Jenny Ruth: NZX short of puff after last year's big run

After making great strides last year, the New Zealand Exchange's results for the six months ended June suggest it has suddenly run out of oomph.

Although the drop in new listings and the loss of some major listings grabbed headlines, the slowdown extends across all the company's activities.

The bottom line looked a bit ugly, down 27.2 per cent to $1.5 million, but that reflected "non-recurring" costs of writing down by $360,000 the exchange's investment in its joint venture with the Sydney Futures Exchange and $344,000 relating to Access Brokerage's collapse.

The latter is on top of the $500,000 it accounted for last year, mainly on accountants' and lawyers' fees.

Chief executive Mark Weldon concedes that if the Access costs continue at such a rate, the board will have to reconsider its treatment of them as "non-recurring".

"When we did the full-year financials last year, we had no expectation that it would continue or that it would cost as much money as it has," he says.

"If it's going to go on in the near-term, we would have to re-assess that line item."

At the earnings before interest, tax, depreciation and amortisation (ebitda) level, the result looks a lot more healthy, up 9.4 per cent to $2.8 million.

That was entirely due to a 17 per cent increase in trading revenue and a 27 per cent rise in annual listing fees, reflecting both the rash of new listings last year and fee increases.

But that looks positively anaemic next to the 69 per cent ebitda increase NZX achieved last year.

The Sydney Futures Exchange joint venture write-down should not come as a surprise. NZX still values the venture in its books at $350,000 and says it intends to amortise this over the remaining four years of the contract.

The venture simply hasn't performed and there seems little appetite for futures and options contracts in the New Zealand market.

Certainly, the current venture's predecessor wasn't successful.

Weldon admits to being disappointed that brokers haven't been willing to support the current venture.

"It is true that over the last 10 years, growth in derivatives globally has been three times as fast as basic equities or bond instruments," he says. "It's something we decided we had to give our best shot at."

The joint venture launched its first product, the Fox15 Index Futures contract, in August last year and it hasn't achieved liquidity.

That's the nub of the problem: investors won't trade a futures contract that lacks liquidity but it won't get liquidity until investors start trading it.

The launch of five options contracts for the most liquid major stocks was delayed from the first quarter this year to later this month.

"I still think the options products will be viable and will provide an investment alternative," Weldon says. "We've seen reasonable take-up of warrant products in the last three months."

The warrants were launched by ABN Amro and UBS.

"I wouldn't say we're 100 per cent confident but we're still reasonably optimistic that there will be a viable options market. It gets down to how much the brokers are willing to try something new and being willing to step outside their comfort zones.

"There's still a mindset in New Zealand that if we don't have it, we don't need it."

Then there's the Smartshares funds management business, which doesn't seem to be flourishing.

The exchange has four index-based funds. The first-half results show that funds under management dipped from $192 million last December to $181 million at the end of the first quarter, but recovered to their December position by the end of June. Investor numbers went from 10,386 in December up to 10,506 at the end of March and down to 10,467 at the end of June.

Weldon says the problem is the TeNZ fund, which is still losing investors. Launched in 1996 and based on the Top 10 index, the fund's performance has been dogged by the poor performance of many shares in the index, including Telecom, Carter Holt Harvey and The Warehouse.

The other three products, MIDZ, FONZ and MOZY, are all growing and Weldon says NZX is planning to launch two new products, a global equities fund and a local debt fund.

"We would prefer it [funds management] to be further along. In 2006, I expect you will see good numbers there."

As for new listings, Weldon says NZX invests a lot of time in talking to companies about listing, but doesn't have much control over when listings actually happen.

In the latest six months, much of the problem has been all the merger and acquisition activity in the market. Not only is NZX losing listings, but "there haven't been a lot of warm bodies to work on IPOs [initial public offerings]".

He is confident of a number of new listings in the current half-year, including some which haven't been made public yet.

The Link registries business, a joint venture with ASX Perpetual Registries, contributed a $25,000 equity accounted loss to the bottom line, although this business could be regarded as still being in start-up mode. It included only a five-month contribution from BK Registries.

But might one explanation of NZX's stalling growth be that the Access situation is distracting management from its core business?

"It's been an enormous drain on management time and it's become increasingly frustrating because all the investors got their money back," Weldon says.

While he just wants to see the back of it, the issue looks likely to drag on.

"As soon as it becomes a matter in which lawyers are involved, it ends up costing a lot of money and an enormous amount of time. That's one of the tragedies of corporate life."

But perhaps one of the most eyebrow-raising aspects of the latest result is how much interest income contributed. The $812,000 in interest income accounted for a whopping 33 per cent of pre-tax profit. In 2004, interest income contributed 30 per cent of pre-tax profit.

Two years on from its $15 million capital raising, NZX still has $22.9 million in cash and investments, down from $29 million at the end of December.

Before the annual shareholders' meeting in June, the New Zealand Shareholders Association said this meant the company was "vastly over-capitalised".

The cash spent includes the $5.1 million paid out in dividends, $1.1 million invested in the funds management business and $3.26 million spent on the Link registry business.

Weldon says he isn't aware of any stock exchange in the world that gears its balance sheet.

"The theory goes that people don't like to trade on markets if they think the market operator is financially at risk in any way.

"What we've done is take our worst-case scenarios - we've constructed the perfect storm."

But he agrees NZX does not need quite as much cash as it has. His ideal balance sheet would have $12 million to $15 million of cash, which suggests at least $8 million could be spent on acquisitions or returned to shareholders.

The company has said it will consider the dividend position at the end of this financial year.

"Until we're at a point where we're clear and confident there will be no use for that cash, we won't return it to shareholders, only to have to ask for it back later," Weldon says.

"We have a number of options and things we could do that would require capital."

Who, What, Where

Headquarters: Level 2 NZX Centre, 11 Cable St, Wellington
Profile: NZX runs New Zealand's major stock exchange, the alternative exchange, debt and futures markets. It also provides passively managed index-based funds and has a joint-venture registry business.
Market capitalisation: $101.8 million.
Management: Chief executive Mark Weldon, head of markets and product development Geoff Brown, head of regulatory and public policy Elaine Campbell, corporate counsel and company secretary Rebecca Cottrell, chief information officer Chris Corke, head of finance and strategy Carl Daucher, head of marketing and communications Melissa Jenner, and head of corporate affairs Rowan Macrae.
Major shareholders: Fisher Funds Management with 9.6 per cent, Forsyth Barr with 8 per cent and ING with 6.2 per cent. (There is a 10 per cent cap on shareholdings in NZX.)