COMMENT

NZX chief executive Mark Peterson is endeavouring to raise his company's batting average.

He has slowly reduced the percentage of off-market trading, has fought off an aggressive attack by fund manager Chris Swasbrook, introduced new Listing Rules this week and is attempting to raise the company's profitability.

However, Peterson is batting on a difficult wicket because the NZX was poorly governed and managed by his predecessors. This is reflected in the following valuation figures for similar Australian and New Zealand companies:

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• Sydney Airport is worth 2.0 times more than Auckland International Airport in terms of sharemarket value.
• Qantas is worth 3.2 times more than Air New Zealand.
• Telstra is worth 4.2 times more than Spark and Chorus combined.
• ASX Ltd is worth a frustrating 43.6 times more than NZX Ltd.

The main problem is that former NZX chief executives focused on non-core acquisitions instead of the company's main activity, the domestic stock exchange.

Consequently, the NZX has failed to attract new initial public offerings (IPOs) and has only 133 listed domestic companies compared with 140 five years ago, while the ASX has 2015 listed domestic companies compared with 1924 in late 2013.

NZX shareholders have also missed out as the company's sharemarket value has declined from $322 million to $285m over the past five years while the ASX's market value has soared from A$7105m to A$11,476m over the same period.

Peterson and his senior management team have been left in a bleak position by their predecessors but they are making steady progress in difficult conditions.

The first positive development has been the reduction in off-market negotiated trades.

Off-market negotiated trading has been a major problem for the NZX as it reflects effective control of the domestic sharemarket by a small number of brokers negotiating large off-market trades for preferred clients.

This discourages retail investors because buy and sell offers are not disclosed, or made available, to all market participants.

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The figures in the table show that off-market negotiated trades have declined from 60.2 per cent of trades by value in 2016 to 57.6 per cent in 2017 and 45.2 per cent in the first nine months of the current year.

Electronic trades represent trades through the exchange's electronic trading system where buy and sell instructions are exposed to all market users. Reported trades are transactions where only one counterparty provides information on the trade.

Although negotiated trades have declined to 45.2 per cent of all trades this is far too high by international standards.

For example, only 12.1 per cent of ASX trades by value in 2017 were negotiated and less than 5 per cent of Asia-Pacific trades were negotiated.

The NZX won't attract more retail investors, who are usually the main supporters of small and mid-sized IPOs, unless a clear majority of buy and sell orders are available to all market participants in a full and transparent fashion.

Early last month the NZX rejected an approach to appoint activist fund manager Chris Swasbrook of Elevation Capital, Craig Stobo and Michael Daniels to its board. Swasbrook made further proposals that were also rejected by the NZX.

The activist fund manager made several valid points and recommendations but Elevation Capital, which owns around 2.3 per cent of NZX, has total funds of only $253m.

It is extremely difficult to be a successful activist investor with funds of $253m unless other major shareholders support the activist.

The NZX has challenged Swasbrook with the following statement: "If Elevation Capital has support to call a special meeting of shareholders (noting there is a 5 per cent threshold), NZX will use it as opportunity to further explain the strategy laid out in November 2017 and the good progress made to date".

This is a sign of confidence, as well as a statement of objective, as far as the NZX is concerned.

If Peterson doesn't achieve his November 2017 objective then Elevation Capital, along with other major shareholders, will be back to make changes to the NZX board and senior management.

On Tuesday the NZX released its "Finalised Market Structure and Listing Rules Explanatory Paper".

The revealing opening paragraph was as follows: "NZX today published its updated Listing Rules to align with the refreshed market structure. This completes the first holistic review of the rule set in 15 years.

The changes support NZX's commitment to create a rule set that will promote market development and assist in the listing of a broader range of financial products for New Zealanders".

Why did it take 15 years to have this holistic review? What has the NZX been doing over the past decade?

The main objectives of the new rules are:

• To collapse the two small equity markets, NZT and NZAX, into the main market.
• To enhance investor protections.
• To accommodate the listing of a broader range of financial products and issuers.
• To improve access for foreign listings.
• To remove unnecessary compliance costs.

The proposed new Listing Rules are a step in the right direction, particularly in relation to eligibility for listing rules, backdoor and reverse listing transactions, capital raising and continuous disclosure.

The amended Listing Rules will take effect from January 1, 2019 with an opt-in six-month transition period. The new rules will be fully effective from June 30, 2019.

From an earnings point of view the NZX is becalmed, which is the main factor contributing to the company's relatively poor share price performance.

Total operating revenue for the six months to June 30, 2018 was $33.4m compared with $32.8m for the same period in the previous year.

However, net profit from continuing operations declined to $6.9m, compared with $7.8m in the previous year, mainly because of cost increases. This included higher employee costs.

Figures for the three months to September 30 show revenue from stock exchange activities was $12.9m compared with $13.0m for the September 2017 quarter while fund management revenue increased from $3.3m to $4.1m over the same period.

Revenue for the wealth technologies division was $0.2m for the September 2018 quarter compared with $0.3m for the same period in the previous year.

As there was no commentary released with the September quarter revenue figures, one can assume that the company is on track for its operating earnings guidance of $28m to $32m for the December 2018 year. This compares with the $27.2m achieved for the full 2017 year.

Peterson and his management team are on the right track but they have a long, long way to go. There is still far too much off-market negotiated trading and there are few signs of new listings on the horizon.

The NZX's objective is to establish the appropriate structure for the exchange and, if it does, business activity will rise and profitability increases will follow. This is a sound strategy but its success will depend on execution — the ability of the NZX to convince market participants to buy into the new market structure.

Brokers are key figures in this equation but they have been reluctant to accept challenges in the past.

Unless Peterson and his senior management team can encourage more market participation then it will be difficult to grow operating earnings substantially beyond $32m.

Profitability will be the key factor as far as Swasbrook and his supporters are concerned and they will be back with more support unless the NZX makes progress in this area.

- Brian Gaynor is an executive director of Milford Asset Management.