, knowing that all members of capital markets will make their own judgement of this political behaviour.

It is regrettable that his response brings to a conclusion the effort to gain compensation. Michael Connor and I have no further avenues of compensation to take in our effort to rectify the deplorable behaviour of all parties involved in the original mismanagement of SCF and the failure of any of the third parties to provide any value by their highly-paid work.

I will be unable to approach imminent retirement with any respect for the multiple parties who feasted on SCF's corpse, without bringing any benefit to investors or taxpayers.

All investors are welcome to contact me. I have copies of The Billion Dollar Bonfire that describes the shameful story of SCF's demise. The remaining dozens of books unsold from the 5,000 copies printed will be couriered on request at a discounted price of $30, or given to investors who have been left destitute by the event.

Thank you for supporting our effort to put this matter right.


Chris Lee AFA

Michael Connor AFA

SCF Action Committee

My reply:


Dear Grant

Re: Crown concealment of Companies Office and National government errors relating to South Canterbury Finance

Your email to me of 11 October, 2019, is noted.

To ensure one of your errors is corrected, I record again that I sold my SCF Preference Shares in August 2010 and have never sought any money by way of compensation. Your remark that I was seeking money personally is insulting and I suspect a petulant remark, based on the vulnerable position you have taken.

I shall publish your letter for capital market and public consumption of your final decision in this matter.

I shall leave it to you to assess the value of respect, and the cost of the disclosure that the role you currently fill is for a government that had claimed to be values driven.

There is nothing honourable in saving money by perpetuating Crown incompetence, and, worse, Crown concealment.



Managing Director

Chris Lee & Partners Limited

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THOSE who invested in CBL shares will know the company is being liquidated, with an expected shortfall that will leave creditors severely unpaid and shareholders with no returns at all.

Given the failure of CBL to disclose its deteriorating state, the obvious option for investors and creditors is to test in court any liability for any failure of duties by the directors, the auditors and even the regulators and the Crown.

This may sound rather like the remedies we sought for the investors in South Canterbury Finance preference shares, a task that was stymied by the politicians and the Ministry of Business, Innovation and Employment, the latter a dysfunctional government department, apparently for many years.

So the CBL investors will face a truckload of obstructions, unless the politicians adopt a standards-based view of justice.

However CBL investors have been thrown a lifeline by LPF, the litigation funder that has achieved some justice for the victims of ineptitude in government departments, and in the private sector.

LPF has recovered a rumored $100 million from PricewaterhouseCoopers for its uninsightful auditing of the Christchurch property-based borrower David Henderson.

It has won an award of hundreds of millions from those in the Ministry of Primary Industries who allowed a virus-infected pollen to sabotage the kiwifruit industry, though this award is being appealed.

It won a huge victory for Mainzeal investors who had been badly let down by incompetent directors, including the former National Party leader Jenny Shipley. This award is also being appealed and counter-appealed.

And it has had many other successes.

That LPF will fund a case for CBL investors will give hope to CBL investors. It should be another chilling reminder to all directors and senior executives that they may face the courts despite the lack of fibre in government, in the MBIE, and in the insolvency practitioners' sector.

Curiously a second litigation funder, from Australia, is also keen to fund a case against CBL but, given the recent successes of LPF and its undoubted firepower, my expectation is that LPF will attract investor support, particularly from the institutions and large investors. All investors should opt in to the LPF offer. There is no risk, but considerable potential reward.

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THE Age is an excellent newspaper in Melbourne, Australia, by any measurement much braver and more relevant to its readers than most.

This week its front pages discussed the corrupt practices in Australia, hidden because of what it describes as weak whistleblowing laws, outdated defamation laws, abuse of suppression orders and a growing practice of government departments to reject information requests and to redact documents (for convenience).

Sound familiar?

The Age alleges that the CEO of a major stockbroking company has indulged in insider trading and other forms of market manipulations, at the expense of clients, and sent tens of millions of dollars of illegal proceeds to a hidden Swiss bank account.

In previous funds management roles the same, unnamed man, repeatedly put himself ahead of his clients.

The regulators have sat on the file for two years, The Age reports.

The newspaper also identifies an energy company which is knowingly putting lives at risk to suppress costs, in quest of profit.

In each case the whistleblower has cowered at the vehemence of the attempts to silence him.   

Without whistleblowers the Royal Commission into banking in Australia, which has led to billions of dollars in compensation, would not have happened.

New Zealanders would be most unwise to believe that the corruption virus cannot swim the Tasman.

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Johnny Lee writes:

Two major developments occurred in capital markets this week, the first being the disastrous events occurring in Auckland at the SkyCity Convention Centre, and the other being the announcement by Rio Tinto that it intends to conduct a review of its Tiwai Point aluminium smelter.

Shares in SkyCity, Fletcher Building and all the electricity companies have been negatively impacted. Together, these companies make up a large proportion of our stock exchange, sending the index lower.

The financial impact on Fletcher Building and SkyCity has not yet been quantified, but both have lost some value. Both have confirmed that the relevant insurances are in place, but further details around the quantum of these is not yet available. For SkyCity, its major assets in the area, including the casino and hotel, have been evacuated until further notice. Fletcher Building has not confirmed whether it faces financial penalties for the likely additional delay of the project. Other local businesses have also been affected, as the heavy smoke has impacted their ability to provide services.

One blessing is that there has been no loss of life.

At times of information asymmetry, shares are often at their most volatile. These awful developments also serve to remind investors that it is impossible to completely quantify risk. Both SkyCity and Fletcher Building intend to update the market in due course.

The Tiwai Point developments are, potentially, just as disruptive.

The Tiwai Point Aluminium Smelter, majority owned by Australian mining giant Rio Tinto, is the country's single largest consumer of electricity. It purchases electricity, at a highly discounted rate, from Meridian Energy's Manapouri Power Station. Manapouri is our second largest power station and was constructed specifically to supply the electricity needs of the smelter.

The smelter directly employs about a thousand Southlanders, indirectly supporting the families of thousands more. It adds hundreds of millions to the Southland economy.

For electricity generators, the uncertainty around the potential withdrawal of the smelter from the demand curve is a major impediment to long-term infrastructural planning and expenditure. The likes of Mercury and Genesis will not want to commit billions of dollars constructing new power stations, only to see the smelter close and a surplus of electricity drive down prices.

The Government, which owns 51% of most of our electricity generators, will not necessarily want that outcome either. The impact would be sizeable.

Many New Zealanders have witnessed this 'dance' before. It would not be the first time Rio Tinto and Sumitomo have conducted such a review, only to emerge with further discounts to their electricity bill, and a temporary commitment to continue operating the smelter.  Those expecting a similar outcome are being presented with an opportunity to buy more electricity sector shares at prices far below recent trading.

Aluminium, globally, is almost entirely smelted in China, where the economics of doing so are perhaps more favourable than in our small country in the corner of the world.

Nevertheless, the politics at play make this a difficult issue to navigate.  The impact of a closure on Southland would be enormous, and the electricity sector would see a significant shift, impacting shareholders of all electricity companies.  This includes the Crown.

Additional obligations to clean up the site, if closed, could pose further hurdles. Such an undertaking would be a significant task, requiring substantial manpower and expertise.

Closure is not the only option if Rio Tinto and Sumitomo choose to exit. Other options, such as a sale to a third party, or the public, may be viable.

Rio Tinto intends to update the market early next year and discuss potential solutions with stakeholders during this period.

_ _ _ _ _ _ _ _ _ _


Kevin will be in Ashburton on Wednesday 6 November.

Mike will be in Auckland (city) on 7 November.

Edward will be in Nelson on 12 November and in Auckland City on Thursday 21 November and Albany on Friday 22 November.

Edward and Johnny will be in Christchurch on Wednesday 27 November.

Chris Lee

Managing Director

Chris Lee & Partners Limited

Taking Stock 17 October, 2019


Chris Lee writes:

THE brewing war between New Zealand’s Reserve Bank and the four Australian banks is characterised by the banks as a phony war, based on poor or, worse, no analysis.

The Australian banks allege there is no need for them to provide more capital to support their loan portfolios.

They say the banks have been stress-tested on highly improbable market downturns, such as the NZ housing market falling to 65% of current levels, and the dairy industry coping with a milk payment of about half of the existing payment.

Even under these ''stresses'' the banks' modelling suggest they would survive.

Of course, survival alone is not an attractive option.

If you want your banks to maintain their lending to all sectors, the banks must fund, at least in part, from offshore sources.

Offshore money might be reluctant to head to NZ if market conditions deteriorated dramatically. Survival might occur, but prosperity would not.

The banks, however, are certain that the RB has its own agenda when it addresses the issue.

There may be two reasons that explain this aggression.

Governor Adrian Orr in earlier years worked for Westpac, unarguably the most arrogant of the Australian banks, renowned for its mapping of New Zealand as being ''East Tasmania''.

Orr also worked for the RB and would have been part of a team the Labour Minister of Finance, Michael Cullen, sent to Australia to discuss the Australian demand that their banks, and all NZ banks, be regulated by the Australians.

That RB team refused to blink, despite Cullen's apparent blessing of the Australia plan. (Cullen, in my view, was an academic historian, playing in a minefield better left to more knowledgeable and experienced players.)

The story goes that the Australians regarded Orr as a ''ginger-headed'' nuisance, to paraphrase what they told Cullen. Orr went off to a successful career as the head of Cullen's creation, NZ Super Fund, but is back again as the Reserve Bank governor, with no memory lapses, no doubt still deeply suspicious of the Australian banks.

And so he should be.

The Haynes' report on Australian banking uncovered behaviour at governance and executive level, that rivalled what I came across in the finance company sector, some of which was revealed in The Billion Dollar Bonfire.

Orr will know that the Australian behaviour revealed the banking leadership as untrustworthy, greedy, self-serving and arrogant towards its clients, its social obligations, the law and the regulators.

So the battle now will be to convince Orr that all those behaviours instantly vanished the moment the Haynes Commission began.

There will be a second reason for Orr’s aggression.

In the period between 2003 and 2008, New Zealand's non-bank deposit-taking sector grew rapidly, in an environment where the laws were pitifully weak, accounting standards were shameful, disclosure was far from ideal, and various crooks and people of no morality ran amok.

The RB should have been concerned.

It was concerned but it had insufficient wisdom to identify the real problem.

Internally it preached that the problem was investors were getting returns too low for risk and it thought the answer was to urge the companies to increase their capital.

While both of those observations were accurate, the real problems were ignored.

The real problems were the astonishing levels of risk taken by finance companies, the lack of expertise of the sector in understanding risk, the non-disclosure of real risks and real cash-flows, the dependence on renewals of investments (with a Ponzi-like cash planning) and the absence of intelligent oversight by auditors, trustees, directors and regulators.

Particularly, the NZX failed abysmally in its obligation to ensure investors were able to make rational decisions, its board and its CEO apparently oblivious to the problems that were to sink most of those finance companies with securities listed on the NZX.

Orr will know all of this.

In my view he has every reason to distrust the claims of the Australian banks, at least until he can see wholehearted implementation of the remedial work that surely will follow the Haynes' report.

I hope he bullies the banks into a new shape, forcing them to hire directors with substance, and executives with social motives, focused on long-term competitive advantage, rather than short-term bonuses and absurd salaries for the executives.

I repeat my advice: read Banking Bad, by Adele Ferguson.

I suspect Orr has read it. I hope he has also read The Billion Dollar Bonfire.

_ _ _ _ __ _ _ __

THE folly of allowing trust companies to write one’s will (or deed for a family trust), then administer it, and then act as investment manager is well understood.

Trust companies became profit focused in the era of non-regulation, which was initiated by Roger Douglas in the 1980s.

Over-regulation became deregulation, which soon became non-regulation and only now is swinging back to over-regulation.

The trust companies, being the least attractive places for clever financial market participants with investment skills, gradually lost their social mandate and are now privately-owned, clinging to an existence that makes no sense.

Of course the drafting of wills and trust deeds must be done legally so lawyers are the logical group to attract experts. Lawyer fees 40 years ago were higher than trust company fees but today are a fraction of the true cost of allowing trust corporations to capture a share of that market.

Getting a will drawn up well is important.

This can be illustrated with humour, as was displayed by Charles Vance Millar (b 1853, d 1926), a cynical and somewhat pompous Canadian bachelor and lawyer.

He wrote his will, beginning thus:-

‘’This will is necessarily uncommon and capricious because I have no dependents or near relations and no duty rests upon me to leave any property at my death and what I do leave is proof of my folly in gathering and retaining more than I required in my lifetime.’’

He then left his Jamaican summer house to three lawyers he knew despised each other, he gave shares in a brewery to religious zealots known for their prohibitionist views, and left shares in a racing club to three men who fervently opposed horse racing.

But his last clause elevated his will into legendary status. He bequeathed most of his assets to whichever woman, in the 10 years after his death, had given birth to the largest number of children, an incentive that led to the ''Great Stork Derby'', into which 11 women entered. Four women produced nine babies and shared the NZ$200,000 pool. That was more than 80 years ago; in today’s money it would have been worth around NZ$3 million.

Wills today are much less colourful, and far more often altered by the courts when beneficiaries dislike their share of a pool.

The idea of allowing a privately-owned trust company with profit motives to draft the will, administer it, invest it, and to adjudicate on it is as logical to me as allowing a restaurant to select your meal and your wine, then eat it.

I urge people who have delegated these tasks to a trust company to visit a lawyer today and start again.

_ _ _ _ _ _ _ _ _

THE response to an earlier Taking Stock item regarding the Todd family and its giant presence has prompted unexpected response, with many people forwarding accounts of their experience with the family, and some sending clippings from media reports going back more than a century.

Two things are clear.

The Todd family brand has always been identified for the vigour of its activities.

And, secondly, it has been single-minded in achieving its goals. This item, published last week, noted that the big impetus achieved came from the close relationships with government during the era of import licensing, ending in the 1980s. (A typing error in that article named the 1990s, well after the end of licensing, a practice now rightly seen as unfair and discriminatory.)

But the Todds’ fortune was multiplied by the good luck of the oil and gas exploration programme it shared, with wildcat strikes at Maui and Kapuni (wrongly typed as Kapanui in the item).

Today, Todds is heavily committed to a mining operation in Australia, and it was that project that led to much of the comment.

Todds aspires to be involved in mining iron ore and needs access to a private rail network.

It part-owns Flinders Mining (FMS), which has access to the network, and wants to have full ownership, or at least control, of FMS, but has yet to offer a price that appeals to the minority shareholders.

The battle is clearly heated.

The minority shareholders have succeeded in getting the ASX to change its rules, preventing an attempt to privatise FMS. The new rules require the consent of 75% of shareholders, not 50.1%.

The minority shareholders value the rail access at ‘’billions’’ and would sell FMS to Todds only at a price many times the price at which Todds might want to pay.

The battle over FMS is heated, judging by the correspondence.

For Todds, the project must be worth a sum that is large, given the flak that the family must be enduring.

My quiet question is whether iron ore mining is the most aspirational activity for anyone to enter in 2019.

Those interested in this battle should watch the Australian newspapers.

_ _ _ _ _ _ _ _ _ _ _

Johnny Lee writes:

THE growing battle between Spark and Sky TV has sent Sky TV shares on a rollercoaster over the past week, illustrating the precarious position Sky TV finds itself in.

The first piece of news was that Spark had outbid Sky TV for New Zealand-based cricket broadcasting rights, which sent some shareholders into a panic, fearing that Sky TV was on the cusp of losing its primacy to the New Zealand sports-viewing public.  Sky TV’s response, abridged, was simply ‘Spark has paid far, far too much’.

Three days later, Sky TV announced it had secured a five-year deal with the SANZAAR unions, sending the share price back up.  The deal was conditional on shareholder approval, as the value of the transaction was more than half of Sky TV’s market capitalisation.  Approval was largely perfunctory, as a failure to pass this would not necessarily have been in the best interests of shareholders, despite the eyewatering figure that is rumoured to be involved.  For reference, half of Sky TV’s market capitalisation would be approximately $220 million dollars, or $44 million a year. The reported amount is about double this figure.

The other curious point was that settlement of the transaction was partly-paid in scrip, meaning Sky TV shares were issued to be given to New Zealand Rugby as part of the deal. The company selling the rights now own a small part of the company it is selling the rights to.

On the face of it, it is a clever move by Sky TV, despite the desperately low price the stock were likely issued for.  By tying its fortunes to the Rugby Union, it would hope to provide something of an incentive for the two groups to collaborate further.

For New Zealand Rugby, it represents something of a risk, but an acceptable one if the total price paid was anything like what media are reporting.  New Zealand Rugby has previously decried the huge costs involved in administering the various unions and levels of rugby throughout New Zealand, and the injection of hundreds of millions of dollars from Sky TV will no doubt be a welcome relief to the union.  It also has a stated strategy of diversifying its sources of revenue.

For shareholders in Sky TV, it will help relieve any concerns that Spark was slowly taking over rugby content.  However, the amount paid will mean that customers may be asked to stump up ever more over time to cover the escalating costs.

The other real loser from this situation may turn out to be cricket fans, who will now require two subscriptions to watch their favourite sport, depending on where it is being played.  Unfortunately, I count myself among this group.

Sky TV plans to provide updated guidance in the months to come.  Long-suffering shareholders, who have watched the share price slowly diminish over the past five years, will be hoping for a return to growth, as new CEO Martin Stewart makes his biggest call yet.

_ _ _ _ _ _ _ _ _ _


Edward will be in Nelson on 12 November and in Auckland City on Thursday 21 November and Albany on Friday 22 November.

Kevin will be in Ashburton on Wednesday 6 November.

Mike will be in Auckland on 7 November.

Edward and Johnny will be in Christchurch on Wednesday 27 November.

Anyone who wishes to meet is welcome to contact us to arrange an appointment.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

Taking Stock 10 October 2019

In the minds of some, the Todd family, who own Todd Corporation, have been clever investors, careful guardians of the fortune the family created, and now are philanthropic, dispensing some of their income to the family and some to charities selected by the Todd Foundation. 

There is some truth in that narrative.

They have certainly built a multi-billion dollar empire over the past 80 years and the Todd Foundation is an admirable example of wealth-sharing, but there are some obvious matters that should be considered by those who acclaim their omniscience and their investment skills.

There is at least some truth in the observation that the Todds built their fortune by shooting rats in the import licensing pork barrel that dominated business in the mid-1960s, an era which granted politicians the power to anoint various families and businesses with licences to print money, in the decades before deregulation.

Todd imported fuel and retailed it through their fuel brand Europa; they captured the agency for Fokker Friendships, one of the workhorses of the NAC, the predecessor to Air New Zealand’s domestic affairs.

They had the licence to import the components and then build vehicles for Mitsubishi, Chrysler, Hillman and other motor vehicle brands, leading to their advancement from a tiny Petone plant to a giant assembly plant in Porirua.

By far their biggest coup arrived from simple good luck. Six decades ago, they decided to invest in oil exploration. The first two holes in which they participated as junior partners with BP and Shell hit pay dirt.

The holes became the Kapuni and Maui offshore oil and gas wells, still by far the most productive holes ever drilled in New Zealand, producers of billions of dollars of wealth.

Not many novice oil players have ever had such luck, anywhere in the world.

Maui and Kapuni turned a family from one that was merely blessed by the munificence of politicians into a seriously wealthy family, almost the sheiks of New Zealand.

However, the key word here was luck, not genius. Many say it is better to be lucky than clever.

The Todd family’s leaders had varied greatly in cerebral endowment, varying from the canny, like Brian Todd, to the skittish, like the late John Todd, to straight out C Streamers, whose names need not be published.

Nor did the Todds always select the smartest outsiders to bolster their corporate team, one remarkably uninsightful figure once declaring at a 1980s board meeting that the kiwifruit industry would be a five-minute wonder, its core product unlikely to be eaten widely.

Perhaps the biggest blunder in public was committed by the late John Todd who, as a neighbour of the slick salesman Bruce Judge, agreed to invest $70 million of Todd’s money into Judge’s thin-air company, Judge Corp, an investment that within a year or two was worth as much if doubled, or halved. 

This error may not have been the worst Todd investment, but it was surely the most obvious example of fallibility.

Today Todd Corp has an excellent chairman in Geoff Ricketts, who wisely retired as chairman from Russell McVeagh in its days of pomp, and now chairs the solid performer, Heartland Bank, as well as Todds.

As far as I can see Todd’s greatest decisions have often not been to buy, but to sell. Unlike many large corporations Todds has always seemed willing to quit while it was ahead, a trait that differentiates the Todds from their Auckland dynasty rivals, the Fletchers.

Todds quit Fokker Friendship ties before that aircraft was usurped.

It quit Mitsubishi Motors, returning its franchise to its Japanese suppliers, before the fall of the car assembly industry.

It quit the finance company sector in the mid-1980s, before the ’87 crash, selling its share of General Finance to the National Bank.

It sold Europa to BP, rather than fight outside its natural division, lightweights rarely beating heavyweights.

Now Todds is quitting hundreds of millions of dollars invested in land holdings in Auckland, Christchurch and Paraparaumu, selling to a property-holding company with connections to investors in Qatar, as well as New Zealand.

In Auckland Todds has land at Long Bay and Stonefields, in Paraparaumu it owns much of the land around Paraparaumu’s airport and in Christchurch it owns land at Pegasus Bay.

That Todds is abandoning an interest in developing what others might see as land ripe for residential development suggests either that the Todds are reducing debt, dispersing some hefty chunks to the various family offshoots, expressing a view about risk and return in the area of land development, or perhaps preparing for a large overseas call on an investment the family intends to fund.

The Todds have made most of their wealth through Maui and Kapuni but they have also made good returns from land development, in their long history.

For example, Todds was a major investor, with Fletchers and National Mutual, in the land that has grown into the Wellington suburb of Whitby, the shareholders wealthy enough to outlast various market downturns leading to painfully slow sales.

Whitby is now a splendid suburb, but it would have remained desolate had the major shareholders not been deep-pocketed, in the 1970s and 80s, when holding costs reached towards 20% per annum.

I have no insight into why the Todds sold land last week but if the decisions were strategic many small developers should pay attention.

Perhaps the Todds can see that Kiwi Build is going to dominate the scene for some years; perhaps the family sees global events impacting on New Zealand; perhaps the family is now influenced by short-termism, the virus affecting so many big businesses.

Maybe they struggle to find contractors to sign up to land development deals with a player that has often been seen as hard-nosed, if not brutal, in its relationships.

It will be instructive to watch the progress of the new owners of the valuable land sites. Has Todds timed its exit with prescience, or does it simply need funds for other purposes?

 _ _ _ _ _ _ _ _ _ _ _ _

Global tremors certainly struck Australia’s capital markets last week.

In two days the ASX lost $80 billion, or 2.2% of its total value, and this was despite the Australian central bank dropping its cash rate to a historic low.

The ASX market capitalisation must be getting close to $4 trillion, a formidable figure compared to New Zealand’s equity market value of barely $150 billion.

The Aussie dollar’s loss of $80 billion last week was equal to more than half of our NZX total market value.

Australians fear a recession. They fear a series of poor corporate results, they fear the effect on their banks of the current mood of regulators, they fear the global scene, and they fear a devastating drought, described last week by its farmers as the equivalent of a  ‘’GFC’’ (global crisis).

Climate change is gradually being acknowledged in a country which still burns and exports coal, which has until recently resisted a move to renewables, has procrastinated over the building of dams, and the spending on desalination plants.

Perhaps the most painful change for Australians to accept is the irreversible and distressing degradation of the coral reefs around the Tropic of Capricorn where the Great Barrier reefs are iconic.

The demise of Holden, and indeed the car assembly industry, has demoralised many.

Right now the finance sector is focused on its main four banks, which are making provision for multi-billion dollar compensation payments to those customers who were cheated by the banks in the last 20 years, the CBA the worst offender, the ANZ agreeing to another half a billion of compensation earlier this week.

The banking era of unjustifiable bonuses is certainly stalling. Vulgar salaries should be next in line.

Dividends have to fall and costs, including executive remuneration, have to be cut.

There will be job losses, more branch closures, and lower share prices, the latter of great concern to Australian fund managers, who tend to be over-weighted in bank stocks.

Indeed fund managers like Perpetual are already announcing job (and bonus) cuts.

Perpetual in Australia is in a different stratosphere from the ugly Perpetual Guardian Trust in New Zealand, but it performs similar tasks.

It has conceded that large swathes of jobs will have to go.

My view has long been that the managers of wills and estates should never be allowed to allocate their captive clients’ money into funds managed by the company, enabling them to double and even triple dip into the funds of the trusts and estates.

I do not have to try too hard to persuade those people who ignore the sales pitch and observe the nett return to estates and trusts.

Trust companies like Perpetual in Australia, and any trust company in New Zealand, would never manage any money for me. They simply do not, and cannot, exhibit the skill or the culture that I would expect, and their costs are exorbitant.

If the Australian ‘’big four’’ banks are facing scrutiny and difficult market conditions, their reduced prospects will have a material effect on pension fund returns there and in New Zealand. Ten percent of the returns of managed funds in Australia depend directly on bank dividends and share price.

The commission of inquiry into the Australian banks, coupled with the determination of the regulators to force the banks to increase their capital, might lead to long-term gain but the short-term pain will be unavoidable, the big banks virtually certain to reduce dividends for many years.

Academics might argue that the regulators are being too tough on the banks, but the momentum will be hard to slow. The reality is that the banks have lost their mojo with their absurd bonuses, their greedy fee-setting and their ghastly selling culture.

Australian finance companies, like Latitude and Pepper, soon might be stealing some of the banks’ plums, if they choose to structure themselves properly, with real capital, independent governors and transparent, sane operational rules, covenanted in a modern trust deed.

Both are raising capital.

It may be improbable but if either of these genuinely large Australian finance companies sought a retail funding base in New Zealand, they would add some much-needed competition for long-term retail funding support.

 _ _ _ _ _ _ _ _ _ _ _ _

I will shortly review in depth the book Banking Bad, a non-fiction account of how the banking leaders in the past three decades have destroyed customer confidence in big Australasian banks.

From a personal viewpoint I have been a grateful user of bank services, largely because I have declined their fee-rich products, refusing to buy into their managed funds, not using their lending products, and not seeking their ‘’advice’’.

The banks have processed our transactions well, at minimal cost, and safeguarded any money deposited with them.

Probably I would be seen by bankers as a ‘’free-loader’’ as I decline to buy the guff they sell.

Banking Bad, the book written by journalist Adele Ferguson, tells the story of what led to the commission of inquiry into banks, and what horror stories the commission unveiled.

Regrettably, various New Zealand bankers in Australia emerge from the stories with ignominy; greedy bullies, some of them psychopaths, apparently indifferent to those whose lives were ruined.

The insurance and funds management industries were just as active, so many focussed on pursuit of revolting, meaningless personal wealth.

Salesmen whose internal fame came from quantitative sales glory were not reported or sacked when their criminal behaviour was detected (such as signature forging, document altering).

Banking Bad reports the outcomes that were forecast in the 1990s, even in Taking Stock, when banks moved their culture from meticulous, caring administration of other people’s money, to a quest for high, short-term profits, high dividends, and, most of all, obscene salaries and bonuses for those in charge.

I will detail this decay by reviewing the book in coming weeks.

Do not read the book, or my review, if you have a weak stomach or have a favourite son-in-law involved in running the banks in this era!

 _ _ _ _ _ _ _ _ _ _ _ _


I will be in Christchurch on Tuesday 15 and 16 October.

Edward will be in Auckland (Remuera) on 16 October.

Kevin will be in Ashburton on Wednesday 6 November.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

Taking Stock 3 October, 2019

Johnny Lee writes:

One of the growing dangers to capital markets is the apparent willingness to price assets at levels the world has never before seen.

I have written before about unicorns – billion- dollar start-up companies, often with no track record, producing enormous losses, and sometimes having little to no intention to produce a profit. The term Decacorn has since replaced it and defines a startup company worth TEN billion dollars. To future proof this trend, the term Hectocorn was created, referring to startup companies ‘worth’ a hundred billion dollars – or about half of New Zealand’s GDP.

How do you value a company that produces no profit, but crucially has no clear path to ever producing a profit?

Low interest rate environments are part of the problem that creates these scenarios.

In New Zealand, even the most optimistic investor would be challenged to describe our share market as ‘cheap’ using historic measures. Fortunately, most of our companies are backed by real products, producing real profits and are managed by people of real commercial nous.

In the United States, the problem is far more complicated. One of the more fascinating stories currently captivating the investment public there is the battle between office-sharing startup The We Company, and its major shareholder, Japanese conglomerate SoftBank.

The We Company could be described as an ‘AirBnB for businesses’. It leases real estate, then sub-leases it for businesses to rent on a short-term casual basis, sometimes even a single day or a single hour. Businesses benefit by paying a small fee for what amounts to a fully functioning office, without having to concern themselves with utility costs, long-term leases or building maintenance. Effectively, they pay a nominal fee for a desk, internet and electricity. The company profits by making a margin between what it pays its landlord, and what it manages to extract when sub-leasing it.

Like many of these ‘Sharing Economy’ startups, the idea is simple, clever and fills a real hole in the market. For instance, one of The We Company’s subsidiaries specifically targets restaurants that open at night. Such an establishment may be completely empty during the day, yet its rental costs are the same whether it is open 6 or 16 hours a day. In New York alone, there are estimated to be over 2,000 empty restaurants during the day.

The risk, and it is a sizeable one, is that a downturn leaves their properties untenanted, with enormous sums locked into long-term leases that are unable to be re-leased on an individual basis.

Nevertheless, the product is real and the value add is demonstrable. Where these IPOs struggle is in financial acumen.

The We Company is currently, somehow, losing close to two billion US dollars a year.  It is committed, over the next 15 years, to pay its landlords a sum close to 50 billion dollars. In January this year, the company itself was ‘valued’ at $47 billion.

Sometimes when reading large numbers, it can be useful to introduce perspective. $47,000,000,000 US dollars could purchase every single Wellington home and have change left over. It is enough to purchase most of the companies listed on our stock exchange. It is an astronomically large figure, for what amounts to a loss-making property sub-letting company.

The We Company’s most recent valuation was closer to 10 billion.

If one was to try to make sense of these valuations, one would need to consider the forces behind the push to list them in the first place.

Often, these companies raise money from venture capital funds and private equity funds as they grow. They lack the capital needed to fund their growth, and traditional lenders are unwilling to lend such enormous sums to unproven ideas and loss-making businesses. In this case, one of the funds that injected this money was a fund managed by Japanese giant SoftBank.

SoftBank, which recently made headlines for its struggling investment in Uber, injected more than $US10 billion to purchase its stake in The We Company. At the updated valuations, it was looking at crystallising an eyewatering loss.

The IPO was subsequently postponed, and the eccentric CEO of The We Company removed.

This is not a one-off. Globally, relatively unknown companies including ‘virtual gym’ Peloton, and Smile Direct Club, ostensibly a 3-D printing company for dental braces, are raising tens of billions from the public, as private equity and venture capital funds look to cash out as valuations soar. Often, the share price plummets, leaving investors holding onto shares in loss-making companies, relying on vague ambitions to perhaps one day turn a profit.

Private equity and venture capital absolutely have a place in a market and can genuinely produce win-win outcomes. Shareholders of Summerset will not begrudge Quadrant Capital’s involvement, which saw the company grow into a sustainable, profitable company before de-risking by selling to the New Zealand public.

However, the current environment is seeing valuations soar to a point that is inspiring a degree of recklessness that can only lead to ruin. The idea of the value of a business being linked to its ability to provide a good or service at a profit is no longer globally accepted – or at least not to a meaningful degree.

In New Zealand, we have yet to see these dynamics play out. Of the two companies that listed this year raising capital, Napier Port Holdings and Cannasouth, both are trading at a premium to what they listed for and are seeing a strong level of buying interest today.

Investors should always take care when investing into speculative, loss-making companies, and ensure that the eventual pathway to profitability is credible and achievable.

_ _ _ _ _ _ _ _ _ _

One consequence of increasing share prices will be an inevitable increase in firms raising additional capital from the public, through rights issues and share purchase plans.

These two mechanisms are different. Rights issues tend to be pro-rata, meaning all shareholders can participate equally, proportional to their investment in the company. The shareholder with 50,000 shares can purchase more shares than the shareholder with 500.

Share purchase plans are usually dollar amounts, which gives all shareholders the same opportunity regardless of the number of shares held. The shareholder with 50,000 shares has the same opportunity as the shareholder with 500.

Typically, a capital raising will be discounted to provide an incentive for investors to participate. It will also normally be a short-term offer, to reduce the possibility of the share price falling below the discount and the offer failing. A business can also issue an ‘accelerated’ rights issue to reflect the very short-term nature of such an offer. This is often done when the funds are needed urgently, such as settling the purchase of a recently acquired asset.

Goodman Property Trust’s recent retail offer gives all shareholders the opportunity to buy $50,000 worth of shares at a price of $2.10, a price well in excess of the value of its Net Tangible Assets, but also slightly below its last traded price, providing an incentive for shareholders to accept the offer.

Kathmandu’s accelerated rights issue gives every shareholder the opportunity to buy a share at $2.55 for every four shares held by the shareholder. The offer is open until 21 October, and the proceeds will be used to finalise the acquisition of the Rip Curl clothing brand. The shares are currently trading around $3.00.

As share prices climb, the ‘cost’ of issuing capital falls, assuming profits are relatively stable. Companies can raise more money issuing the same number of shares. Dividend-paying shares, such as Goodman Property Trust, may be finding the gap between its dividend yield and the cost of bank debt to be narrowing. Typically, equity risk will pay more to reflect the higher ‘risk’ element of the asset.

Discounted rights issues are not exactly ‘free money’, but can offer a compelling opportunity to profit from price arbitrage. Those shareholders who wish to increase their holdings in the company can do so at a discounted price (and no brokerage) while those who do not, have the opportunity to sell the amount of shares they are entitled to, and purchase them back in the offer, capturing the difference between the market price and the offer price. Although it is not as common as it once was, rights issues themselves can be tradeable. This offers a more simplistic way of capturing this gain.

We anticipate more rights issues over the medium term, and shareholders should consider each one individually, both in regards to the offer itself, and the subsequent effect it may have on their broader portfolio.

_ _ _ _ _ _ _ _ _ _

Shareholders of retail stocks have had reason to smile recently, as the Warehouse Group, Kathmandu and Briscoes have all seen share price rises in recent weeks on the back of strong results.

Retail is a fair-weather sector, and the sun has clearly been out during the past 12 months, as all three companies reported rising revenues and dividends. Hallenstein Glassons has also seen a leap in share price. During the Global Financial Crisis of 2007-2008, the retail sector was one of the hardest hit in New Zealand, as our willingness to spend on discretionary goods fell. Hallenstein was a rare exception to this.

Retail operators have traditionally offered a slightly higher dividend yield than average, reflecting the more volatile nature of the share price. Today, they are among the highest yielding stocks on our exchange. 

Nevertheless, long-term shareholders of our retail sector have been left behind in recent years, as other sectors have broadly outperformed. In a world where bricks and mortar shops are losing ground to storage warehouses and online catalogues, companies will need to be cleverer about utilising technology and maintaining appropriate levels of debt. However, last month’s share price rally is, hopefully, a sign of sunnier forecasts on the horizon.

_ _ _ _ _ _ _ _ _ _


Edward will be in Wellington on October 10 & Auckland (Remuera) on 16 October.

Chris will be in Christchurch Tuesday 15 and 16 October.

Johnny Lee

Chris Lee & Partners

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