Brian Gaynor 's Opinion

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor: Judge IPOs on their merits, not the hype

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Investors should always focus on the quality of — and reasons for — an issue

Dick Smith is one of the companies that has been caught up in IPO fever across the Tasman. Photo / Dean Purcell
Dick Smith is one of the companies that has been caught up in IPO fever across the Tasman. Photo / Dean Purcell

It has been a great year for sharemarket investors, with the NZX50 Gross Index up 19.4 per cent since the end of 2012.

Xero's shares have soared 435 per cent, Kathmandu 107 per cent and Ryman Healthcare 88 per cent.

However, bull markets have their challenges, particularly the quality of initial public offerings (IPOs).

One of the consistent features of a sustained sharemarket rise is the deteriorating quality of IPOs, particularly when existing shareholders use the IPO as an exit strategy. Investors should be wary of the hype and publicity associated with these issues.

We have largely avoided this hype in New Zealand because the IPO market has been crowded out by the Crown's selldown of Mighty River Power and Meridian Energy.

But the Australian sharemarket is experiencing IPO mania and we could have a similar experience on this side of the Tasman next year once the Genesis Energy IPO is either completed or cancelled.

Investors should always focus on the quality of an IPO rather than the hype and media commentary associated with the issue.

The NZX has had a great run since the NZX50 Gross Index bottomed out at 2418 on March 3, 2009 with the benchmark index soaring 98 per cent since then. Trading volume has steadily risen, particularly this year.

The NZX reported that trading volume was up 44.2 per cent for the first 10 months of the current year, to $34.1 billion, and $927 million worth of shares changed hands on Tuesday. This was an all-time high for a day without a new listing, major selldown or stand in the market. There were 12,050 individual trades reported on Tuesday, an NZX record high.

Trading volume has risen because of increased investor interest, profit taking, index weighting changes and the Mighty River Power and Meridian Energy IPOs.

Overseas investors have been taking profits because of the market's strong performance and the sharp appreciation of the NZ dollar.

For example, Fletcher Building's share price has risen by 77 per cent, from $5.15 to $9.13, since March 3, 2009 and the NZ dollar has appreciated against the US dollar by 64 per cent over the same period.

Some of the recent Fletcher Building selling seemed to be by offshore investors who are taking advantage of the company's share price improvement and the strong performance of the NZ dollar.

One would have expected a large number of IPOs in this environment but the two large Crown IPOs have crowded out the market and their poor post-listing performances have had a depressing impact on IPO enthusiasm.

By contrast Royal Mail Group, the British postal company, has experienced a 68 per cent share price surge, from 3.30 to 5.55, since listing on the London Stock Exchange following the Government's sale of 70 per cent to the public last month.

British investors will be toasting government officials over Christmas dinner but the Treasury in Wellington won't be receiving any Christmas cheer because its handling of our government privatisations, which began in the mid-1980s, continues to be totally unsatisfactory.

The preferred objective of an IPO is to raise new capital to facilitate the growth of the company. Unfortunately most of the money raised on the NZX this year has been used to buy existing shares with only $128 million, or 3.2 per cent, of the total $4 billion raised being for the issue of new shares (see table).

As a general rule companies that raise new capital have a better post-listing share price performance than IPOs that are mainly used as an exit strategy for existing shareholders. This year is no exception as the two companies that have mainly used their IPOs to raise new capital, SLI Systems and Synlait Milk, have had much better post-listing performances than Meridian Energy, Mighty River Power, Wynyard Group and Z Energy.

The two electricity generators and Z Energy raised no new capital while 60 per cent of the money raised by Wynyard Group went to existing shareholders.

As a general rule investors should have a bias towards IPOs where all or most of the money raised goes to the company to grow its operations.

Xero is an excellent example of this as the money raised through the IPO was used to grow the company.

Meanwhile, IPO fever is clearly evident across the Tasman with a large number of companies raising money before the Christmas break. One of these is Dick Smith, which has 61 stores in New Zealand and 298 in Australia.

Dick Smith was founded by Australian entrepreneur Richard "Dick" Smith in Sydney in 1968. Woolworths acquired a 60 per cent stake in 1981 and the remaining 40 per cent two years later.

On November 26, 2012 Anchorage, a turnaround-focused private equity firm, paid A$70 million ($78.3 million) for Dick Smith with a further A$24 million still to be paid.

Two weeks ago Dick Smith issued a prospectus for the sale of 66 per cent of the company at A$2.20 a share. This will raise A$344 million but Dick Smith is paying A$358 million to Anchorage and A$24 million to Woolworths to complete the 2012 purchase.

Anchorage will hold the remaining 34 per cent, worth a further $104 million at the A$2.20 a share IPO price Thus, Anchorage will turn A$70 million into A$462 million in just 12 months.

Dick Smith has a number of New Zealand connections in addition to its 61 stores.

Ralph Waters, Fletcher Building's former chief executive and the current chairman of Woolworths, has been accused of selling Dick Smith too cheaply to private equity interests.

Australian retailer Myer Holdings listed in 2009 with shares issued at A$4.10 and all of the proceeds going to existing shareholders, to repay debt and fund the IPO. The IPO was extensively promoted through the use of Miss Universe Jennifer Hawkins.

The directors said that Myer would expand from 65 to 80 stores and had the "potential to expand to over 100 stores".

Myer still has only 68 stores, its shares trade at just A$2.85 and the all-time high was A$4.02 compared with the IPO price of A$4.10.

The Dick Smith issue also has plenty of hype or "gold talk" as it is often referred to in the industry. Unnamed investment bankers and fund managers are quoted as saying there was huge demand for the shares, the issue was substantially oversubscribed and fund managers and retail investors only obtained a small proportion of the shares they were seeking.

These non-sourced quotes, which were evident during the Mighty River Power and Meridian Energy floats, should be banned because they can be used to give a false impression of demand and encourage investors to buy shares for the wrong reasons.

It is extremely important for investors to assess all IPOs on their merits and avoid being influenced by hype, particularly when most of the proceeds are going to existing shareholders who are selling out.


Brian Gaynor is an executive director of Milford Asset Management.

- NZ Herald

Brian Gaynor

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular 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 Financial Markets Authority (FMA) in 2011. He is also a Portfolio Manager at Milford Asset Management.

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