By BRIAN GAYNOR
Why have so many of our largest listed companies either failed or fallen well short of their potential?
This phenomenon is in the spotlight again because of the Air New Zealand debacle and the publication of Bruce Wallace's book on Fletcher Challenge.
As well as Air NZ and Fletcher Challenge, five of the 20 largest listed companies over the past 15 years - Chase, Equiticorp, Judge Corporation, Rada and Renouf Corporation - went bankrupt. Several others, including Bank of New Zealand, Brierley Investments, Robt Jones Investments (now Trans Tasman Properties) and Wilson Neill, turned into big flops after showing early promise.
These performances have had a big impact on the New Zealand sharemarket because most of these companies had more than 30,000 shareholders and at one stage, BIL had in excess of 200,000.
The poorly performing companies had several characteristics, including:
* They paid too much for assets.
* These purchases were mainly funded by debt.
* The companies had high dividend payout policies.
* Management dominated the board of directors.
* When problems arose they were either ignored or not dealt with effectively.
Air NZ, BIL and Fletcher Challenge all paid big bucks for overseas assets.
At the end of 1990, BIL bought Mount Charlotte Investments (later called Thistle Hotels) for £644 million ($2.17 billion). Last year, Air NZ completed the purchase of Ansett for a total of $A1.05 billion ($1.26 billion). These were largely financed by debt and contributed substantially to the problems experienced by both firms.
It is more difficult to identify one specific buy that was responsible for Fletcher Challenge's problems but Wallace picks out UK Paper for special mention in Battle of the Titans.
In 1986 a management group bought UK Paper from Bowaters UK for £38 million. In late 1989, the Finnish firm Metsa Serla, made a £263 million takeover offer for UK Paper but Hugh Fletcher already had his eye on the printing and writing paper producer.
When Fletcher Challenge directors were asked to approve a counter bid most of them had reservations, but Mr Fletcher's arguments prevailed. Directors gave their approval without formally agreeing to a price.
Mr Fletcher went to Britain and made a successful £299 million counter bid. The UK Paper management team kept their highly paid jobs and realised a huge profit on their three-year-old investment.
UK Paper was a disaster for Fletcher Challenge. Eight years later the assets were sold to two parties for a total of £118 million (Metsa Serla bought three-quarters of the assets for a mere £91 million). The NZ conglomerate lost more than $600 million on its UK Paper investment.
Battle of the Titans says Bill Wilson, Fletcher Challenge chairman from 1995 to 1999, blamed UK Paper for the group's disintegration. He believed it was "the anchor that dragged down the paper division and then the whole of the group".
But one of the most bizarre features of the NZ corporate scene is that most companies borrow to fund takeovers, but at the same time have high dividend payout policies. In most other countries, growth-oriented companies pay no, or minimal, dividends and use retained earnings to pay for expansion.
All of the five top 20 companies that collapsed after the 1987 crash - Chase, Equiticorp, Judge Corporation, Rada and Renouf Corporation - paid out a large proportion of earnings in dividends (their accounting earnings were usually much higher than their operating cash earnings).
Air NZ adopted an aggressive growth plan when it bought Ansett yet since 1996, the year it bought its first 50 per cent of the Australian carrier, the group has paid dividends of nearly $500 million. The national carrier paid 15c a share or $85 million for the 12 months to June last year even though it recorded a loss of $600 million.
It also paid 4c a share for the December six months after recording a profit of just $3.8 million.
While paying out big dividends it had to take on huge borrowings to finance the Ansett deal.
The only way one can rationalise these dividend payments is that the cash requirements of the group's largest shareholder, BIL, were more important than a strong balance sheet.
In the three years before the Mount Charlotte acquisition, BIL paid out 52 per cent of reported earnings in dividends. The dividend was reduced from 11c to 9c in 1991 but it was still 86 per cent of reported earnings.
BIL's directors were caught on the high dividend treadmill and did not have the courage to jump off until it was too late.
Fletcher Challenge also paid huge dividends before its transformation into a letter stock structure in the mid-90s. Term debt increased by $4.5 billion between 1986 and 1993 yet total dividends of $1.9 billion were paid over the same period.
Fletcher Challenge might still be intact today if it had adopted a dividend policy more suited to its high-growth plans.
NZ directors need to convince shareholders that a low dividend or no dividend policy is appropriate for growth-orientated companies. If investors want a high yield they should look to the fixed interest market.
NZ companies are also slow to face problems, particularly when they are management dominated. This was a feature of most of the groups that failed after the 1987 crash.
It is also an issue that is raised in the Fletcher Challenge book. Mr Fletcher promoted the letter stock concept at Fletcher Challenge because he was convinced that the group was on the right track but that investors had failed to recognise this.
He refused to accept that the group had big problems and that it needed more than the cosmetic patch offered by the letter stock structure.
Several board members were strongly opposed to the letter stocks but the concept was approved, partly because Fletcher Challenge had a large number of executive directors.
Overseas experience indicates that the best way to deal with deep-rooted problems is to appoint a chief executive from outside who does not have an emotional attachment to the problem areas. This worked for AMP, BHP and Westpac in Australia.
In New Zealand we have a tendency to appoint from within. Sir Roger Douglas replaced Paul Collins at BIL and Sir Selwyn Cushing in turn succeeded him.
Sir Selwyn took over from Jim McCrea at Air NZ until the belated arrival of Gary Toomey.
One of the problems with attracting good overseas executives, as AMP, BHP and Westpac did, is that they demand high remuneration packages. A chief executive at a Fletcher Challenge-sized organisation would be paid millions in the United States.
The New Zealand group could not justify these figures and an internal appointee, Mike Andrews, replaced Mr Fletcher.
A final observation from the Fletcher Challenge book is that senior executives were constantly moved between positions. Mr Fletcher is quoted as saying "never leave a person in the same position for more than 18 months and, preferably, transfer them to an industry in which they have even less knowledge and empathy".
Although this was said with a certain amount of tongue in cheek it was a strong theme at Fletcher Challenge's senior executive level. Yet some of the more successful chief executives in the past few years, including Stephen Tindall, Gary Paykel and Keith McLaughlin, are industry specialists who have been in their positions for a long time.
The experience of BIL, which bought companies in over 20 different industries, suggests that specialisation is usually the best way to go.
* bgaynor@xtra.co.nz
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