Brian Gaynor: The beauty of long-term relationships

COMMENT

The old saying that "we would have a great sharemarket if it wasn't for stockbrokers" came to mind this week when the New Zealand Exchange (NZX) launched its new NZAX.

The NZAX is an important step in the exchange's attempt to attract new listings, yet the response from brokers has been lukewarm, at least in public.

One broker, who gives the closing prices on radio every day, showed as much enthusiasm as a young child visiting the dentist for the first time. He said it was too early to tell whether the new market would be a success and implied that its success or failure was dependent on the exchange rather than the broking industry.

One cannot imagine a Toyota dealer adopting the same lukewarm approach to a new model launch by its Japanese supplier.

At least the NZAX is not totally dependent on brokers as the new market has 25 sponsors and over three-quarters of these are non-brokers.

One of the main objectives of the NZX is to attract new listings. The exchange hopes to achieve this through the NZAX because the new facility has lower listing costs and a greater number and range of organisations that can sponsor new NZAX companies.

Costs are an important feature of every capital raising and can represent more than 10 per cent of the amount raised, particularly for amounts up to $10 million. According to the exchange, Turners Auctions raised $6 million last year at a total cost of $650,000. This equated to 10.8 per cent of the amount raised.

The NZX raised $15 million this year at a total cost of $650,000 or 4.3 per cent of the amount raised and Zintel Communications, one of the NZAX companies, has raised $5 million at a cost of $260,000 or 5.2 per cent.

Accounting and legal costs are two of the biggest costs associated with equity raisings. According to one corporate adviser "accountants go mad on fees when they are mandated to audit prospectuses and produce five-year historic data". NZAX companies have fewer requirements in this area and, as a consequence, lower costs.

Profit forecasts are particularly costly because of due diligence and legal requirements. The NZX, which estimates that profit forecasts account for up to a third of the cost of a new listing, was widely criticised for not having forecasts when it listed earlier this year but this was one of the main reasons its costs were so low.

Profit forecasts probably do more harm than good in New Zealand because most of them are woefully inaccurate. A June 2002 survey in this column showed that only four of 24 new listings in the previous few years had achieved their prospectus forecasts. Only one of the 24 was within 10 per cent of its forecast.

What is the use of forecasts when less then 20 per cent are achieved and the combined net earnings of the 24 companies covered in the June 2002 survey was $24.5 million compared with prospectus forecasts of $52.9 million?

To compensate for the absence of forecasts NZAX companies will have to give far more details of the risks associated with their business. This will allow analysts and investors to make a more detailed assessment of these organisations before investing.

The lower costs associated with the NZAX should encourage small and medium sized companies to list on the new facility.

The requirements regarding organising brokers and sponsors are another big difference between the existing market and the NZAX. Brokers have always had a monopoly in this area but non-broker sponsors can bring NZAX companies to the market.

The NZX has certified 25 sponsors, only six of whom are recognised broking firms. Some of the larger brokers, including ASB Securities, Deutsche Securities, Direct Broking, Goldman Sachs JBWere, Citigroup Global Markets and UBS Warburg, have either not applied or shown any interest in sponsor status.

The non-broking sponsors are a combination of accountants, lawyers, investment bankers and corporate advisers.

NZX chief executive Mark Weldon describes these non-broker sponsors in terms of relationship economics, whereas the traditional broker relationship can be described in terms of transactional economics.

The beauty of the non-broker sponsor, particularly lawyers and accountants, is that they have long-term relationships with companies and may be willing to reduce their listing charges because of this. They are also less likely to abandon a company if the listing is not a big success.

Stockbrokers are driven by front up fees and on market transactions once a company is listed. This is why many brokers allocate shares to overseas interests because they know that a high percentage of these will be traded back through the market and they will earn brokerage.

Brokers abandon companies when they perform poorly after listing and trading volume dries up. This has been one of the contributing factors to the poor performance of the New Capital Market.

The exchange is hoping that the relationship contract between non-broker sponsors and NZAX companies will prove to be far more robust than the transactional contract between brokers and listed companies.

But non-broker sponsors still need distribution and brokers have a monopoly in this area. To get around this non-broker sponsors may make greater use of the public pool or utilise their own distribution networks.

One of the more interesting non-broker sponsors is Westpac, which seems to be making a big commitment to the new market and could use its client base to distribute NZAX shares.

Westpac's Ann Sherry made a special trip to Wellington on Wednesday for the launch of the new market.

One of the concerns regarding the NZAX is its relatively light regulatory regime. NZAX companies can proceed with a big transaction without shareholder approval as long as shareholders have a 10-day period to sell their shares if they disapprove of the transaction. The threshold under which a related party transaction can proceed without shareholder approval is 10 per cent of a company's sharemarket capitalisation instead of 5 per cent for main board companies.

Corporate governance requirements for NZAX companies are also less onerous.

Corporate advisers indicate that prospective NZAX companies are determined to maintain the highest corporate governance standards because that is what investors are demanding. The NZAX got off to a fairly slow start yesterday with 11 listings, three of which were previously on the New Capital Market. Hopefully the NZAX will gather momentum and it is encouraging to note that there will be more new listings in the months ahead.

Charlie's Trading Company, which is the brainchild of sports and television personality Marc Ellis, is already attracting considerable interest. Cimino Partners, the sponsor, will do a far better job for Charlie's than Direct Broking did for 42 Below.

An encouraging sign for the exchange is that the new web-based sharemarket, backed by M-Co and former stock exchange boss Bill Foster, isn't gaining much traction. This new sharemarket was supposed to start before the end of October but its web site is still blank.

The exchange is expected to stop brokers from using its computer facility to trade unlisted stocks in the near future. There are 44 companies on this facility with A2 Corporation moving to the NZAX and Widespread Portfolios gaining a backdoor listing through NZIJ.co.nz. If 50 per cent of the remaining 42 unlisted companies join the NZAX it will give the new market genuine momentum.

But the big challenge is for the 25 sponsors to find two new NZAX listings each before the end of 2004. If this can be achieved the NZAX has a bright future.

* Email Brian Gaynor