Taking Stock 17 August 2017

THE concept of incubating a fledgling company, and patiently supporting it to achieve its potential, has come under the spotlight at great cost to a set of investors this week.

Last week we heard from one of New Zealand’s best performing companies on its plan to support companies with debt or equity (or both) to achieve long-term success.

And we also witnessed the probable destruction of a high-potential company, HydroWorks, in large part because its ‘’incubator’’ is itself a ‘’cot case’’ and has failed to offer the required support.

What a contrast these two ‘’incubators’’ demonstrate.

The shining philosophy came from our best investment bank, FNZC, which announced its plans to support great companies by giving them time and resources to achieve their potential.

FNZC opened a division (Principal Investments) stating it had no pre-defined views, no end philosophy and no short-term goals.

It would provide equity and junior debt to enable companies to execute and grow their business, including acquisitions.

It would provide growth capital and assist in succession planning.

It might do no deals in any year, and maybe approve only one deal of every 20 it was offered.

It would not expect any investment to convert to a conclusion in a year.

‘’We should be making almost no money in the first three years.  If our time horizon was that short we would be thinking about it the wrong way,’’ FNZC said.

‘’If we think in the very long term, call it 10 years, we should have a network of companies coming in and out being ready to move into private equity hands, or ready to list, ready to carry on and have genuine earnings and growing.’’

The noise readers can hear now is my loud cheering of a philosophy every experienced, successful businessman will support.

Call it ‘’long termism’’.  The Swiss, the Germans and the Dutch will understand.

Mainfreight, Auckland Airport, Port of Tauranga, Fisher & Paykel Healthcare, Ebos, Ryman and even Xero will understand.

Now contrast that philosophy with that of Powerhouse Ventures Ltd, which for some years has claimed that it is a patient, supportive incubator of potentially great companies.

It has shareholdings in 24 fledglings, often providing around $100,000 of capital, always claiming to offer governance and capital market expertise.

Last year it revalued upwards by nearly 50% the shares it held in these 24 companies and, based on those revaluations, sold to the public shares in Powerhouses Ventures Ltd at AUD $1.07, raising, with the help of some smoke and mirrors, the minimum sum its offer could accept.  Probably those ‘’revaluations’’ also had an implication for executive cash bonuses.

Its biggest investment in value was HydroWorks, an engineering company with genuine capability and undoubted ability to improve the output of hydroelectricity from established plants and to build new hydro stations.  HydroWorks is not a disruptive technology company.  It is simply a clever designer and builder of hydro schemes.

Trustpower labelled HydroWorks’ clever turbine design as a world-leading product.

Powerhouse Ventures Ltd had a 23% interest in HydroWorks, controlled its board and extolled its future, when talking to capital markets.

Last week, just 11 months after Powerhouse Ventures Ltd revalued HydroWorks to around $20 million, Powerhouse Ventures Ltd declared its investment in HydroWorks was worthless, effectively signalling that it would no longer support HydroWorks, consigning it to receivership.

If we put aside the ‘’incubation’’ promise and the governance promise we must also put aside the written promise to be a ‘’patient’’ investor, or even a competent investor.

HydroWorks had a new partnership with Australian companies that promised a pipeline of hydro plant work, probably at prices that might have converted HydroWorks’s engineering design and skill into significant profits, in coming years.

It now needs a new source of capital if it is to survive.

To be fair, HydroWorks had, under Powerhouse Ventures Ltd.’s governance, made some progress, but PVL had made some serious errors which had left HW with millions of debt, a list of unpaid creditors, and a debt to PVL with a 48% interest rate, becoming 120% if the debt was in default.  This loan was crafted by a patient, supportive incubator?

To secure a manufacturing capacity of its unique turbines, HydroWorks, led by Powerhouse Ventures Ltd, had bought a Christchurch manufacturer, Mace Engineering, after what  we now can see as childishly poor due diligence by the PVL directors.

Mace Engineering, a mature Christchurch manufacturer, had far more internal problems that PVL seemed to recognise, including an ageing union-dominated work force, with a potential redundancy entitlement of some magnitude, old plant, and a legacy of losses surfacing in its work in progress ledger.

So it had ageing plant, was making losses, and required expensive restructuring, and HW picked up the tab.

Yet PVL and HW published forecasts predicting almost immediate multi-million dollar contributions of cash to HydroWorks from Mace profits!

Mace actually consumed cash, never produced it.

Further, PVL and HW produced forecasts in 2015 that HydroWorks would make millions by selling mini turbines for use in irrigation canals, estimating that activity would produce millions of revenue.  They forecast sales of forty units.  They sold one.

Interestingly the PVL-dominated board of HydroWorks abandoned that mini turbine strategy before January 2016.  Read this again.  The timing is relevant.

In 2015 Powerhouse Ventures Ltd employed the corporate valuer Edisons, and later Woodward Partners, to value HydroWorks.

Analysts Moira Daw and Simon Wilson gathered up the information they were supplied, did the arithmetic, and calculated that based on supplied information, the present value in 2015 of HydroWorks’ 339,000 shares was $57 per share in Edison’s opinion.

This assessment assumed spectacular sale of mini turbines, Mace profits, and profits from two major projects in Australia.

Armed with this assessment, HydroWorks raised more capital.

By January 2016, PVL’s directors on the HW Board ought to have been aware that Mace was not profitable and should have accepted that there would be no sales of mini turbines to irrigation canals.

Indeed HW abandoned that mini turbine strategy and was busily restructuring Mace.

Directors would have known that the other source of revenue, completing major hydro projects in Victoria and Queensland, would provide no nett gains, or more likely losses.

Powerhouse Ventures Ltd, by early 2016, realised HW could not be sold to the public through a public offer of listed shares.  HydroWorks was making losses; it was unable to pay its creditors on time; indeed it was borrowing from Powerhouse Ventures Ltd a sum that reached $1.4 million just to survive, and was paying Powerhouse Ventures Ltd.’s demanded interest rate of 48%, with a penalty rate of 120%, according to one insider.

HydroWorks needed much more capital to be eligible for proper banking facilities and to provide the bonds required by those who were advertising tenders for multimillion projects in Australia and Asia.    (These bonds guarantee project completion).

So HydroWorks in January 2016 was short of capital, short of cash-flow, was unprofitable, and had an expensive problem with Mace to address.

Powerhouse Ventures Ltd needed money to maintain its 24 start-up companies so Powerhouse Ventures Ltd listed its own shares, justifying the A$1.07 by displaying what it called fair value for its various investments which included HydroWorks.

It valued for its IPO in September 2016, the HydroWorks shares at $57 per share, the value Edison had calculated in 2015, when HydroWorks was still expecting Mace to contribute millions of profit and when HydroWorks was hoping to make millions by selling mini turbines for irrigation canals.

PVL had directors on HW’s board during this period, led by the Powerhouse Ventures Ltd managing director (Dr) Stephen Hampson.

Perhaps it might have been wise to re-assess HydroWorks’ ‘’fair value’’ in 2016, before the Powerhouse Ventures Ltd documents for the IPO were printed.  Were Powerhouse Ventures Ltd investors misled?

The investigating accountant for PVL’s IPO was BDO Spicers which certified that it knew of no material changes that might deceive or mislead investors in the PVL offer.

The Powerhouse Ventures Ltd IPO displayed a board chaired by one of New Zealand’s well known economists and public company directors (NAB, Comalco as examples) in Kerry McDonald.  He resigned three months after the IPO, without explanation.  

It also displayed Rick Christie, once a BP Executive but in the last 30 years a public company director, once chairman of Ebos.   He remains a Powerhouse Ventures Ltd Director.

Prospective PVL investors might have taken for granted that both of these fellows would have performed extensive due diligence before agreeing to join the Powerhouse Ventures Ltd Board, and before selling PVL shares at A$1.07 to the public.

Powerhouse Ventures Ltd, despite having very little cash and being still in its infancy, paid Hampson $350,000 plus bonuses, for his role as MD.  His bonuses are likely to be linked to revaluations of the incubated companies.

PVL simply ought to have seen that HydroWorks was fighting for survival, paying 48% for short term loans, well behind its commitments to creditors and lumbered with a poor decision to buy Mace Engineering.

No one else knew all of this and it was not implied by the revaluation in Powerhouse Ventures Ltd IPO.

The PVL IPO documents were silent on these problems.

I would have guessed that Powerhouse Ventures Ltd.’s obligations after its September 2016 IPO began with a commitment to restore HydroWorks, which it had described as being worth nearly $20 million.  It had an obligation, I would have thought, to ensure that HW was given the time to be worth what PVL said HW was worth.

Without that assistance, HydroWorks was clearly at risk of failure.

There was a case for a $5 million placement of HydroWorks shares to Powerhouse Ventures Ltd, which a long term, patient incubating company might have seen as a much better option that allowing HydroWorks to fail, with all the obvious consequences and the obvious questions such a failure, so soon after the Powerhouse Ventures Ltd IPO, would raise.

This did not happen and cannot happen now PVL has disclosed that it regards HW as being worthless.

The consequences will now unfold. 

HydroWorks is a candidate for receivership.  Creditors would lose money.  The convertible note-holders would be wiped out.

Those who crowd funded HydroWorks in 2015 would lose all of the $1.5 million.

The HydroWorks shareholders would lose everything if a new shareholder does not emerge.

The intellectual property, engineering skills and any manufacturing assets would be bought for some sort of a price and with luck, the HydroWorks expertise would be used by the new buyer, who might acquire the asset for even less than a song; perhaps a brief moment of humming.

Will Powerhouse Ventures Ltd continue to be promoted as a patient investor, incubating good ideas?  Will it even survive this ugly demonstration of its skills?

Will its sources of new start-ups - the universities - observe the HydroWorks experience and form a judgement on Powerhouse Ventures Ltd.’s ability to help start-ups mature?

If I were the commercial manager at a university and wanted help to incubate a start-up, my first call would be to the HydroWorks executives to ask of their experience with Powerhouse Ventures Ltd as a patient, incubator of new companies.

 The Powerhouse Ventures Ltd saga, I fear, is symptomatic of much that is wrong in investment practices.

I have great faith that FNZC, adhering to its philosophy, will show how it should be done.  It has an excellent board of directors and its CEO understands his obligations to all stake-holders.

Note: Powerhouse Ventures Ltd.’s shares sold at A$1.07 11 months ago are now traded at less than a third of the figure.

Will the Australian regulators wonder why?

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REGULAR readers of Taking Stock will know of my view of the trustee company Perpetual Guardian Trust, formed by Englishman and ex-Macquarie staffer Andrew Barnes.

Several years ago Barnes and PGC owner George Kerr hatched a deal for Barnes to buy from Kerr Perpetual Trust, then buy NZ Guardian Trust, merge the two companies and then list it on the NZX after creating some one-off cost savings, bolstering profits! 

As it transpired the market was less enthusiastic about a listing, so that did not happen.

Any sale deal included a $22m bonus payable to Kerr’s company PGC which had owned Perpetual Trust, once the re-sale took place, or so Kerr believed.  He argued the bonus was part of his and Barnes’ deal.

There were some other conditions unknown to me and for a while Kerr and Barnes shadow-boxed, Kerr claiming he would sue Barnes, the English visitor claiming he would counter-sue Kerr. In the end Kerr and Barnes seemed to be in harmony.

Barnes bought one or two other tiny trust companies, failed to sell his new grouping via an IPO, but then announced he had been inundated with offers from private sector buyers.

Eventually he announced he had chosen from the various interested parties a newly-formed company called Trustee Partners, based in Australia.  Presumably he saw TP as the best of these buyers.  (I wonder what the other interested buyers were like.)

Quite remarkably, the new company Trustee Partners had agreed to pay A$200 million for a newly configured NZ company which, with the help of cost cutting, had announced an inaugural profit of $8.5m.

Whether that $8.5m will be repeated obviously would depend on the various clients of all the amalgamated trust companies agreeing to continue to pay the handsome fees that trust companies charge for managing estates and family trusts.

As noted, my view on this is well known.

Trust companies, I think, should write wills and trust documents but should be engaged to manage the funds of estates and trusts only if there is simply no alternative.  Rarely, very rarely, are there not better alternatives.

I have yet to see any trust company with any comparative advantage in managing money for other people.

If I were asked I would urge every trust or estate to replace any trust company manager with an external, proven and competent fund manager, with the best protocols and staff in the market!

I would be emboldened in my view by the large number of examples I have seen of very poor relationships between their clients and the Perpetual and NZ Guardian Trust managers, going back well before Barnes arrived in NZ to do his deal with Kerr.

So when the sale to the tiny new Australian company took place I was amazed at the price Trustee Partners had agreed to pay but was delighted that it was an Australian company that had made what I considered to be such a serious misjudgement of PGT’s long-term value.  It was nice to see Australians rating a NZ asset so extravagantly.

Well, we now know the saga is not over.

According to Australian media reports Trustee Partners has not paid Barnes or his company for PGT and so Barnes reverts to being the owner, perhaps holding the TP deposit, if one was paid.  The Australian media reports Barnes will now sue TP, which apparently explains its default by arguing about some details of some leasing agreements.

If that means Barnes must return to one of the other companies who had clamoured to buy PGT I imagine we will hear soon, and that Trustee Partners would be sued should the new sale price be less than Barnes thought he was to receive.

For those who are clients of PGT I repeat my view which is that PGT should be well capable of drafting a will or a trust for which effort a solicitor might charge a few hundred dollars.  I believe PGT should be capable of drafting such documents.

But the money held in any estate or trust should be managed by people or fund managers who are completely independent from PGT, and who should represent the best available talent in the sector.  I would regard this as an urgent matter.

No trustee company in New Zealand’s history, certainly not in the past 25 years, would have achieved a reputation as being amongst the best available talent for managing money.  Indeed NZ Guardian Trust was demonstrably among the worst, as we saw in 2008.

I hope another Australian buys PGT from Barnes and that the re-sale prompts all trusts and estates to review who manages their money.  I prefer a NZ manager. 

Funds management should be separated from will or trust design, in my opinion.

If Barnes decides to retain PGT he might assist, by outsourcing the funds management or by encouraging settlors and testators to manage their funds themselves, without fees.

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THE fines applied to the Commonwealth Bank of Australia for what seems like a refusal to comply with anti-money laundering laws, will total a few million dollars, perhaps quite a few.  So it should!

In theory, if the regulators used the maximum fine for each of CBA’s offices, the fine could be in trillions, not billions, as there were multiple offences, and maximum penalties are extreme.

The errors by the CBA are astonishing as even the most casual observers of banking practices would know that no bank, indeed no sharebroker, real estate agent, car dealer, lawyer or accountant, can allow unexplained or uncontrolled cash transactions.

It is unimaginable that CBA was unaware of the new strict protocols that treats every customer as a potential drug lord or terrorist.

The CBA’s chairman, a practical woman, has cancelled executive short-term bonuses, punished the non-executive directors with a fee-cut, and may have to fire those who failed.  The CEO is to resign.

Of course it is the CBA shareholders who will pay any hefty penalties, not the dopes that made the errors, or failed to oversee the errant staff and processes.

This is pretty much the same outcome that has been seen in Britain after the absolutely dreadful behaviour of its banks in the lead-up to the global financial crisis in 2008.

All the banks were fined a total of many billions for cynical and often criminal behaviour but the fines were paid by shareholders and the only consequence for bankers that I recall was the loss by one chairman of his right to call himself ‘’Sir’’.  I cried when I read of that severe penalty.

Conversely in Iceland and Spain the bankers were sent to jail in quite large numbers, though of course this did not happen in the USA, where the senior bankers simply paid themselves multi-million dollar bonuses, often from money supplied by the taxpayers to bail out the bank.

One imagines that the most nauseating of these banks, Merrill Lynch, is now a name no sensible banker would want to have on his CV, its behaviour even worse than Goldman Sachs.

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THERE is a growing tendency for New Zealand fund managers to seek high ground by boycotting investments in companies whose products are deemed to be morally reprehensible.

Investments in areas like armaments, cigarettes, alcohol, oil, coal or anything that feeds an argument about climate change are increasingly being avoided. 

One imagines sugar, fat and Enid Blyton books will be next on the banned list, perhaps accompanied by non-organic rhubarb.

But how do the tracker funds (ETFs etc.) track an index if it has companies within the index that some would regard as purveyors of nasty products?

Would some regard pesticides as a negative, while others saw pesticides as necessary to allow grain to survive so that the starving in Africa or South America could be fed?

Some regard travel, with all its dependence on jet fuel, as having a hefty footprint.  Will we screen out investments in airlines and airports?

And might we have to revise our admiration for Warren Buffet who rescued Goldman Sachs and is now a substantial shareholder in that controversial self-focussed company?

I would much prefer that it is someone else, certainly not me, who decides what is and is not, acceptable to the majority in this new age where one can be hissed at, for allowing marmalade to be spread on one’s toast.

(Look at all that sugar that man is putting on his toast!)

Who would dare stay in one of Trump’s hotels, let alone invest in the banks that lend to him?

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Travel

Kevin will be in Christchurch on 31 August.

I will be in Auckland on 4 September and in Tauranga on 5 September.

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.

Anyone wanting to make an appointment should contact us.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.

Chris Lee

Managing Director

Chris Lee & Partners Ltd