Gaynor: How clients analyse the analysts

By BRIAN GAYNOR

With analysts in the Northern Hemisphere being sued left, right and centre for hopelessly bullish reports during the dotcom frenzy, many firms say they now make as many "sell" as "buy" recommendations.

These orders have obviously not reached New Zealand because a sell recommendation in this country is as rare as a cricket victory over Australia. But experienced analysts have developed sophisticated communications systems with regular clients that go something like this:

* Strong buy (yes, that is a winner).

* Buy (we are hoping it will become a corporate client).

* Speculative buy (Howard Paterson or Eric Watson had dinner with a director).

* Buy on weakness (don't buy).

* Add/accumulate (the stock has no liquidity).

* Long-term hold (we are brokers to the company).

* Hold (we want to get another client out first).

* Avoid (sell immediately).

* Reduce/Sell (it is probably too late to get out).

One cannot totally blame analysts for avoiding sell calls because companies are uncooperative with individuals who make negative recommendations.

A few years ago a young analyst made a sell call on Regal Salmon and was severely castigated. He was spot on - the company subsequently changed its name successively to Queen Charlotte, Aquaria 21, AQL and now Certified Organic.

Analysts no longer cover the company and its share price consistently trades below the 1c mark.

Baycorp

The Baycorp/Data Advantage merger has been greeted with enthusiasm, yet the merger document reveals the new company may operate at a loss because of the huge amount of goodwill created by the deal.

As the Australian company is effectively taking over Baycorp, and the transaction values the New Zealand company at $1 billion compared with its net assets of $133 million, the difference has to be taken to account as either revaluations or goodwill.

Baycorp's database will be revalued from $21 million to $270 million, but the combined group will have $729 million of goodwill, representing 56 per cent of total assets. According to the merger documents, the new group would have reported a loss of $8 million pro forma for the June year after goodwill amortisation of $37.4 million. The merger documents concentrate on the net profit before goodwill amortisation. This is appropriate because cash flow will not be affected by the goodwill amortisation, but the relatively low reported earnings of the new group may confuse some investors.

The information booklets also show that the migration of Baycorp to Sydney will be a loss to the New Zealand economy.

Baycorp's auditors, Arthur Andersen, received total fees of $570,000 in the June year but the Australian auditor will receive most of the big payments in future.

As Grant Samuel's Sydney office prepared the independent expert's report and Baycorp's financial advisers are based in Australia, much of the $16.2 million merger costs will be paid to Australian advisers.

New Zealand shareholders will also lose imputation dividends because Australian franking credits cannot be transferred to New Zealand taxpayers. This will reduce net after-tax dividends by about 33 per cent for taxpayers on the top marginal rate of 39 per cent.

There may be some relief. The Australian and New Zealand governments are considering a mechanism whereby New Zealand shareholders will be entitled to a pro rata share of imputation credits generated by New Zealand subsidiaries of Baycorp Advantage.

Finally, the documents highlight significant differences between directors' retirement allowances in Australia and New Zealand. Three Data Advantage directors are retiring and shareholders are being asked to approve a golden handshake equal to one year's fees.

Baycorp's constitution, and those of most listed New Zealand companies, allows directors to be paid a retirement allowance equal to three years' fees without requiring shareholder approval. (No Baycorp director is retiring and the group's constitution will be defunct after the merger.)

Baycorp's annual general meeting, which will be asked to approve the merger, will be in Auckland on November 21.

Annual reports

The annual report season is in full swing and the disclosure standards in these documents vary considerably. Two companies are worthy of special praise, Cavalier Corporation and Fletcher Building.

Tony Timpson, Cavalier's chairman, has always set high standards and the company's latest report, which comes in two booklets, is better than ever.

The corporate governance statement, directors' report and disclosures under the Companies Act 1993 are comprehensive. The last section reveals one director received a retirement allowance of $1.8 million, but shareholders have nothing to complain about because the retiring director had been an employee of the company for almost 40 years.

The important issue as far as Cavalier is concerned is its excellent share price performance as demonstrated by graphs on page 23 of the annual review. The company has outclassed the New Zealand sharemarket in terms of investment returns as well as disclosure.

Roderick Deane and his fellow Fletcher Building directors have maintained Fletcher Challenge's excellent disclosure standards in their annual report. The divisional breakdown is particularly comprehensive and details of the company's insider trading rules are informative.

Other companies should strive to follow.

Spectrum Resources

One of the issues raised at yesterday's Spectrum Resources annual meeting was the company's lack of media coverage. Shareholders were annoyed that the media was failing to report its positive developments.

The problem is that Spectrum is small, has only one product (a software application aimed at energy companies) and sends out mixed messages to investors.

Chief executive Gavin Mitchell told more than 30 shareholders: "We expect to see revenues well in excess of last year and we expect to be in profit." But when asked for more specific information, directors made several vague comments, including "we are hesitant to give actual figures", "we have budgets but they are not a reliable guide" and "we are hoping for a better performance".

The best way for Spectrum to receive more media coverage is to achieve the targets indicated in Mr Mitchell's address.

The motion to extend the terms of Spectrum's options by two years and to change the exercise price from 8 to 6 cents was passed by a substantial majority.

There were no dissenting voices from the floor.

* bgaynor@xtra.co.nz