Taking Stock

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Taking Stock 28 May 2020

WHEN financial markets were first rattled by the fears of a deadly epidemic, investors naturally sought to identify business sectors that would survive.

Food production and distribution, electricity generation, internet and telecom services, and technology-based deliverers of goods (like Amazon) were easy to identify. So too were those who produced medical protective clothing and respiratory-assisting equipment.

Not so obvious was the unheralded financial services monopoly, the NZX, on whose platform all New Zealand listed securities trade.

Yet in less than three months, NZX has been a star performer, after an initial slump in price. Last week its share price was higher than it was before the crisis, its profit forecasts confirmed, its dividends safe and possibly rising.

Those with good recall must see this restoration of NZX as almost as counter-intuitive as the rise in sales of an anti-malaria drug that apparently goes well with a daily diet of presidential-size McDonald's burgers, one being about as effective in countering the virus as the other, except in the minds of infants.

The NZX has indeed transformed. It needed to transform.

During the ugly years of the 1980s, the NZ Stock Exchange was a mutual, a non-profit organisation regarded as a cost centre by all NZ Stock Exchange members.

For a while it was run by Roger Gill, a former St Pats rugby prop with the build of a wrestler and the humour of a town jester. He was rarely surrounded by impressive people, though one ought to tip one's hat to Brian Kreft, who helped to improve the market surveillance bible that aimed to staunch the spillover from some pretty poor practices that characterised the 1980s.

The NZSE demutualised, enriching a generation of individuals, and became the NZX in 2002, listed on its own platform. It became a listed company, the market regulator, and the provider of services to all listed companies. The conflict of interest was obvious, and still is.

Having been established in the 1860s, headquartered in Dunedin, the NZX became just one organisation based in Wellington, shed of a past when at one stage it had exchange branches in Auckland, Wellington and Dunedin, all of which operated independently, often communicating by postman-delivered telegrams, enabling clever brokers to exploit pricing inconsistencies.

Buy in Dunedin at 11am, sell in Wellington at 11:01am.

The new NZX made a significant error when it transformed, its choice of chief executive poorly considered, in my opinion.

One of the late Lloyd Morrison's few lapses was his endorsement of the ambitious youngster Mark Weldon as the NZX Chief Executive.

Weldon, like most successful swimmers, was a loner. Having worked in New York, he was highly motivated to achieve personal glory but was never a team player.

In my view he lacked wisdom and was wrongly incentivised by a weak board, though in ANZ director Nigel Williams it did have one identifiable strength.

Weldon sought to diversify the NZX income streams, charging into other activities including newspaper publishing, but ironically duffing what would have been a pipeline to Fort Knox when he missed the chance to buy Diligent's board paper platform at a time when Diligent was seeking capital and was being sold for pennies.

Later Diligent was bought for more than seven times its listing price.

Dedicated swimmers, ambitious and often lacking social skills, rarely make great chief executives. They are loners, by definition.

The NZX, poorly led and poorly governed, managed to lift its share price, and then split the shares profitably, but it alienated the markets on which it depended and failed miserably to grow the staffing skills needed of a specialist financial services company.

Indeed, staff turnover at 60% per annum in one year was higher than any other NZX-listed company.

After ten years Weldon left, his legacy scarred by criticism from the other market regulator (the Securities Commission), by abject failure with the finance companies whose securities were listed on the NZX, not helped either by the dysfunctional staff relationships.

To be fair some blame must be accorded to the governors of the NZX, whose chairman was Andrew Harmos, a competent, aggressive Auckland lawyer, whose long-present director was Neil Paviour-Smith.

In my view the NZX was at that time a poor-performing market participant.

I was unimpressed by Weldon but also unimpressed by the failure of the exchange to uphold continuous disclosure obligations.

One of its most obvious failures was with South Canterbury Finance, whose adviser was Paviour-Smith, and whose principal, the late Allan Hubbard, engaged Harmos as his legal adviser.

SCF and Hubbard clearly did not listen, if Paviour-Smith or Harmos were demanding that continuous disclosure obligations be met.

Weldon resigned and took on a role, utterly inappropriate as a match-up of his skills, as chief executive of Media Works, then owned, to its subsequent regret, by a US private equity fund.

Today Weldon lives in Central Otago, his former wife managing some grape-growing land near Cromwell.

When Weldon left, a highly successful and sociable investment banker, Tim Bennett, agreed to take on the restorative role for five years, in part motivated by the presence in Wellington of his ageing parents.

He restored some goodwill in the exchange, settled the staff and dealt to some cupboards where old bones were rattling.

He also appointed as his deputy Mark Peterson, who succeeded Bennett and has brought a calm intelligent leadership to the exchange that has led to its current successes and its restored profile.

The confusing and irrelevant diversifications that so distracted the board have now mostly been solved, old disputes settled, and NZX now has a staff so empowered that the NZX has calmly navigated lockdown, while handling an unprecedented new level of transactions and foreign investment interest.

Indeed, in mid-April the NZX software had to handle a transaction number more than five times the levels of the same days, a year ago.

The software designed many years previously was unable to cope. A new challenge arrived.

Part of the growth in transactions came in the tiny ($5 minimum) orders that new NZX member Sharesies collected during the market downturn in March.

Sharesies attracts young first timers to the market, often armed with $5, $50, or perhaps $500, looking to buy perhaps three shares in X, five shares in Y and 10 shares in Z.

Transaction numbers were not the main issue, though they would not help reduce the strain.

The old software was complex, comingling the transacted deals with account enquiries, which greatly increased.

Simultaneously the NZX would have been attracting new foreign investment, exploiting the lower prices, and perhaps hinting that NZ is now a contender for more international funds management interest, as one of the few places left where solid companies, like the electricity generators, still produce 4% after tax returns.

The NZX has thrived but its software does need refining.

At $1.40 its share price is higher now than it has been for years.  Given its history, who would have guessed?

Disclosure: Many of our staff, including me, hold shares in the NZX.

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THE ability of Sky Television to find underwriters for a capital raising of $150 million frankly amazed me. The underwriting fee explains Sky's survival and the restored value of its 2021 bond.

The issue is at a horribly discounted 12 cents, just the tiniest fraction of the price when Todds sold out a few years ago, the share price sometimes surpassing $7.00 in those years. Todds quit Metlife and SKY TV and now has a focus on iron ore mining in Australia.

To underwrite such an issue, which aims to raise money to repay bank and, hopefully, bond debt displays significant faith in Sky TV's plans to recover, after losing during lockdown its main advertising magnet, international sport.

Those who pay Sky a monthly bill of around $140, as I do, are dwindling in number, barely a third of the audience Sky enjoyed just three years ago.

With international sport currently hibernating, and with Spark demonstrating that modern audiences will watch sport on tiny screens, Sky TV's recovery is by no means guaranteed.

Yet Goldman Sachs, leaning on its parent's balance sheet, and Forsyth Barr, with a smaller balance sheet but a large sum of client money under discretionary management, have agreed to fully underwrite the issue, for the sensibly high fee offered.

Of the $160 million sought, just $9 million will come from institutional placements.

The remaining money will be from a non-renounceable rights issue, meaning the rights are not tradeable. I am unsure why the issue does not have tradeable rights.

One imagines there will be ample ''force majeure'' conditions to annul the underwriting agreement if there were unhealthy developments in the market during the term of the agreement.

A major Sky shareholder is NZ Rugby, which two years ago traded off a cash payment for Sky's access to rugby, in return for shares in Sky TV.

These shares were issued at around seven times the price Sky TV is now putting on its shares, meaning NZ Rugby has a heightened level of interest in the recovery of Sky TV. NZ Rugby itself is short of cash today, and is an improbable subscriber to the new issue.

The arrival of a vicious virus that seems destined to become endemic has caused great damage to all sporting codes, including those that do not involve physical contact.

If professional sport were to pay extreme sums to sportspeople the key issues would be gate takings and broadcasting rights.

Two-metre separation health protocols do not allow the world's sporting stadia to be filled, so gate takings are a problem, at least in the short term. Lower takings would naturally lead to lower revenues, lower salaries, and fewer paid professional sportspeople, an unvirtuous cycle.

Without a constant diet of top sport, the television sports channels would have a weak story to sell to advertisers.

As a sports lover as well as a constant user of international news channels, I commit to keep paying my monthly dues to Sky. I hope I am not in a diminishing minority.

Further I hope Sky TV's shareholders, of which I am not one, are committed to make up revenue needs by injecting cash. One hopes these injections are not required at regular intervals.

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THE Sky TV underwrite has brought about a great occasion for me personally, ending two decades of an arduous search.

The underwrite by Goldman Sachs and Forsyth Barr is priced correctly at about five or six per cent, setting a long overdue benchmark that correctly prices the value of sharebroking firms' balance sheet-threatening commitment.

If the Sky TV rights issue fails, GS and Forbar will subscribe for all of the shortfall. Bless them.

This correct pricing gives me the opportunity to end my long hunt for common ground with Forbar's chief executive Neil Paviour-Smith.

Ever since he ascended to the right hand of the Forbar principal, Eion Edgar, roughly 20 years ago, I have wanted to find an opportunity to offset the very occasional, usually kind and mild, but nevertheless critical comments I have offered on Paviour-Smith's strategies.

Mostly we have lived on different planets.

I would have had an opportunity to praise him highly 10 years ago had he succeeded in getting Key's government to discount its liability to South Canterbury Finance investors by paying the distressed asset maestro Duncan Saville to take away the Crown's roughly $2 billion liability.

Saville wanted the Crown to pay him around $400 million in return for his agreement to take over SCF's assets and their investor liabilities.

Saville offered to underpin his offer by adding his New Zealand share portfolio to the pot, pretty well ensuring the Crown could not lose more than $400 million.

If Key and his colleagues had had financial objectives and business acumen, rather than political goals and cosmetician skills, the offer would have been accepted, Saville would within a few years have cleared the liabilities, and the Crown, through profit share, would have escaped its obligations, without any destruction of taxpayer wealth. In five years Saville's patient approach would have netted him a tidy profit and all the shareholders and creditors would have been satisfied.

Politics and cosmetics prevailed. Key won two more elections. Taxpayers watched at least a billion dollars destroyed. Key's legacy had been set in concrete, his judgement defined by the behaviour with SCF.

Egregious Crown errors were not disclosed to the world until Key, English, Joyce and Power had retired from political office. An idiotic receivership was allowed to destroy a billion of taxpayer money, and disgrace descended on the 18 people who must bear principal responsibility for corporate and political vandalism.

Paviour-Smith, representing the late Allan Hubbard who hatched ideas like this, tried his best to persuade Treasury and Key to accept Saville's offer.

Had his effort succeeded, my book, The Billion Dollar Bonfire, would have had an opportunity to laud Edgar's right-hand man.

I remained patient.

I now applaud Paviour-Smith and Forbar for the new standard set in pricing the small firms balance sheet guarantee.

For years, all banks, investment banks and sharebroking firms, including ours, have agreed to sub-underwrite or underwrite at ridiculously low prices, grossly under-pricing risk.

In effect, we have committed our capital for a musket and a bag full of pippies.

This time, the size of the underwriting fee acknowledges the value of that underwrite.

May this new standard become the new norm

Praise be to Neil Paviour-Smith and Forbar.

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ONE of the great privileges of being a long-time financial adviser and capital market participant is the contact it brings, often with old-timers who helped build New Zealand.

One meets retired engineers who built our dams and bridges, farmers who helped develop our reputation for premium food, horticulturists who foresaw the need to develop our apple varieties, industrialists who followed in the steps of the likes of Jim Wattie and Woolf Fisher, and many others. The latter might not be household names today but what they achieved, with much less access to technology and finance than applies today, was often material for legends.

We lost one such fellow last week when Christchurch farewelled one of its many successful business leaders, who carved out careers in the grim days after World War II.

Wyn Fairclough died last week, just three months after his 100th birthday.

Having fought in World War II, Wyn returned to a fairly bleak New Zealand, its people and financial resources diminished, but within a few years was the South Island manager of Dominion Sales, a Fletcher subsidiary which provided the scarce building materials of the time.

Fun-loving, bright, indeed shrewd, and with admirable judgement and high personal standards, Wyn went on to join WJ Scott Motors, a Christchurch automotive business formed by his grandfather and two uncles. By 1954 he was running the business, growing it and helping to mobilise Christchurch.

In those days, cars were imported under licence. The licensing system often led to families like the Fletchers and the Todds exploiting political connections, gaining import licences and then having dominant high-margin businesses in essential products. Little businesses had to be clever to gain licences.

Wyn travelled to Europe in 1957 and returned with a franchise for the Goggomobil, a tiny 250-500cc car which, because of its engine size, was blessed by low sales tax imposts.

He gained an import licence enabling WJ Scott to scoop up the Holden and Mercedes Benz franchises, a treasure trove eventually sold to Cable Price when Wyn semi-retired in 1975, still owning the original auto workshops and its premises. His business serviced thousands of people.

What I came to see as special about Wyn was what I learned after he rang me in the mid 1990s and asked me politely if he could become a client.

He had decided that he shared some of the values I used to discuss in the Christchurch Press in a regular column provided to various papers between 1987 and 2003. Within a year he was a ''friend'' of everyone in our offices. He knew how to charm both genders.

Wyn had wisdom. He saw through veneer, he knew that many expensive cars were paraded by people who had borrowed to buy, he was unimpressed by glib property developers always funded by debt, and he had some great sayings.

''Eat your cake while you've got your teeth,'' was one of them.

He ate his cake. He had won a Canterbury championship with a yacht and later become Patron of the sailing club. He played golf and bowls, the latter till he was in his 90s, he played bridge every week and was still skiing Mt Hutt until he was 80.

He invested on the basis that he could see excellent, committed people. Short-termism was never in his lexicon. He was not greedy. You might say he was a model client for our business.

After his wife Dot died in her 90s, Wyn's memory for detail began to fade but he continued to read Warren Head's ''Headliner'' business magazine until the last of his days, and met with me monthly to review his portfolio, often wearing a tie and jacket to formalise the occasion.

Even at 90 he would travel down to the Chateau on the Park near Hagley Park, arriving when my day was over, to enjoy a drink and a chat.

The youngsters of today would learn heaps from the ''oldies'' when they share their stories, displaying their tenacity in tough times, and their ability to find fun in these austere moments in our history. Heaven knows, that ability to find fun in today's environment is a crucial talent.

I hope those youngsters know how to listen.

Wyn is survived by his son Scott, a retired law firm partner, and Scott's wife, son and daughter.

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Travel

The government hints that air travel may be normalised before the end of July.

We hope to resume our city visits to Blenheim and Nelson at that time, if we are in Level 1.

I intend to visit Auckland and Whangarei in late June to see clients, under the same condition.

Clients should contact us to discuss dates and times.

 

Chris Lee

Managing Director

Chris Lee & Partners Ltd

 

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