Teething troubles fail to thwart second market

By ANDREW LEWIS*

The New Capital Market, launched with the promise of providing a real alternative for small to medium-sized companies seeking to raise capital, made its debut in March.

Designed to suit small investors who traditionally favoured unproductive property-based investments, the market operated by the NZ Stock Exchange provides an opportunity for public investment in growth companies, which would not otherwise exist. It recognises that a large proportion of the economy is made up of small to medium-sized companies, and that the country's future rests largely on them accessing capital for growth.

So what impact has the market had so far and is the vision of growth becoming a reality?

Despite generally soft market conditions and initial teething problems, the market has put in a solid performance during its first few months, with six listings and a total of 10 companies expected to complete the process by the end of the year.

The market enables smaller companies to raise money from the public at a lower cost, due to the provision of standard form documents, lower listing fees and limits on broker and issue expenses.

While the experience so far is that the process has not been as seamless and cost-effective as expected, this should improve as participants, advisers and the Stock Exchange become more familiar with the requirements and refine their processes.

To date, all companies that have listed have already identified a key transaction that must be completed within 18 months from the time of the company listing.

To be successful, the market must work for both promoters and investors and also the organising brokers, who are required to find the investors within the prescribed fee caps.

For promoters, the principal attraction is the opportunity to attract public capital which may not otherwise be available and at a lower cost. There are also the opportunities to sell a target business to the listed entity at a fair value - whereas a venture capitalist will always seek a discount to that value so that it can make a margin on any subsequent offering - and to make a profit on shares acquired by the promoter at half the public price.

The attractions for investors are less obvious at first glance and many have questioned whether investors will be prepared to invest in a company which has no business and only an intention to invest in a business at a price which has not been established.

On the other hand, the investors have the comfort of knowing that they must approve all aspects of the key transaction, including the price.

Some investors are also attracted by the strict market rules, which commit the company to a growth path (such as the prohibitions on distributions and most borrowings) and restrict the remuneration of the company's directors.

The market's underlying investment philosophy is taking speculative risks for potentially high returns in high growth potential companies. One strategy recommended to investors is to spread relatively small investments over several new listings in the hope that one of them might be the next Microsoft.

Evidence of investor support for the market and this philosophy can be found in the establishment by some brokers of New Capital Market clubs, where investors put in lump sums that are spread over new listings. This, coupled with the fact that all offerings so far have been fully subscribed, are positive signs that, given the opportunity, investors are prepared to nurture growth.

For brokers, who have the key role of finding the public investors, there have been frustrations over not being able to provide more information about the key transaction targets or any financial predictions. However, broker support, particularly from locally based brokers with strong private client bases, has been encouraging.

The marketing focus for market listings by necessity centres on the "reputational" capital of the directors. But for those who are looking for ideas or industries that are a bit different, the companies listed so far certainly offer diversity.

Identified key transactions have come from industries that range from wireless communications (Rocom), stamps (Mowbray Collectables) and stockbroking and investment banking services (NZIJ), to medical and beauty clinics (CACI Group), and eco-tourism with submarine technology (Submarines Australasia).

That diversity has surprised the Stock Exchange and other observers, many of whom expected that most companies would have a technology focus. The New Capital Market model can be applied to any industry where capital for growth is required.

Meanwhile, the Stock Exchange believes that the existence of the new market has reignited interest in the public float option for raising capital.

There has been an increase in the number of smaller floats on to the main Stock Exchange board, suggesting that they started down the new market track but subsequently decided to go straight to a main board listing.

With only one key transaction completed so far, it is still too early to say whether new market companies will deliver the high returns expected by investors. However, the future looks promising for smaller companies seeking to take that first major step towards growth.

* Andrew Lewis is a partner with law firm Simpson Grierson, which will host a seminar on the New Capital Market in Auckland on Tuesday, in association with broker DFMainland.