COMMENT
Why has Jim Scott's Aquiline Holdings been widely criticised since it announced a $90 million capital raising? Why have stockbrokers and investment managers taken such a negative view of a company that has had such a fantastic share price performance?
To answer these questions, we have to look at several
issues, including Brierley Investments' acquisition of Air New Zealand in 1989.
Jim Scott had a distinguished career at Carter Holt Harvey, where he ran the Whirinaki pulp mill and was later group director of operations. He was also a non-executive director of Electricorp.
On April 7, 1988, Scott was appointed chief executive of Air New Zealand. He took up his position on July 1. Hugh Fletcher, who was chairman of Air New Zealand, had extensive knowledge of the forestry industry and was impressed by Scott's abilities and credentials.
The new chief executive replaced Norman Geary and jumped ahead of Jim McCrea, who joined the company in 1956 and is five years older than Scott. McCrea became Scott's right hand man at the national carrier.
Shortly after Scott joined Air New Zealand the airline was placed into full sale mode.
It looked as though it was going to be sold to a British Airways consortium but in December 1988 the Lange Government announced that the national carrier would be sold to a Brierley Investments consortium and the Wellington investment group would own 65 per cent.
When the sale was completed in April 1989, Bob Matthew was appointed chairman and three other Brierley representatives, Paul Collins, Selwyn Cushing and Patsy Reddy, joined the board.
The sale to Brierley was a big blow to Scott, as he did not believe the investment company had the expertise to be Air New Zealand's controlling shareholder.
A frosty relationship developed between Scott and Brierley Investments, but one of the more annoying aspects as far as Scott was concerned was that brokers and investors held Brierley Investments in the highest esteem and wouldn't heed to any criticism of the investment company.
Scott was extremely disappointed with this lack of perception, and developed a major scepticism towards brokers, fund managers and the sharemarket.
This is one of the main reasons Aquiline does not use brokers, is not listed and uses an unorthodox method to value its shares.
On April 29, 1991, Scott resigned from Air New Zealand and soon after became Pacific vice-president for Northwest Airlines, working in the United States and Japan.
When he returned to New Zealand, Scott established Aquiline in Napier in 1995. Aquiline acquires 100 per cent interests in small to medium enterprises , mainly involved in importing and distribution, and now owns 14 companies.
The main criticism of Aquiline is that the directors set the share price every six months and it has risen far more quickly than earnings, shareholder funds or total assets.
Aquiline's share price was set at $1.75 on July 1, 2001, when the company had a total value of $4.8 million and a price/earnings ratio (PE) of 7 based on net earnings of $682,000 for the previous year.
Share price increases were reasonably modest until July last year, when the price shot up from $4.80 to $13.95, a rise of 185 per cent.
As trailing 12-month net earnings rose by only 8 per cent over the same period, the historic PE went from 16 to 49.
The difficulty with Aquiline is that its share price and total value are going up far more rapidly than anything else. For example, between July 1, 2001 and January 1 this year:
* The share price rose 916 per cent to $17.78.
* The company's total value went up 3258 per cent to $162.5 million.
* Tax-paid earnings increased 503 per cent to $4.1 million.
* Total assets were up 523 per cent to $90.2 million.
* Shareholder funds rose 207 per cent to $22.6 million.
At the end of last year, Aquiline had $34.1 million of intangible assets and shareholder funds of $22.6 million - a negative net tangible asset backing per share of $1.29 and a share price of $17.78.
Aquiline's share-price fixing policy is a virtual gold mine for shareholders because the company can buy small and medium-sized businesses on a 4 to 5 PE and immediately translate them into a PE of up to 40.
For example, if it spends $2 million on buying a company that earns $500,000 a year (PE of 4), it is able to translate this into a value of $20 million (a PE of 40) as far as its own shareholders are concerned.
This is clearly absurd, because the sale value of the acquisition remains at $2 million unless Aquiline can achieve an instant and spectacular increase in its earnings.
Scott says he and the other three directors know far more about Aquiline than outside investors and it is appropriate that they set the share price.
But is it appropriate for the directors to set the share price when the company is hoping to raise $90 million from the public?
Scott is the biggest beneficiary of Aquiline's phenomenal share price performance. His 3.3 million shares will be worth $76 million on July 1, compared with $2 million three years ago. He is hardly independent as far as share-price setting is concerned.
Jim McCrea, Scott's old workmate from Air New Zealand, is probably Aquiline's only true independent director.
Aquiline is planning to raise $90 million by issuing 65 million converting preference shares (CPS) at $1 each and 25 million redeemable preference shares (RPF) at $1 each.
The $25 million raised through the RPF issues - redeemable for cash in June 2007 - can be used for acquisition purposes, but the bulk of the CPS money could end up financing the acquisition of Aquiline shares from existing shareholders.
The company has established a capital register, and all the new CPSs will be entered on this register in the order in which they are subscribed for.
If an existing shareholder wishes to sell ordinary shares, the CPS money will be used to buy these shares if no outside buyers exist. CPS holders will be issued with these existing ordinary shares at the prevailing market price in return for their CPSs.
The problem with this is that Scott confidently predicted at his Auckland presentation that Aquiline's total shareholder returns (mainly share price) would increase by 40 per cent in each of the next two years.
This means the company's share price should be more than $40 by mid-2006 and CPS holders will have to buy shares at this price if existing shareholders wish to sell.
(A page containing the 40 per cent shareholder returns target was removed from the company's web site after a complaint to the Securities Commission).
This is a most unusual situation and potential investors should make sure they understand the CPSs before they invest in them.
Scott is a likeable and competent individual but he has one big blind spot - a distrust of financial markets and the people who run them.
This attitude, which is a legacy of his involvement with Brierley Investments and his disbelief that investors could have held it in such high regard, has led him to adopt an unorthodox capital management strategy.
* Disclosure of interest: none. Brian Gaynor is an executive director of funds manager Milford Asset Management.
* Email Brian Gaynor
COMMENT
Why has Jim Scott's Aquiline Holdings been widely criticised since it announced a $90 million capital raising? Why have stockbrokers and investment managers taken such a negative view of a company that has had such a fantastic share price performance?
To answer these questions, we have to look at several
AdvertisementAdvertise with NZME.