Brian Gaynor: Xero sends a message to the market

Rod Drury says Xero won't seek shareholder approval for its move to the Australian market. Photo / Michael Craig

Xero's proposed NZX delisting is a huge blow to the domestic sharemarket. The unexpected announcement is accentuated because Xero's founder and CEO Rod Drury was an NZX director from November 2009 to May 2013.

Following his NZX board appointment, Drury was quoted as saying: "Listing on the NZX - our national stock exchange - should be an aspiration of all New Zealand business owners. Our businesses need the capital to grow, and create attractive investment opportunities for other New Zealanders to be part of the growth".

What went wrong, why is Drury turning his back on the NZX? Why didn't Xero consult shareholders on this issue? Is this another case of corporate arrogance?

The first company to jump ship in recent times was Nufarm, formerly known as NZ Farmers Fertilizer and Fernz Corporation.

Nufarm moved its head office and primary stock exchange listing to Australia in January 2000, but remained listed on the NZX. Eighteen months later the company was removed from the benchmark S&P/ASX200 Index because it failed to meet market liquidity requirements.

An independent analysis showed that Nufarm would have remained in the Australian benchmark index if the company's NZX turnover was added to its ASX turnover.

Consequently, Nufarm held a shareholders meeting in Melbourne on August 6, 2001, which approved its NZX delisting.

The important point about Nufarm was that it had already moved its head office across the Tasman and the company clearly explained the reason for its delisting proposal. It also allowed shareholders to vote on the proposal.

Michael Hill was another company to engage with shareholders when it decided to move to Australia, while remaining listed on the NZX.

Listing on the NZX - our national stock exchange - should be an aspiration of all New Zealand business owners.

Rod Drury

In June 2016, Michael Hill International held a special meeting of shareholders in Auckland to approve the transfer of its registration to Australia and listing on the ASX. Chairwoman Emma Hill wrote: "Over time, the listing on ASX will also bring to the company a much wider group of investors, and this in turn will benefit all shareholders."

This prediction was accurate, as Michael Hill has more shareholders than it did two years ago. Meanwhile, its annual share trading volume has soared from 33.5 million in 2015, when the company was only listed on the NZX, to 123.5 million shares this year, with six trading weeks remaining in 2017.

The ASX has accounted for 56.8 per cent of the 123.5m Michael Hill shares traded this year.

Richina Pacific held a highly charged shareholders meeting to approve its NZX delisting in 2008 and the shareholders of Future Mobility Solutions (FMS), formerly known as Sealegs, recently approved a proposal to list on London's AIM market and delist from the NZX.

FMS Chairman Eric Series wrote: "The proposed listing on AIM and delisting from the NZX are, in the board's view, a logical step in [the company's] continued global expansion".

The FMS motion to delist from the NZX was carried by a substantial majority.

A2 Milk listed on the ASX in March 2015, while remaining on the NZX, and 72 per cent of its 2017 trading volume has been on the Australian bourse.

Xero listed on the New Zealand sharemarket in June 2007 after an IPO at $1.00 a share. The newly-listed NZX company attracted only 1265 shareholders, clearly indicating that most New Zealanders are reluctant to invest in unproven companies.

The Wellington-based company listed on the ASX in October 2012. Figures in the accompanying table show how the total number of Xero shareholders jumped sharply after the dual listing, and share trading activity on the two exchanges.

It is important to note that Xero, unlike Michael Hill and a2 Milk, remains predominantly traded on the NZX, with 42.7 million, or 73.6 per cent, of the 58 million shares traded this year crossed on the NZ bourse.

Xero claims it faces the same issue as Nufarm 16 years ago: it wants to be included in the ASX benchmark index but shares traded on the NZX are not considered under ASX index liquidity requirements. Consequently, Xero wants to delist from the NZX with the aim of encouraging all NZX share trading to move to the ASX so it can meet ASX index liquidity obligations.

The company is worried that if it doesn't delist from the NZX, then share trading activity may drift from New Zealand to Australia. As a result, Xero won't have sufficient ASX liquidity to be included in the benchmark index but the reduction in NZX trading could lead to its removal from the NZX50 Gross Index.

This is a hopeless situation for the New Zealand sharemarket because domestic brokers are being severely penalised for researching and encouraging investors to buy and sell Xero shares through the NZX, rather than the ASX.

It is a major blow to New Zealand because nearly $1.1 billion worth of Xero shares have been traded through the NZX this year, representing around 3 per cent of total NZX trading value. This means that at least $5m of annual broker income will shift from NZX to ASX stockbrokers.

This is a consequence of passive investing, as one of the key objectives of listed companies is to be included in major, large market benchmark indices. Ironically, the NZX is part of this move to passive investing as its funds management business offers a wide range of passive funds.

The issue of shareholder approval seems to be covered by NZX Listing Rule 5.4.1(b), which states that the NZX "may" require shareholder approval for any proposal to delist from its market.

It isn't clear why Xero seems to be exempt from this requirement, but chief executive Rod Drury and chief operating and financial officer Sankar Narayan told this column that there were two main reasons why the company decided not to seek shareholder approval. These are:

The company was confident that shareholders would approve the NZX delisting

A shareholder meeting would be an embarrassment to the NZX because Xero would have to explain why an ASX listing was a much better proposition than a NZX listing.

At an analysts' briefing yesterday morning, the company added that one of the issues was the structure of the domestic market, where more than 50 per cent of trading was off-market, and the dominance of one broker. Consequently, many major overseas fund managers will not invest through the NZX because they don't trust our market's integrity and transparency.

The simple response to these issues is that a company shouldn't be allowed to waive a shareholders meeting because it has predicted a positive outcome for all resolutions. Second, the proposed Xero delisting is an opportunity for a public debate on the future of the NZX, particularly its market structure.

Hopefully, the NZX hasn't given Xero an exemption from Listing Rule 5.4.1(b) because it is concerned that a Xero shareholders meeting will focus on the NZX's market structure.

Xero can be accused of corporate arrogance for not consulting with domestic shareholders before announcing its delisting proposal and by not holding a shareholder meeting to approve the move.

The Xero delisting clearly demonstrates that the NZX has major problems as it struggles to attract new listings and is losing a large growth-oriented company.

Two of its biggest problems are the huge amount of off-market trading and the dominance of one broker. The NZX needs to address these issues immediately if it wishes to boost the integrity and long-term viability of the New Zealand sharemarket.

• Brian Gaynor is an executive director of Milford Asset Management which holds shares in Xero and NZX on behalf of clients.