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Brian Gaynor 's Opinion

Investment columnist for the NZ Herald

Brian Gaynor: Political risk at the heart of Meridian Energy float

30 comments
Nothing wrong with Govt trying to maximise sale proceeds but this can hurt investor returns once firms list

Electricity companies have copped criticism because prices have surged 133% since 1999. Photo / APN
Electricity companies have copped criticism because prices have surged 133% since 1999. Photo / APN

Meridian Energy's IPO is all about political risk.

Political risk has increased because our politicians keep changing tack, as highlighted by the Labour/Greens proposal that could substantially reduce the profitability of the electricity sector.

Government ministers have also been determined to extract the highest price from the sale of state-owned-assets (SOEs). This was clearly demonstrated by the sharp drop in Mighty River Power's share price after the company's IPO.

Our political parties have been all over the place as far as privatisation is concerned.

Political polling in the late 1980s showed New Zealanders believed the sale of SOEs was the best way to reduce the national debt compared with the two other alternatives, tax increases and Government spending cuts.

Polling also showed that the public strongly supported privatisation because they believed former Crown-owned businesses would be more efficient and profitable under private ownership.

The Labour Government enthusiastically supported full privatisation whereas the National opposition wanted the Crown to continue to own at least 75 per cent of SOEs.

The Labour Government was also determined to maximise the sale value. A joint 1989 Jarden Morgan/Goldman Sachs report to ministers concluded that Telecom would realise about $3 billion from an IPO but in excess of $4 billion if sold to a trade buyer.

The Labour Administration wanted to realise the highest price and sold the telco to a United States-led consortium for just over $4 billion. This was after rejecting submissions that the company should be sold through a partial or full IPO.

Air New Zealand and Tranz Rail were also sold to trade buyers and Bank of New Zealand was partially sold to interests associated with Sir Michael Fay and David Richwhite.

These three companies had to be bailed out by the Government, totally debunking the widely held belief that the private sector was more effective at running businesses than the Crown.

Thus, it was a Labour Government's trade sale of SOEs to buyers with no operating experience, including Fay, Richwhite and Brierley Investments (Air New Zealand), that has led to fierce Labour Party opposition to the current partial privatisation programme.

Labour has flip-flopped from full privatisation in the 1980s to absolutely no sales at present whereas National has switched from being willing to sell up to 25 per cent 25 years ago to 49 per cent at present.

As far as the electricity sector is concerned the assets of the old Electricity Corporation were distributed among Contact Energy, Genesis Energy, Meridian Energy and Mighty River Power between 1996 and 1999.

In 1999 the National Government announced the sale of 40 per cent of Contact Energy to United States-based Edison Mission Energy at $5 a share and the remaining 60 per cent through an IPO at an indicative price range between $2.40 and $3 a share.

Demand was overwhelming because Edison Mission was paying $5 a share, the electricity demand outlook was positive and there was limited opposition to full privatisation.

The final price was set at $3.10 - 10c above the top end of the indicative price range - and the company attracted 225,000 shareholders.

The share price finished the first week at $3.51, a gain of 13.2 per cent, whereas Mighty River Power finished its first week at $2.53 for a gain of just 1.2 per cent.

Opposition to full or partial privatisation has grown dramatically since 1999 because the Greens now have 14 MPs, compared with none in 1999, while left of centre politicians are highly critical of electricity companies because retail prices have surged from 12c/kWh (kilowatt hour) to around 28c/kWh since 1999.

This represents a 133 per cent increase in retail electricity prices whereas the Consumer Price Index has increased by 41 per cent over the same 14-year period.

Mighty River Power's IPO struggled, attracting only 104,000 shareholders, because of the radical Labour/Green proposal, uncertainty over the Tiwai Pt aluminium smelter contract, flat electricity demand and the widely held belief that the huge hike in retail electricity prices has come to an end.

The float's structure was also flawed because the lead managers were incentivised to achieve only the highest IPO price because total fees, which were estimated at $48.7 million, were mainly based on a percentage of the total proceeds raised.

These fees represented 2.88 per cent of the amount raised compared with 2.62 per cent for the Contact Energy IPO and a projected 2.07 per cent for Meridian at the $1.60 a share retail cap.

Investors would be far happier if these generous fee structures were based on a combination of the amount of money raised and the share-price performance of companies after listing.

The Mighty River Power bookbuild to establish the IPO price was extremely disappointing both in terms of procedure and transparency. It is a shame that Meridian hasn't adopted the new ASX bookbuild process (http://www.onmarketbookbuilds.com/) as this becomes effective on October 8, two weeks before the Meridian bookbuild.

A well run and transparent price-setting process is critically important as far as investor confidence is concerned and this was sadly lacking in the Mighty River Power IPO.

The Government had two choices as far as Meridian Energy's IPO is concerned; it could either drop the price to encourage individuals to invest or dress the IPO in fancy packaging.

It adopted the fancy packaging approach by putting a $1.60 a share cap on the retail price and introducing an instalment receipt structure.

Under the instalment receipt structure investors will pay $1 a share up front, with the full dividend paid on this amount, and the remaining to be paid in May 2015.

It is disingenuous to promote the issue on the basis that investors will receive a 13.4 per cent gross dividend yield over the first 12 months.

In reality the dividend yield is only 8.4 per cent, based on the full $1.60 a share retail cap.

This is little different to a property developer company promoting the sale of investment apartments on the basis of a guaranteed income for the first 12 months even though this guarantee lapses at the end of year one.

There is a strong argument that Meridian's retail cap should be $1.50 a share or less, rather than $1.60, and the indicative price should be $1.30 to $1.70 instead of $1.50 to $1.80.

This argument is based on the premise that investors should receive a gross dividend yield of at least 9 per cent gross to compensate for the political risks associated with the Labour/Greens proposal and the sector's low growth profile.

Meridian offers a forecast gross yield of 9 per cent at a $1.49 a share IPO price.

The prospective price/earnings ratio (P/E) of 21.8 at $1.60 a share compares with prospective P/Es of 21.8 and 23.8 for Mighty River Power and Contact Energy respectively at their IPO prices.

Analysts may argue that Meridian's 21.8 prospective P/E fails to reflect the company's higher "normal" earnings and strong cash flow but the fact of the matter is that an official prospective P/E in excess of 20 in the prospectus is extremely high for a company with low growth and significant political risk.

New Zealand privatisation programmes, which started more than 25 years ago, have not encouraged wider participation in our capital markets because they have been characterised by poor decision making, huge political flip-flops and a strong desire to extract the highest price for taxpayers.

There is nothing wrong with the Government trying to maximise its sale proceeds but this can have a negative impact on investor's returns once companies list on the NZX.


Brian Gaynor is an executive director of Milford Asset Management which holds Contact Energy and Mighty River Power shares on behalf of clients.

- NZ Herald

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Brian Gaynor

Investment columnist for the NZ Herald

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the FMA in 2011. He is also a Portfolio Manager at Milford Asset Management.

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