Brian Gaynor: Get ready for new disclosure rules

Regulatory changes are sweeping through world sharemarkets and one of these, continuous disclosure, has had a huge impact on the New Zealand market in recent weeks.

A continuous disclosure regime has already been introduced by the Australian Stock Exchange (ASX) and it is not surprising that the three companies adversely affected by surprise announcements, Baycorp Advantage, Telecom and Tower, are all listed across the Tasman. Baycorp is based in Australia, and Telecom, Tower and several other New Zealand companies have had full ASX listing since July.

Continuous disclosure rules will be introduced in New Zealand on December 1 under the Securities Markets and Institutions Act and, based on the performance of the three ASX companies, our directors are not prepared for the new regime.

Companies will have to put a great deal more thought into its impact if they wish to avoid the humiliations experienced recently by Tower, Telecom and Baycorp.

Continuous disclosure requires a listed company to immediately inform the Stock Exchange when it becomes aware of any information concerning it that a reasonable person would expect to have a material effect on the price or value of its securities.

The important point is that this information must be released to the market in general, it cannot be disseminated through analysts without the Stock Exchange being informed.

Under new NZSE Listing Rules, which come into force to coincide with the act, companies are specifically required to disclose changes in financial forecasts or expectations to the market.

The new rules abolish the traditional cosy relationship between companies and analysts.

Up to now, management has been able to massage market expectations by nudging analysts' forecasts up or down. Analysts either send their reports to companies for comments before publication or attend private briefings that keep them informed of trading conditions.

This approach has suited both listed entities and analysts. Companies can orchestrate earnings expectations and then announce profits that are in line with analysts' forecasts. Analysts can keep their favoured clients well informed and are rarely embarrassed by results that are inconsistent with their forecasts.

Continuous disclosure rules are being introduced and strengthened throughout the world because the old regime gave analysts access to inside information which they could pass on to their favoured clients. With the growth of no-frills internet stockbrokers that do not employ analysts, this gave one group of investors a clear advantage over others.

The objective of continuous disclosure is to create a flat playing field and remove any suggestion of insider trading and favoured treatment for some investors.

But how many New Zealand companies, and analysts, have anticipated the new regime and developed strategies to ensure that they are not adversely affected?

Tower was the first New Zealand company to be nailed by the ASX's continuous disclosure rules when it told the Stock Exchange it expected to report a net loss after tax of approximately $30 million to $40 million for the September year.

The public announcement had a devastating impact on the group's share price, whereas under the old regime, which would have allowed the company to gently reduce expectations, the sharemarket impact would have been more muted.

The company's announcement was confusing and contributed to the share price mayhem. Directors said the poor result was strongly influenced by one-off costs and profitability would return to more normal levels in the 2002-2003 year. At the same time, they announced that the group was unlikely to pay a final divided.

This is a totally inconsistent message. Tower directors flunked Stock Exchange 101 as companies should never, never cut the dividend when trying to convince investors that a profit downturn is temporary.

A day later, Telecom announced that it expected to report net earnings in the range of $145 million to $150 million for the September quarter compared with forecasts as high as $173 million.

Telecom could have big problems under the continuous rules because it almost totally relies on analysts to communicate its message to the market. It has never held an annual meeting or a results briefing outside Wellington, and chief executive Teresa Gattung might as well live in Shanghai as far as Auckland shareholders are concerned.

As Telecom will now have to deal directly with the market, it will have to substantially upgrade its links with the media, individual shareholders and other interested parties outside Wellington.

Ernie Newman, chief executive of the Telecommunications Users Association, pointed out this week that Telecom had too much focus on Wellington, particularly Parliament, and too little on the market.

The same could be said for its investor relations.

Finally, Baycorp Advantage's share price was hammered this week after the release of an earnings guidance for the June 2003 year. The announcement was unclear and needed to be read several times before it was fully comprehensible. The release pointed to an earnings forecast downgrade, but it confused investors by trying to balance the negative figures with positive ones.

Baycorp has a close relationship with New Zealand institutions and analysts and has been able to convey a positive image to investors through them. But now that it has to communicate directly with all market participants, Baycorp will have to make sure that announcements can be fully understood by less sophisticated investors but contain enough information to satisfy analysts.

The same applies for all listed New Zealand companies. The continuous disclosure rules will be effective from December 1 after Parliament's decision to grant urgency to the final stages of the Securities Markets and Institutions Bill next week.

The legislation could be a real problem for the NZSE because New Zealand companies have a natural tendency to make overly optimistic predictions. The vast majority of our new floats fail to meet their profit projections, while listed entities tend to emphasise positive news and avoid disclosing negatives.

At Fletcher Forests annual meeting, chairman Sir Dryden Spring gave the impression that the company was heading for a fantastic year, but under questioning from a shareholder he admitted that it would be difficult to sustain the year-on-year improvement throughout the full 12 months.

This month Tranz Rail advised the Stock Exchange that it had reduced its profit forecast for the June 2003 year announced only a few months earlier.

The problem with optimistic comments and forecasts is that the market will hammer a company's share price when directors are forced to announce profit warnings under the continuous disclosure rules.

The new regime will also put a great deal of pressure on analysts because they can no longer rely on exclusive profit guidance from management. They will be in the same boat as everyone else, they will have to make their own assessment of earnings prospects and no longer rely on management to relay price-sensitive earnings indicators.

The early indications from the Baycorp, Telecom and Tower debacles are that analysts will have to be far more objective, even cynical if they are to anticipate major profit warnings.

Companies can ensure that there is no major negative impact from a profit warning by keeping investors fully informed. Profit trends should be advised to the market on a regular basis and companies must be careful to avoid overly optimistic predictions.

Quarterly profit reporting is one of the best ways to keep investors fully informed. Maybe continuous disclosure rules will be the catalyst for the introduction of quarterly reporting by our large and medium-sized companies.

* Disclosure of interest: Brian Gaynor is a Baycorp Advantage and Telecom shareholder.

* bgaynor@xtra.co.nz