Brian Gaynor 's Opinion

Investment columnist for the NZ Herald

Brian Gaynor: NZX's growth needs ethical foundations

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Dodgy practices of past must not recur as new investors join market.

Some company executives have a tendency to leak information to broker analysts.  Photo / Getty Images
Some company executives have a tendency to leak information to broker analysts. Photo / Getty Images

January was a great month for sharemarkets with the NZX 50 Gross Index gaining 4.6 per cent while the ASX200 Accumulation (gross) Index appreciated 5 per cent.

The NZX 50 Gross Index, which has had four 4 per cent-plus months in the past year, expanded by 29 per cent in the 12 months ended January 31.

By comparison the ASX200 Accumulation Index increased by 20.1 per cent over the same 12-month period but by a more modest 15.9 per cent in NZ dollar terms because of the strength of our currency.

The MSCI World Gross Index was up 16.6 per cent in the January year with the NZX being the third-best-performing developed market stock exchange, in US dollar terms.

The Belgian and Danish markets were the only ones to outperform the NZX in the 12 months to January 31.

The strong market surge has attracted new investors to the NZX and it is vitally important that market leaders do not behave irresponsibly, as they did in the 1980s.

There are two major concerns at present.

The first is the tendency for chief executives, chief financial officers and investor relations personnel to leak information to broker analysts about earnings prospects. This practice is adopted far too often in New Zealand, even by our largest companies.

For example, if broker analysts are forecasting a profit increase of 20 per cent for the year - but the company is expecting a more modest 12 per cent rise - then company executives may subtly convince analysts to reduce their forecasts.

There are two main reasons:

If analysts reduce their forecasts from plus 20 per cent to plus 12 per cent, and the company then reports a 12 per cent increase, the chief executive can claim that the result was in line with market forecasts.

If the forecast remains at plus 20 per cent and the company realises that it will be only plus 7 per cent, it will have to announce a profit downgrade to the market with potentially dramatic share price consequences. However, if executives can massage broker analysts' forecasts down to plus 12 per cent, and earnings are looking like plus 7 per cent, then the company isn't obliged to announce an earnings downgrade as it would be within the generally accepted 10 percentage points threshold.

The practice of privately talking profit forecasts up or down to broker analysts gives these analysts, and their clients, an unfair advantage compared with other investors. Companies should be required to make announcements to the market when they believe profit forecasts are too high or too low as these releases protect the integrity of the NZX.

For example the CFA (Certified Financial Analysts) Institute requires that "when information is disclosed selectively, ie, to a handful of investment analysts, or perhaps on a conference call, or in an email, the information may still be regarded as non-public".

"Companies are bound by specific procedures to make the information public and to ensure a system of fairness in which all market participants are given a chance to act on the information."

Another unfortunate practice is when analysts write favourable reports about their investment banking clients and reveal these positive recommendations to selected clients before the report is published.

These positive reports can lead to a sharp appreciation in share prices, particularly in bull markets.

There is supposed to be a "firewall" between brokers and investment bankers but this is difficult to achieve here because organisations are relatively small.

It is not unusual to see a broker publish a positive analysts' report about a company that is about to have a capital raising that the broker is organising or is pitching to organise.

In a similar vein, a broker analyst will never publish a negative report on a company that his or her investment banking division has a relationship with. One of the worst features of the 1980s was when companies released positive news to a limited number of investors and when broker analysts wrote particularly optimistic reports and gave a pre-publication preview to their favoured clients.

It is vital we don't see a repeat of these manipulative practices, particularly if the sharemarket attracts new and relatively inexperienced investors.

Meanwhile, there have been several takeover offers which have received scant media attention.

The bids for L&M Energy and New Image, by their respective chairmen, illustrate a disturbing trend because they indicate that these individuals see far more value in their companies than sharemarket investors.

L&M Energy chairman Geoffrey Loudon, who owned 22.9 per cent of the ordinary shares, has made an offer for the New Zealand oil and gas explorer at A$0.06 a share. L&M is listed on the NZX and ASX.

KordaMentha valued the company between A$0.02 and A$0.051 a share and Loudon has reached 95.1 per cent after moving to compulsory acquisition.

New Image chairman Graeme Clegg, who currently holds under 70 per cent, recently announced his intention to make an offer for the company at $0.26 a share.

Clegg said he expected the NZX listing to provide a platform for growth but "I have formed the view that the increasing costs arising from changes to the regulatory regime applying to listed entities means that in the absence of compelling reason to remain a listed company, it is better ... the company be privatised again".

This is an example where companies can be encouraged to delist because of unethical behaviour by some market participants leading to more regulation and costs.

These delisted companies miss out on potential capital raisings and growth opportunities to the detriment of the economy.

New Image shares initially sold slightly above the offer price but have settled back to the $0.26 bid price.

The independent adviser's report, being prepared by Simmons Corporate Finance, is expected to be sent to shareholders by February 15.

The bid for New Zealand Experience, which operates Rainbow's End in Manukau, has reached an interesting stage although the bidder should reach 90 per cent and move to compulsory acquisition.

The bid was triggered when Rangatira, the Wellington-based investment company, agreed to purchase the 74.9 per cent stake held by Canadian beneficiaries of the late George Gardiner.

The $0.36-a-share offer price compares with Simmons Corporate Finance's valuation between $0.33 and $0.42 a share.

The offer closes on February 15 with Rangatira sitting on 82 per cent and the share price trading slightly above the offer price in small volumes.

Last week NZ Experience announced that it expected a net profit of $1.3 million to $1.4 million for the June 2013 year instead of its earlier target of $1.4 million to $1.6 million.

Rangatira's response was that it would not increase its $0.36 offer price and would request the NZX to delist the company, even if it did not reach 90 per cent.

Australia-based Lempriere Group has reached 88.3 per cent of New Zealand Wool Services International, the scourer and exporter of wool. The $0.45-a-share offer compares with Northington Partners' valuation of between $0.38 and $0.47 a share.

Finally, there is a great deal of talk about an increase in the number of NZX IPOs in the current year but the fact of the matter is that we will probably have four delistings before we have any IPOs.

Meanwhile the ASX has already announced 11 IPOs this year.

Where are all those ambitious New Zealand entrepreneurs who want to raise capital and grow their businesses?

Brian Gaynor is an executive director of Milford Asset Management.

- NZ Herald

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.

Read more by Brian Gaynor

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