Andrew Taylor and Gareth Galloway: We look healthy but we're still vulnerable

Andrew Taylor and Gareth Galloway of Ernst and Young. Photo / Supplied

Opinion

Spectre of regulation could spark uncertainty and undermine recovering capital markets

This was touted to be the year equity markets boomed.

Twelve months ago, in this column, we projected "significantly enhanced" capital markets, fuelled by Government plans to partially privatise state-owned power generator and retailer Mighty River and by Fonterra's proposed share trading among farmers.

We expected the momentum to continue for the following 24 months, under-pinned by the planned sales of minority interests in SOEs Meridian, Genesis and Solid Energy, alongside a significant pipeline of private businesses coming to market.

What a difference a year can make.

On the major issue, we were not wrong. Ernst & Young's just-released Capital Confidence Barometer shows our capital markets are in good heart.

Nearly 90 per cent of the 130 executives surveyed in New Zealand and Australia perceive the global economy to be improving or stable, 70 per cent expect merger and acquisition (M & A) volumes to improve and 63 per cent say capital allocation is receiving greater focus in the boardroom.

Globally, almost 1600 executives took part in the survey.

Critically, the mindset of companies has undergone a sea-change in Australasia - and around the globe - in the past six months. The focus has shifted from cost-cutting and operational efficiency to planning for more top-line growth.

In Australasia, growth has become the major priority for 51 per cent of those surveyed, compared with 37 per cent six months ago.

The percentage of those focused solely on maintaining stability within their organisations has slumped from 32 per cent last October to only 18 per cent at the end of April this year.

The earnings front is similarly bullish. Some 58 per cent of Australasian respondents are confident about corporate earnings, 44 per cent say they expect to create jobs in the next 12 months and 88 per cent say the valuation gap (between buyers' and sellers' expectations) will remain the same, or contract.

Australasian organisations say they also believe the likelihood of closing deals has improved, with 38 per cent saying they're more confident in getting transactions across the line, up from 25 per cent last October.

The IPO (Initial Public Offering) sector, too, is slowly recovering from the abyss of 2009 (see graphic).

So what could go wrong?

Plans by the Labour Party and the Greens to nationalise the wholesale electricity market if they become the government next year risk derailing this fragile recovery.

The resulting investment uncertainty will erode and undermine our still-vulnerable capital markets. A group of business leaders, including Business New Zealand's Phil O'Reilly, did not over-state the case last week when they warned Labour's plan would have a chilling effect across the entire New Zealand economy.

An investment analyst had calculated the Labour-led policy had the potential to wipe $1.4 billion of shareholder value from the books of private power companies, they said. A similar amount would be stripped from public power companies.

Capital destruction on that scale would severely undermine business confidence, investment plans and job creation.

And our market is still vulnerable.

Though our public equity markets have significantly strengthened in the past 18 months, the most recent figures from New Zealand's Private Equity and Venture Capital Monitor, released in mid-April, showed a significant drop in private equity investment activity.

This plunged 80 per cent last year, compared with activity in 2011. Total investment in 2012 was $111.4 million over 62 deals, down from $553.4m across 84 deals in the previous year.

In our view, this reflects a combination of global economic uncertainty driven by the eurozone in the first half of 2012, a weaker deal pipeline and several of New Zealand's larger funds being in fund-raising mode during the year.

Looking behind these headline numbers, we see the New Zealand private equity market being poised for significant activity.

The capital-raising by New Zealand mid-market managers in their current funds is around $1 billion. When this is aligned with the sentiment shifts identified in the Capital Confidence Barometer - such as increasing confidence in the economic outlook, the increasing availability of debt finance and a renewed growth focus among clients - all factors point to increased activity during the next 12 months in the private equity capital market.

So the overall outlook for New Zealand capital market health and activity in the coming year remains positive - with the proviso that the threat of Labour/Greens electricity market reforms raises the spectre of regulatory and political uncertainty and an unwelcome risk to the recovering confidence being seen in our private and public capital markets.

• Andrew Taylor and Gareth Galloway are transaction advisory partners at Ernst & Young