Be wary of stocks in new guises

By BRIAN GAYNOR

One of the sharemarket's more widely anticipated events is a backdoor listing. This is when a struggling company acquires a new business and new controlling shareholder.

Backdoor listings are greeted with great enthusiasm but few are successful over the longer term. The big winners are usually the new controlling shareholder rather than investors who buy into the restructured group.

The backdoor listing also offers plenty of scope for insider trading. This is why most stock exchanges delist a company until the transaction is completed.

At present, 118 domestic-based companies or property trusts are listed on the New Zealand Stock Exchange. Of these, 42 were listed at the end of 1989, 56 are new floats or compliant listings since that date, and 20 have come through the backdoor medium.

These figures clearly illustrate the volatile nature of the New Zealand corporate scene. The number of listed companies has fallen from 195 to 119 since December 1989 and only 36 per cent of the companies listed were on the Stock Exchange 10 years ago.

Amid this volatility two Dunedin-based companies, Arthur Barnett and Reid Farmers, stand out. As the rest of the corporate world restructures and reorganises, these two companies remain essentially unchanged.

The sharp decline in the number of listed companies has been due to a spate of company failures in the early 1990s.

These included Anzon, Chase, Landmark, Fortex, Fullers, London Pacific, Pacer Kerridge, Smith City, TV3, Wilkins & Davies and a large number of investment and property companies conceived in the mid-80s.

According to the strict definition, 20 companies are listed that have come through the back door since 1989.

Using a more liberal definition, other companies could be added to this list. These include:

Advantage, which has come under the control of Evan Christian and Eric Watson.

Pacific Retail, formerly called Noel Leeming and now under the control of Eric Watson.

Richina Pacific, formerly Mainzeal and now controlled by interests associated with Richard Yan.

Trans Tasman Properties, under the control of Jesse Lu since the merger with Seabil in 1995.

Montana is the only remaining backdoor listing from the pre-1989 period.

In 1973, Allied Group, an Auckland vehicle distributor and financier, joined the Stock Exchange and shortly after changed its name to Collingwood Holdings.

The business interests of Peter Masfen were backed into the company in 1985 and it became Corporate Investments.

In 1987, Montana Wines was acquired but in the early 1990s the group's share price slumped to 14c as it struggled to survive.

Under Mr Masfen's chairmanship, the company has made a strong recovery, and changed its name to Montana in September 1999.

There is little doubt that Allied/Collingwood/Corporate Investments/Montana has been the most successful backdoor listing of the past 25 years.

Montana is the exception rather than the rule.

Most backdoor listings have not delivered long-term share-price growth for investors.

Savoy Equities is a good example of this.

Genestock was listed on the Stock Exchange in 1983 as a developer of embryo transfer technology for goats.

The company was the brainchild of Emmett Hobbs, brother of the cabinet minister Marian Hobbs.

Its share price climbed to 161c in 1984 but investors lost interest as its losses mounted.

Fay, Richwhite took a 58.3 per cent shareholding but its share price slumped to just 4c after the 1987 sharemarket crash.

The timber interests of Garrick Wells were backed into the company, its name changed to Parapine Timber and Fay, Richwhite sold out.

In 1997, Mr Wells sold his shareholding to interests associated with the controversial Auckland businessman Jihong Lu.

The company changed its name to Counterpoint Equities, had a two-for- three cash issue at 11c and bought a majority shareholding in Dairy Brands.

In the past two years Mr Lu has sold the Dairy Brands shareholding, acquired the Britomart development company and the Auckland Hyatt Regency Hotel and changed the name to Savoy Equities.

Savoy has been no more successful under Jihong Lu than it was under Emmett Hobbs and Garrick Wells.

High-profile backdoor listings have come and gone over the past 15 years.

They include Renouf Properties (formerly Repco), Pacific Beef (previously Apparel Holdings and Hutton Kiwi) and Fay, Richwhite (Horizon Oil Exploration and Capital Markets).

The most positive aspect of a backdoor listing is that it offers shareholders of the beleaguered company the opportunity to exit at a higher price.

The problem is determining the correct time to sell because the normal trend is for the share price to rise but then to fall after investors have had time to assess the new business.

The initial share-price surge is normally based on sharebrokers' hype and the small size of the backdoor vehicle.

The new business is usually in a fashionable sector and investors rush in regardless of its substance and quality.

The recent backdoor listings E-Force, e-Phone, IT Capital, Newcall, Strathmore and Spectrum are good examples of this.

The initial response to their listings was positive but their share prices have fallen sharply in recent months.

This raises important questions:

Why do companies with good long-term prospects not list through a prospectus offer instead of a backdoor listing? A prospectus offer allows the business to raise new money and requires it to disclose more information to investors.

Why does the Stock Exchange not delist companies until the backdoor transaction has been completed and the market is fully informed? Insider trading is a common feature in these situations. The Australian Stock Exchange delists a company until the transaction is completed because it wants to reduce the opportunity for insider trading.

Why do most backdoor listed companies have poor corporate governance standards? The boards of directors of most of these companies are stacked with friends and business associates of the controlling shareholder.

Why has Eric Watson always gone by the backdoor route and never floated one of his companies through a prospectus offering? Mr Watson has done very well for himself - his average entry cost to Advantage was 35c a share, Eldercare 15c and Strathmore 6.2c - but he has yet to prove he can deliver, long-term, above-average returns for minority shareholders.

There are exceptions to the general rule of poor standards among backdoor listings.

Dorchester Pacific and Hellaby Holdings have good corporate governance procedures. They have also performed well since their change in direction although Hellaby has run out of puff in recent years.

But the usual experience is that backdoor listings fail to perform over the longer term.

With this in mind shareholders should not be greedy.

They should take the opportunity to reduce their shareholding in the backdoor vehicle, particularly when the initial announcement and hype have had a positive impact on its share price.