Investment columnist for the NZ Herald

Brian Gaynor: Good news for investors is bad for the market

Takeovers by cashed-up buyers mean less choice for KiwiSavers
Photo / iStock
Photo / iStock

The Diligent and Nuplex offers are both positive and negative -- good news for the shareholders of the individual companies, but negative developments for the NZX.

Both companies are in the benchmark NZX50 Index and they have a combined market value of nearly $1.7 billion at the offer prices. The NZX cannot afford to lose two benchmark index companies, particularly as KiwiSaver funds already find it difficult to identify suitable domestic investments.

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One of the more interesting aspects of the two proposals is that they are both private equity-driven. This suggests there could be a large number of these private equity deals in the months ahead.

The recently released 2016 Preqin Global Private Equity & Venture Capital Report revealed that, widely defined, private capital funds raised over US$500 billion in 2015, the third consecutive year they raised in excess of US$500 billion. This compares with less than US$50 billion raised by New York Stock Exchange and Nasdaq IPOs in the same 12-month period.

Preqin also reported that these private capital funds had $4.2 trillion under management. The report also estimated that $1.3 trillion of this $4.2 trillion was dry powder or unused capital at the end of 2015 -- a record.

In light of these huge dry capital levels, and extremely low interest rates, it is not surprising that the week opened with a flurry of private equity initiated activity on the NZX.

The first announcement on Monday was at 8:48am, when Nuplex revealed it had received an indicative, non-binding and conditional proposal from Allnex Belgium. Allnex is a coating resins company backed by Boston based private equity firm Advent International Corp, which has US$31 billion under management.

The Diligent and Nuplex offers give a strong signal that there will be more private equity offers in the months ahead.

The target company reported that "following the initial approach, the board entered into discussions, which were strictly confidential and inconclusive.

With the assistance of financial and other advisers, the board initially rejected Advent's proposals. Subsequently, after three offer revisions since the initial offer from 30 October 2015, Allnex and Advent have submitted the current proposal, offering improved total consideration of $5.55 per share".

As the offer price represents a 44 per cent premium over the previous day's closing price of $3.86 per share, and there are break fees in excess of $10 million on both sides, there is a very strong probability that the offer will be completed. The break fees are a particularly strong incentive because if Nuplex rejects the proposal it will have to pay $10 million to the offeror and if the Allnex/Advent consortium withdraws its offer it will have to pay $10 million to Nuplex.

Graphic / NZ Herald
Graphic / NZ Herald

At 9:10am Diligent Corporation announced it reached an agreement with Insight Venture Partners, a New York based private equity company with US$13 billion under management. This offer, for US$4.90 ($7.39) a share, represents a premium of 31 per cent over the previous day's closing price of NZ$5.64.

It is reasonable to assume that Diligent and Insight know each other fairly well as they are based just six blocks APART in central Manhattan.

The Diligent proposal should go ahead, though it is less certain than the Nuplex deal because the share price premium is less, there is no mention of break fees and there are currency risks for New Zealand investors because the offer is in US dollars.

The Diligent and Nuplex offers give a strong signal that there will be more private equity offers in the months ahead, particularly as private equity funds are awash in cash.

The accompanying table ranks the world's stock exchanges in terms of the number of domestic companies listed at the end of last year. The table, compiled from World Federation of Exchanges' data, also shows the number of listed companies at the end of 2009 and 2003.

The Bombay Stock Exchange, established in 1875 and Asia's oldest exchange, is in first position with 5835 listed domestic companies. It is well ahead of the BME Spanish Exchange which has a substantial number of listed open-ended investment companies.

This will be good news for some investors but the NZX cannot afford to lose any more companies.

Japan Exchange Group, in third place, includes the Tokyo Stock Exchange and Osaka Securities Exchange, which merged in 2013.

TMX Group, which includes the Toronto Stock Exchange and other Canadian exchanges, is in fourth place, Nasdaq is fifth and the Australian Stock Exchange, which has 1989 domestic listings, is sixth.

Most of these large stock exchanges are either Asia-based or have attracted a large number of small and medium-sized companies.

The NZX is in 37th place in terms of the number of listed companies and in 38th place as far as total sharemarket capitalisation is concerned. The NZX has attracted a number of partially privatised or formerly publicly controlled companies but it has failed to entice a large number of small and medium-sized growth oriented companies.

The paucity of new NZX listings is due to a number of factors, including the limited number of investment bankers, particularly ones that focus on the smaller end of the corporate market, and the absence of widespread analytical reports on small and medium sized companies once they list.

The largest 10 NZX companies by market capitalisation are:

Auckland International Airport ($7b), Spark ($6.0b ), Meridian Energy ($5.9b), Fisher & Paykel Healthcare ($5b), Fletcher Building ($4.6b), Ryman Healthcare ($4.1b), Mighty River Power ($3.8b), Contact Energy ($3.2b), Vector ($3.1b) and Air New Zealand ($3.1b).

Only three of these, F&P Healthcare, Fletcher and Ryman, originated in the private sector.

The formerly fully-owned public-sector companies make a huge contribution to the NZX but where are our small and medium-sized growth oriented companies?

The number of ASX companies has increased by 584 over the past 12 years, from 1405 to 1989, while the number of listed NZX companies has risen by only 5, from 166 to 171.

What has happened to the NXT market for small and medium-sized companies, which was launched by the NZX in June last year?

So far NXT has attracted only two companies -- G3 Group and Snakk Media. The former has had only $33,575 worth of shares traded on NXT while the latter has had less than $400,000 worth traded since it migrated from the NZX Alternative Market to the NXT Market in October.

Unless the NZX can convince more companies to list, then New Zealand investors -- particularly KiwiSaver members -- will be forced to divert more and more of their funds to income assets or overseas sharemarkets.

New Zealand investors, particularly long-term KiwiSaver members, would benefit from a much stronger and larger NZX because there are no direct foreign exchange risks associated with NZX-listed companies and the tax treatment is more favourable than for companies listed and domiciled overseas.

Accordingly, KiwiSaver investors have a bias towards bonds and cash when equities usually generate higher returns over the longer term.

Private equity activity could further reduce the number of NZX-listed companies in the months ahead.

This is likely to be outside the top 10 companies, as Meridian Energy, Mighty River Power and Air New Zealand are government-controlled and Auckland International Airport and Vector have public shareholders that are unlikely to accept offers.

Unless the NZX can convince more companies to list, then New Zealand investors -- particularly KiwiSaver members -- will be forced to divert more and more of their funds to income assets or overseas sharemarkets.

This represents a massive lost opportunity for domestic companies to raise new equity to fund their growth.

- NZ Herald

Brian Gaynor is an executive director of Milford Asset Management which holds shares for clients in all of the companies mentioned, with the exception of Diligent Corporation.

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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.

Read more by Brian Gaynor

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