Gaynor: Briscoe Group offer looks a winner

By BRIAN GAYNOR

The Briscoe Group share offer has only one negative feature: demand will substantially exceed supply and investors will not be able to buy all the shares they want.

Every other aspect is positive. Managing director Rod Duke is one of the country's best retailers and the group has a strong track record and very good growth prospects.

A PhD thesis by Dr Graeme Camp of the University of Auckland Business School also suggests that the stock will trade at a healthy premium to the $1 issue price when it lists in mid-December.

Rod Duke, who was born in Adelaide, came to New Zealand in 1988 to run Briscoe. He had extensive experience of the Australian retail industry and was managing director of Norman Ross before he came to Auckland.

He was recruited by Hagemeyer, a Dutch-based international company that had controlled Briscoe since 1977, and was given a mandate to prepare the retailer for sale.

But the story took an unexpected twist when Mr Duke, under the auspices of the RA Duke Trust, bought Briscoe for a nominal sum in 1990.

Since then he has built Briscoe into a leading retailer with two chains - Briscoes Homeware and Rebel Sport. Mr Duke has been extremely successful yet has had almost no equity capital to support the group's development.

Briscoes Homeware, which operates throughout New Zealand, has expanded from 22 to 28 stores since 1997.

Rebel Sport operates on a loose franchise arrangement with Rebel Sport Australia. This will end in March 2003.

The sports goods retailer has grown from 2 to 11 outlets in the same period and now represents 28 per cent of total group sales compared with just 5 per cent four years ago. Although no earnings breakdown is given, it is clear that Rebel Sport has generated most of the growth in years and part of the proceeds of the share issue will be used to expand the chain from 11 to 21 outlets.

The success of Briscoes has been built on several features, including vendor refills and advertising rebates. Under the vendor refills system, the supplier is responsible for maintaining stock levels within stores. This reduces working capital requirements and gives Briscoes a huge advantage over smaller competitors.

The group relies heavily on advertising and promotion, and suppliers pay up to 50 per cent of the group's advertising costs under the advertising rebate scheme.

The initial public offering will inject $40 million into the group, and this will be the first time that Mr Duke will have a strong equity base to expand his organisation.

At present RA Duke Trust owns all 170 million shares on issue. With the exception of 100 shares, these were issued in a 1.7 million for 1 share split.

The trust will sell 10.5 million shares to Gerard Harvey and Harvey Norman Holdings and 2 million shares to two staff members, leaving it with 157.5 million shares. ]

The proceeds from the 40 million new shares to be issued to the public will be used thus:

* $10 million for the expansion of Rebel Sports from 11 to 21 outlets.

* $9 million to partly fund a dividend payment to Mr Duke.

* $3 million to modernise Briscoes Homeware stores.

* $18 million is unidentified but it may be used to develop a new retail chain.

Briscoe's profit forecasts are optimistic. The company expects to achieve net earnings of $15.1 million for the January 2002 year compared with $12.5 million last year. The $15.1 million target will be difficult to achieve because the group will have to achieve an ebit (earnings before interest and tax) margin of 9.5 per cent in the second half compared with 9.0 per cent in the same period last year.

But Mr Duke is absolutely confident that he can achieve the 2002 profit target. He is not concerned about the poor earnings record of most new listings and says the September 11 terrorist attack and drop in consumer confidence have not affected Briscoes.

The company is forecasting a net profit of $17.7 million in the January 2003 year but its cashflow figures are even more impressive. The group is expecting to generate surplus operating cash of $23.8 million in the January 2003 year and to have $65.5 million in the bank at year-end.

The 2003 profit forecast is very conservative as it does not include earnings from any new stores. Mr Duke is in an expansionist mood and he now has the financial resources to expand his Rebel Sport operation and introduce a new retail chain to New Zealand.

Although he has an excellent record, Mr Duke is not immune to mistakes. The Briscoe Group produced disappointing results in 1998 and 1999 because of problems with a new electronic stock management system. The group was also overstocked at the end of the January 2001 year.

The listed Rebel Sport in Australia, which is now controlled by Gerard Harvey and Harvey Norman Holdings, has had disappointing performances from its traditional activities and large write-downs associated with its expansion into the Glue youth lifestyle chain.

At the issue price of $1 a share, Briscoe Group has a prospective price:earnings ratio of 11.8 and a fully imputed dividend yield of 5 per cent based on 2003 forecasts.

Briscoe's float has many of the characteristics identified by Dr Camp in his thesis, "An examination of underpricing and short-term aftermarket volatility in New Zealand initial public offerings". Dr Camp's extensive study, completed last year, is based on firsthand knowledge as he is a former stockbroker and member of the New Zealand Stock Exchange.

Dr Camp found that the average market adjusted underpricing of 163 IPOs on the New Zealand Stock Exchange was 32 per cent (the difference between the issue price and last sale price on first day of trading adjusted for general market movements over the period). Approximately 30 per cent of new issues performed better than the average and a quarter traded below the issue price.

Dr Camp drew several additional conclusions including:

* The underpricing of a new issue is greater when all the shares are reserved for clients of New Zealand Stock Exchange members and there is no public pool. The Briscoe offer has no public pool.

* Higher underpricing and slightly lower aftermarket volatility occurs when the organising broker is large and has been involved in several IPOs. JBWere, Briscoe's organising broker, is one of the larger brokers. It has managed several public offers, although not all have been successful.

* Retention of shares by existing shareholders is strongly correlated with underpricing. If existing shareholders use the IPO to sell most or all of their shares, they need a high issue price to maximise their wealth from the transaction. If they sell only sufficient shares to achieve a spread of shareholding, the issue is usually underpriced. Mr Duke is retaining a 75 per cent shareholding, the maximum allowed under Stock Exchange rules.

Dr Camp also found that new issues with a low level of disclosure substantially outperformed issues with high disclosure.

This helps explain why Howard Paterson's new issues A2 Corporation, Bliss Technology and Botry-Zen initially did very well, but most investors are better off sticking to Briscoe and other companies with high disclosure levels.

The study also looked at the performance of new issues in the 30 trading days immediately following listing and found that they generated an average market adjusted negative return of 4.7 per cent.

This empirical information, which is well known to professional investors, emphasises the importance of getting in at ground level. It also explains why stockbrokers are being swamped with requests for Briscoe shares.

* Disclosure of interest: Brian Gaynor has applied for Briscoe shares.

* bgaynor@xtra.co.nz