Brian Gaynor: Tranz Rail windfall looks dubious

Investors shouldn't get carried away with the prospects of Tranz Rail realising a windfall profit from the sale of its network assets, and making a big capital repayment to shareholders, until they have had a good look at the company's privatisation a decade ago.

In September 1993 a consortium of investors purchased the country's railway operator from the Crown for $328.3 million. The acquired company had net assets of $265.5 million and debt of only $71.7 million. Its network assets had a book value of $86.9 million.

In an extremely clever move, the investors contributed only $105 million of equity and borrowed the rest of the purchase price against the assets of the acquired company. To achieve this objective, the network assets were revalued from $86.9 million to $185.7 million.

Just before a public offering in June 1996, at $6.19 a share, the network assets were revalued again, to $260.7 million. Included in this was a $67.1 million valuation of the company's right of way. (The right of way is the lease over the land on which the railway network operates. Tranz Rail pays the Crown $1 a year for the lease of this land but is obliged to pay all expenses associated with the lease.)

As the accompanying table indicates, the value of Tranz Rail's network assets has increased dramatically since privatisation. This has been due to a combination of revaluations, genuine capital expenditure and expenditure on track maintenance that should have been expensed but has been capitalised.

The book value of the network assets fell slightly as at June 2002 because the Auckland corridor was sold to the Crown for $81 million. Tranz Rail realised a profit of $58.3 million on the sale, indicating the extent to which the Crown overpaid for these assets.

At the end of the June 2002 year, the network assets were valued at $400.5 million, with the right of way worth $61.5 million and track, signals and communication equipment $339 million. The network represented 45.5 per cent of Tranz Rail's total assets compared with just 20.7 per cent at June 1993.

Why would the Government pay anywhere near book value for Tranz Rail's network assets when there is no other buyer, the assets had a book value of only $86.9 million when sold by the Crown a decade ago (the Auckland corridor has since been bought back for $81 million) and the network has probably deteriorated?

If Tranz Rail sells the network assets and doesn't realise book value, it will suffer a loss and a reduction in shareholder funds. This would not please the banks and it is logical to assume that they will have first call on any money realised from the sale and there won't be much left over for a capital repayment to shareholders.

Tranz Rail has played down the possible sale of the network. On January 21 it responded to an article on the rumoured sale with the following comment: "Tranz Rail has not, in fact, received any such offer from the Government in any shape or form as claimed in the article. To our knowledge, no such offer is imminent."

Tranz Rail shares closed yesterday at $1.36, a 28.3 per cent rise since the end of 2002.



Analysts' Recommendations

One of the big issues on Wall St is the independence of brokers' research. Are analysts giving independent advice to clients or are their recommendations based on the best interests of their firms' investment banking operations?

The same questions need to be asked about analysts' recommendations in New Zealand.

New York Attorney-General Eliot Spitzer has been crusading against corrupt practices on Wall St. One of these is the lack of independence amongst analysts.

He concluded that analysts had recommended stocks, mainly new shares issued by internet companies, to the public that they were referring to as dogs in private emails.

Many of the stocks recommended to clients, but derided by the authors of the reports in private, were clients of their firms' investment banking divisions and analysts were under pressure to recommend these companies as a buy.

Mainly as a result of Spitzer's investigations, 10 leading Wall St firms agreed to pay US$1473 million to settle allegations regarding the mis-selling of share offerings during the technology boom. The settlement comprises US$925 million in fines, US$463 million to fund independent research companies and US$85 million to educate investors.

Spitzer took a big swipe at analysts' recommendations at the annual Institutional Investor analysts' award dinner in New York on November 12. He said that these awards were not being given to the analysts with the best buy, sell and hold recommendations as an investigation by his office had found that most of the winners had a poor record when it came to specific advice.

Spitzer supports a system that would measure analysts on the basis of their buy, sell and hold recommendations. He argues that the investment management industry has prospered since the performance of managers became subject to standardised measurement.

He suggested that analysts' recommendations should be provided to an evaluation agency 90 days after they are issued.

The 90-day deadline would allow broking firms to provide recommendations to their clients on a proprietary basis while giving the investing public an assessment of how analysts performed on the basis of their buy, sell and hold recommendations.

Meanwhile, analysts' independence is not a major issue in New Zealand for several reasons:

* Most of the abuses in the United States have been associated with new share offerings and there have been very few of these in New Zealand in recent years.

* Some bullish research reports have been issued in New Zealand in conjunction with share placements or selldowns by major shareholders, but most have been taken up by institutions or habitual investors. These are sophisticated investors who should be able to do their own research.

* Most of the companies that have been the subject of hyped research reports - Wilson Neill is a good example - are not mainstream and investors should have been aware of their speculative nature.

Any attempt to impose black-letter law on analysts' reports would be a step in the wrong direction, particularly if it reduced the number of companies covered.

The New Zealand sharemarket is hopelessly under-researched and independent research is not a viable option in this country. Every attempt should be made to encourage the broking industry to produce more, not less, research.

The best option would be for a regulatory authority, probably the Securities Commission, to establish an evaluation system for analysts' buy, sell and holding recommendations.

If the commission published an analysis of these on its website, investors would have a better idea of the analysts who are, and are not, worth paying attention to.

* Email Brian Gaynor