Taking Stock

Read the latest Taking Stock

Taking Stock 4 August 2022

Chris Lee writes:

APPARENTLY leaked to the National Business Review, the details of Kiwibank's sale of its KiwiSaver business will be most encouraging to the shareholders of Kiwibank.

It seems that the Community Trust created to own the Taranaki Savings Bank (TSB), as the current principal owner of Fisher Funds, has bought Kiwi Wealth from Kiwibank for a price north of $300 million, a figure that highlights the richness of KiwiSaver fees (and all managed fund fees).

The sale will represent a huge bonus for the owners of Kiwibank.

What is effectively the TSB had bought Gareth Morgan Investments for around $55 million several years ago and has grown the KiwiSaver fund to the point where another manager has now paid more than $300 million to take over collecting of the annual fee income.

Morgan's success in selling his brand to Kiwibank had itself been a marvel, given that investment management was not how he earned his admired reputation. His management of personal risk was not from a risk/return assessment that would comfortably fit most people. Gareth's flight path through life has never been preordained. He is a champion, but unconventional.

Ultimately his funds management company grew beyond his expectation, requiring him to manage dozens of staff and hundreds of millions of client money. Morgan is not, by nature, a desk-based chief executive.

Wisely, he sold, effectively monetising his personal brand name.

Kiwibank grew the savings pool from hundreds of millions to multi billions and now has cashed up on what was obviously a triumphant foray into ownership of a contract to manage the money of people who vary greatly in their attention to their savings.

Years ago TSB and its Trust had acquired control of the Fisher empire built by the adventuress Carmel Fisher, itself an acquisitive company unafraid of borrowing to buy management contracts, its purchase of the damaged Tower brand bringing scale to Fisher Funds.

When TSB bought Fisher Funds it did so in partnership with TA Associates, based in Hong Kong.

The Asian appetite for funds management contracts is no less voracious than those in New Zealand. Hundreds of millions are made from trading in these contracts to manage other people's money.

By buying Kiwi Wealth from Kiwibank, the Fisher/TSB/ Hong Kong group now becomes a relative giant, with around $12 billion of KiwiSaver funds on which to calculate fee income.

This makes Fisher Funds comparable with the big banks and in terms of all funds under management, roughly half the size of Jarden, Craigs or Forsyth Barr, Fisher Funds raking in from captive clients hundreds of millions of fees each year.

KiwiSaver has been so lucrative for all those who capture the management contracts because once the retail saver signs up most savers never change their provider, irrespective of the often humdrum performance of the manager. Negative results seem to have no consequence. Some of the vessels now managing KiwiSaver have undistinguished, grasping helmsmen. Yet the new money gushes in, every week.

Very lightly regulated, KiwiSaver funds management is just about the living definition of a free lunch, especially for those who simply ape an index, something a chimpanzee could do.

Enjoying their lunch last year was NZ Funds Management, which claimed tens of millions of bonus fees for its small group of private owners.

It made a whirlwind profit from investing in crypto currencies. At the time bonuses were calculated NZFM was permitted by its client-approved management agreement to retain around $50 million in extra fees. When the investor returns turned south, in 2022, after a year of such hollow gains, the bonuses were not refundable. The rules displayed this process. My own view is that the ''rules'' are in urgent need of revision.

NZFM is principally owned by Gerald Siddall and Russell Tills, two of the principals in the dreadful First Step fund it developed alongside its partner, Money Managers, run by Douglas Lloyd Somers Edgar, two decades ago. First Step cost its investors tens of millions of capital.

NZFM as a fund manager is a tiny player acting quite properly and legally when it structured a high-risk fund permitted to trade in cryptocurrencies.

Its retail investors must have accepted and authorised its adventure.

NZFM receives its investor funds largely as a result of a cache of rewarded financial advisers who are authorised to sell such funds. Perhaps these salespeople included those trained in an earlier era.

Fisher Funds, by contrast, like Kiwi Wealth, largely does its own selling and, like NZFM, operates legally, benefitting from the scale of the operation.

As the market regulators gain in experience and resources, I expect there will be new attention given to the skills of all fund managers, given the sales process varies so much. I will applaud when I observe investors are understanding the details of the strategies they have accepted. Currently most KiwiSavers have no apparent interest in such details.

Theoretically regulatory supervision is adequate.

Theoretically, regulation of the 60-odd finance companies extant in 2006 was judged to be adequate.

I have very little respect for the value of trustees and auditors, who supervise.

As managers report negative returns, there may well be a new emphasis on risk and return, and on FMA supervision.

By selling Kiwi Wealth, the Kiwibank owners have dragged in a sum north of $300 million, presumably to add the book value gain to capital, enabling the bank to grow.

In rough terms $200 million of nett gains, capitalised, ought to enable Kiwibank to grow by a factor of ten times that sum. A book larger by $2 billion ought to produce around $50 million of additional surpluses to the owners, every year.

Meanwhile Fisher Funds will gain new income with very little increased administrative cost.

Inevitably there will be a hundred or more redundancies from Kiwi Wealth's team, the Fisher team able to cope with the additional administrative work. The Hong Kong partner will receive some nice, fat NZD dividends.

One wonders how many years will pass before the combined Fisher/TA/Kiwi Wealth group returns to the market, looking to sell at an even greater sum.

Would the next buyer be a Chinese bank, able to fund its acquisition with Chinese government money? The Chinese government love gold mines, especially those that are lightly regulated.

 _ _ _ _ _ _ _ _ _ _ _ _

AT the seminars held around the country two months ago, a frequently asked question was when the Bank Deposit Guarantee promise by Labour's Robertson would be implemented.

Many bank depositors were anxious to hear when the promises of Robertson and his colleagues would be effective.

We now have a clearer hint of timing, Robertson having indicated that the government scheme would be attached to other legislation scheduled for introduction around 2024.

Readers may recall Robertson promised the Labour government would guarantee a deposit with any bank, and possibly any similar deposit-taker, up to the extravagant level of $100,000 per person, per bank.

This might mean, if he was quoted correctly, that a couple could each put $100,000 in five different banks, enabling them to have $1 million of Crown guaranteed deposits.

Such largesse seems out of place with a government which regularly has mocked the wealthy, its late Minister Cullen, finding a rather crude way of addressing moneyed people, when he was describing Key in Parliament.

The number of New Zealanders with a million of cash to put into bank deposits would be less than one percent of the voting public and would be a group not expecting much help from the government.

There are at least two interesting aspects of this Labour promise.

The first is that it contrasts with long-held Treasury thinking that bank deposits should not involve a Crown liability given the Reserve Bank is tasked with ensuring the competent supervision of banks.

I am unsure whether deep within this Treasury position was an element of dislike for the RB's independence, something Treasury has been unable to achieve for itself. The RB is across the road from Treasury on The Terrace, in Wellington.

The RB's principal roles in New Zealand used to be controlling the money supply to keep inflation within accepted levels, and the supervision of banks, to minimise the levels of reckless behaviour, ensuring the banking system was resilient and functional.

The RB is today still fumbling with Robertson's new ideological directives, that it underwrites unemployment, incorporates a Maori perspective in its thinking, and takes into account the need to address climate change.

It has not yet been instructed to measure the hoof prints of cattle in wet, sloping paddocks, though there will be at least one Minister who might be seeking the right organ of government on which to impose this task.

Of course most adults will remember how the barely-supervised second tier of deposit-takers damaged the country in 2008.

The banking system survived, boosted then by tangible support from its Australian shareholders, and by the Crown's dreadfully-drafted, irresponsibly-supervised guarantee of all deposit-takers, including hundreds of billions of bank deposits.

We now all know that various plonkers in Cabinet, Treasury, the Reserve Bank, the Securities Commission, the NZX, and the Justice Department, allowed the guarantee to be exploited.

These same people, having set the fire, then allowed passers-by to extract billions of dollars of value from the Crown, exploiting some appalling decisions by receivers, the worst being with South Canterbury Finance.

Guarantees of deposits distort.

Today, the RB, led by an activist governor in Adrian Orr, is much less enamoured with the governors and executives at the banks, Orr having watched, from within, banking behaviour, earlier in his career.

He has loudly challenged the amateurish governance of ANZ and Westpac. Indeed if he had the power, I expect the banks would be required to use quite different criteria when selecting their head honchos.

Orr-supervised banks, if his style was unhindered by politicians, might indeed preclude the need for a guarantee. For one thing capital levels would be higher, and risk assessment more brutal.

The other issue arising from the guarantee is who would bear the cost.

Why would Robertson want to socialise any cost of investor hazard, given that it is these ''rich twits'' who would benefit the most.

An obvious response would be to price the guarantee, the cost taken from the interest rate, the depositor paying for the benefit, the bank simply a conduit of the fee.

Invest at 4% for four years in Bank XYZ, or accept a Crown-guaranteed 3.5%, eliminating the risk of default.

The cost/benefit would then rightly be borne by the investor.

If Robertson is still around in 2024, and his plan is implemented, one imagines he will by then have had sane advice and will not be offering yet another free lunch.

 _ _ _ _ _ _ _ _ _ _ _ _

Johnny Lee writes:

A SERIES of announcements from major New Zealand companies will have triggered alarm for some and relief for others, as our sharemarket prepares for reporting season to commence later this month.

The worst news came from bladder-cancer technology company Pacific Edge, as it responded to a proposed change in the way its tests are reimbursed from some providers in the US. The change relates to the coverage for tests reimbursed by the US Centers for Medicare and Medicaid Services.

Pacific Edge has, over the past several years, been expanding its US presence and reporting growing test numbers and revenue from that market. Although the company has not yet quantified the impact of the proposal, some analysts have warned that Pacific Edge's revenue could more than halve. It is a significant announcement that saw its share price fall more than 40%, wiping hundreds of millions from its market capitalisation.

Pacific Edge was at pains to reiterate that the proposed changes are in a draft form and therefore subject to change.  However, shareholders are ultimately the group that must carry this risk.

It was clear from the immediate market response that many investors have had enough, with the sell-down being fairly indiscriminate on price, as shareholders rid themselves of a stock that has had its fair share of highs and lows over the past two decades.

Of course, every seller must match a buyer. Those buying today at around 50 cents will no doubt be harbouring a hope that the proposed changes do not come to pass, or that the fears around its impact are overstated. Risk tolerances vary, as do investment horizons. The many false starts experienced by the company have rewarded traders more than investors, and those choosing to remain shareholders in the face of this proposed change are clearly accepting of the new risks in front it.

A2 Milk has also made an announcement, responding to media speculation that the company's infant formula product was to receive, this week, approval for its sale within the United States.

The US has experienced a temporary infant formula shortage over the past six months, after the closure of a key facility in February following a product recall. The US Government has responded by approving a range of global providers for import. Market speculation was that A2 Milk was to be added to this list, adding revenue during a time of downturn in certain Asian markets.

A2 Milk reiterated that approval has not yet been granted, but is being sought. There is also no certainty around how meaningful and long-lasting such revenue would be. Nevertheless, the market was happy to accept positive news and sent the price higher. One could expect the company's result announcement, due later this month, to expand on the potential impact of this.

Mainfreight provided another update to the market, with its first 16 weeks of the year continuing the fantastic run of results it has experienced over the past two years. Double digit – in some areas triple digit – growth is still being observed in the logistics sector.

While it would be true that these conditions cannot persist indefinitely, Mainfreight is clearly still enjoying a period of elevated margins and planning ahead for further growth. The company's growth ambitions – particularly in Asia – are very aggressive and supported by its excellent track record. Indonesia and India appear to be the next on its list, with dozens of other locations also being explored.

Barring a sudden reversal, November's result promises to be another strong one, perhaps beginning to justify the enormous share price gains the company has enjoyed over the past two years.

Lastly, Infratil's revaluation of LongRoad Energy further narrowed the gap between Infratil's share price and Infratil's underlying value, with the share price rising alongside the rising valuation.

LongRoad is a developer and owner of renewable (wind and solar) projects in the United States, and is part owned by Infratil. Infratil also has a stake in Galileo, a similar business in Europe, and large stake in Gurin, which targets Asian markets.

Infratil's share price performance, one of the best in the market, has nevertheless long trailed the underlying value of its assets, with many inside and outside the company believing the company to be undervalued.

Infratil will not spend all its time trying to convince the market it is worth more than its share price implies. Market forces should be determining this. Instead, it simply allows actions to speak in its place, Vodafone's tower sales and LongRoad's revaluation being two examples of the company proving its value for its shareholders.

The market continues to await the outcome of the RetireAustralia strategic review. This is unlikely to find a conclusion that will generate the same level of optimism amongst investors.

Infratil's half-year results will be released in November.

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


Johnny Lee will be in Christchurch on Wednesday 24 August (Russley Golf Club).

Edward will be in Wellington on Thursday 25 August (Featherston Street); and in Auckland on 31 August (Ellerslie), 1 September (North Shore) and 2 September (City).

In September, he will be in Blenheim on Thursday 8 and Nelson on Friday 9 and in Napier on Thursday 22.

Chris will be in Takapuna on August 16 (p.m.) and has several vacant times in Ellerslie on August 17 (a.m.) and in Ellerslie on August 19 (a.m.). He has two available vacancies in Ashburton on September 7 (a.m.) and one in Timaru (p.m.) on September 7.

David Colman will be in Lower Hutt on Friday 26 August and is planning trips to Whanganui and Palmerston North.

Please let us know if you would like an appointment.

Chris Lee & Partners Ltd

This emailed client newsletter is confidential and is sent only to those clients who have requested it. In requesting it, you have accepted that it will not be reproduced in part, or in total, without the expressed permission of Chris Lee & Partners Ltd. The email, as a client newsletter, has some legal privileges because it is a client newsletter.

Any member of the media receiving this newsletter is agreeing to the specific terms of it, that is not to copy, publish or distribute these pages or the content of it, without permission from the copyright owner. This work is Copyright © 2022 by Chris Lee & Partners Ltd. To enquire about copyright clearances contact: copyrightclearance@chrislee.co.nz