Owning Mixed Ownership

Transcription

1 Owning Mixed Ownership July 2012 Investment Strategy Group Strategy: Bernard Doyle bernard.doyle@jbwere.co.nz Overview Asset Allocation: Hayden Griffiths hayden.griffiths@jbwere.co.nz Analyst: Hamesh Sharma hamesh.sharma@jbwere.co.nz We view the introduction of the Mixed Ownership Model (MOM) as a significant step forward for NZ Inc. In particular, the program has the potential to help put the New Zealand capital markets back onto a path of self-sustaining growth. We expect strong interest in Mixed Ownership companies. Our analysis suggests pent-up demand for quality equity offerings amongst local investors with up to $5bn of potential demand simply from a reweighting of household assets back to mid-1990 s levels of domestic equity ownership. Public Asset sell-downs generally have had a good track record for investors. Year 1 returns of a comparable sample to the Mixed Ownership candidates show an average return of >50%. However the reasons are not as obvious as hocking off the family silver. History shows private sector involvement can significantly enhance returns achieved from state owned entities. From JBWere s perspective, IPO s are a critical part of a healthy capital market. We believe large, liquid IPO s of businesses with a profitable track record should be considered for inclusion into equity portfolios. Accordingly, where possible, JBWere s Investment Strategy Group intends to assess IPO s for model portfolio inclusion prior to listing. A Significant Forward Step for NZ Inc. NZ capital markets need the mixed ownership program hence successful execution is critical In November 2010 JBWere made a submission to the Government s Savings Working Group. Our message was that any effort to improve savings required improved ways to save. In particular our concern was the New Zealand Equity market had become a poor vehicle for facilitating savings behaviour, and that the current lack of IPO s, waning international investor interest, and poor market liquidity were indicative of a market in structural decline. One of our recommendations to the Government in our 2010 submission was the partial sell-down of State Owned Enterprises what is now referred to as the Mixed Ownership Model (MOM). The political debate around mixed ownership has been disappointing. From our perspective some fundamentals are too easily overlooked: A partial sell-down is exactly that. There is plenty of international (and local) precedent for the Crown to remain a long term holder of listed assets. A portion of private ownership, with all the market disciplines that entails, generally results in businesses that are better run. There is no strategic imperative for the Crown to remain a 100% owner of electricity generators any more so than it is for it to remain a 0% owner of Fletcher Building or NZ Refining which are arguably equally strategic assets. Without a partial sell-down of State Owned Enterprises, the NZ equity market would probably continue to struggle for relevance and critical mass. With that as a backdrop, we view the introduction of the Mixed Ownership Model as a significant step forward for NZ Inc. Successful execution will benefit the crown, investors, customers and taxpayers. However successful execution is the operative phrase. The Government will have to balance the competing motives of interested parties: Taxpayers should want as high a price as possible, to get maximum bang for their buck. Investors (many of them taxpayers) will want a low price to provide an attractive entry point into quality assets. They will also want efficiencies to manifest as improved profitability and dividends. At a minimum, customers will want existing service levels maintained. The crown will want to keep everyone happy, but no single party too happy. JBWere Investment Strategy Research All figures in NZD unless otherwise advised 1

2 Is There Demand? The New Zealand Treasury has estimated that extending the Mixed Ownership Model to five companies will raise $5.0 to $7.0 billion dollars. These companies are, in no particular order: Air New Zealand; Genesis Energy; Meridian Energy; Mighty River Power and Solid Energy. The Mixed Ownership program should generate significant interest NZ households have run down their allocation to domestic equities If the MOM is extended amongst all of these companies, they will be judged as individual investments. Even the three electricity generators, which share much in common, have enough important differences to see them treated as stand-alone investments. Mighty River for example, made significant investment in geothermal generation which neither Genesis nor Meridian are exposed to. All that said, we think there are good grounds for expecting each of the Mixed Ownership offerings to generate significant interest from a wide range of investors: Prior sell-downs have seen broad public interest, and in some cases, been subject to heavy scaling. These companies have gone on to become the backbone of the NZ Sharemarket. Indeed prior Public Owned assets (eg Contact, Telecom, Auckland International Airport) make up over a third of the New Zealand Stock Exchange s market capitalisation. In that respect, the MOM is already well accepted in New Zealand. Investment in NZ shares has shrunk as a proportion of Household Assets over the past 15 years, while bank deposits have grown at almost 20%pa (below). If households expanded their proportion of equity ownership back to mid-90s levels, this alone would create $5 billion of new demand for equities. Our discussions with investors over many years suggest it is New Zealand s poor supply of new equities that has been the major impediment to greater participation in the local market. With bond yields low around the world, investors are placing a premium on companies that can deliver a relatively stable dividend yield. Some, though not all, of the MOM companies may provide this sort of investment. Equity Demand: Household Financial Assets are Light on Equities 250 $bn Other financial assets Fixed Income Bank deposits 50 Direct NZ Equities Source: Reserve Bank of New Zealand Possible Structure and Performance Case studies can provide clues to upcoming transactions With the Mixed Ownership Model Bill now passed by Parliament, we expect information on the float process to increase. In the meantime, there is a large sample of public asset sale transactions from both within New Zealand and abroad that we can draw on. We have chosen four case studies that, as a group, provide a useful template for what to expect from the upcoming MOM program. Our selection is based on relevant features in each case study: Contact Energy, like Genesis, Meridian and Mighty River is an electricity generator. Auckland Airport and Contact were both large New Zealand companies, floating JBWere Investment Strategy Research All figures in NZD unless otherwise advised 2

3 Past Public Selldowns: Some Case Studies within a year of each other. The MOM program will also probably see large companies floated in relatively close proximity. Queensland Rail is a recent public IPO within the Australasian region. The float embedded novel mechanisms such as loyalty shares and retail discount. Telstra was part of ongoing program, with a three tranche sell-down. Similarly the MOM program is not a one shot game. Company IPO Method Day 1 Return 1 Year 1 Return Features Auckland Airport Jul-1998 Equity float with sale of majority Government holding Local councils maintained shareholding 13.9% 66.6% Retail pool significantly oversubscribed Significant short term rally post IPO Overwhelming demand resulted in heavy scaling back of public applications Investors allocated shares at $3.10 (a discount to cornerstone investor) Full Equity Sale Edison Mission Energy allocated 50% of shares at $5.00 Contact Energy May % cornerstone holding sold to a US electricity utility 7.7% -21.4% All tranches were heavily oversubscribed NZ retail investors who pre-registered were allocated 25% more shares than the minimum sold Queensland Rail Nov % Equity Stake sold to investors % AU/NZ institutions, 52.8% Foreign institutions, 34% retail 8.2% 33.0% Retail investors entitled to a 10c discount with a hard cap at $2.80 per share, resulted in a price paid of A$2.45 per share, versus A$2.55 for institutions For every 20 shares allocated under the retail offer held until 7 Dec 2011, investors were entitled to receive 1 loyalty bonus share up to a maximum of 500 bonus shares guaranteed allocation for pre-registered applicants Telstra (T1) Nov-1997 First IPO 33% of Equity Subsequent secondary sales in 1999 (T2) and 2006 (T3). Floated using an instalment payment process 36.9% 168.0% 65% of float reserved for Australian investors, foreign investors allowed to subscribe to 35% (with no single foreign investor allowed to acquire more than 5%) Shares were issued at A$3.30 payable in two instalments: $1.95 ($2.00 for institutions) payable on application, and a second $1.25 ($1.30 for institutions) payable by the shareholder in November 1998 (one year later) Source: JBWere ISG, Datastream, IRESS, NZ Treasury, Company Data 1: Based on return to Retail Investors Based on our analysis of prior sell-downs, and information made public to date, we can make some inference about the likely features of the MOM program: As entrenched in the Mixed Ownership Model Bill, the Government by law must retain 51% ownership of each mixed ownership entity. No single non-crown shareholding can exceed 10% (source: Mixed Ownership Bill 2012) The IPO will probably target a 85%-90% NZ allocation at the offer (source: Ministerial comment). A minimum parcel of $1000 will probably apply to the IPO (source: Ministerial comment). Based on prior precedent (eg Contact and Queensland Rail) individual investors who pre-register will probably receive a preferential allocation. Based on ministerial comment, a loyalty share seems possible (source: NZ Herald). Although the idea has received little commentary, Telstra shows how an instalment receipt (essentially buying shares on lay-by) can be used to assist with especially large share floats. This may be helpful later in the MOM program (with say, an especially large transaction like Meridian Energy). The first float will occur in September, market conditions allowing. This would provide time for June 2012 year accounts to be incorporated into offer documents. Balance seems right to us at this stage From what we have seen to date, and based on prior precedent, we think the Government is on the right track with achieving a program that will generate widespread public interest, without overly sacrificing price. In other words, the interests of investors seem to be fairly balanced against those of the taxpayer. JBWere Investment Strategy Research All figures in NZD unless otherwise advised 3

4 An area of modest concern to us is the extent to which retail participation is encouraged through the use of loyalty share incentives. Our view is this should be an either or: either receive a loyalty share; or a (smaller by value) discount to the IPO offer. This will help the Crown avoid arguably enticing unsophisticated investors into holding onto a relatively complex investment case simply to receive the loyalty bonus. Even in normal market volatility (let alone the post GFC world) month to month share price movements could easily swamp the benefits of the loyalty share. Moreover, via Kiwisaver, there is now a safer channel for unsophisticated investors to participate, admittedly in a diluted manner, in the Mixed Ownership program. Change in EBIT Margin: 3yrs Pre vs Post Change in Return on Assets: 3yrs Pre vs Post 14% 12% Change in EBIT Margin 12% 10% 8% 6% 4% 2% 0% -2% -4% POT AIR AIA Source: Goldman Sachs Research estimates Average TEL WIA POA Change in EBIT over Total Assets 10% 8% 6% 4% 2% 0% -2% -4% POT WIA AIR Source: Goldman Sachs Research estimates AIA Average POA TEL Public sell-downs generally have a good track record Public Asset sell-downs generally have a good track record for investors. However the reasons are not as obvious as a hocking off the family silver proponent might argue. To be sure, Governments have a strong incentive to price an IPO fairly. This is because they are selling to taxpayer/voters, and thus will be exposed to the consequences of a poor investor experience. This is an important contrast to a private sector seller. That said, other drivers are also important: Private sector involvement will generally result in operational efficiencies. A Goldman Sachs study in 2011 showed an average 33% proportionate increase in return on assets (an average 3% increase from ~9% to ~12%, above). Forward looking investors may price these benefits ahead of time. Governments are typically sellers of assets with an infrastructural flavour. Listed infrastructure assets tend to do well in an environment of falling interest rates. This has been the prevailing global environment for the past three decades. In the case of a partial sell-down, incentives are well aligned, with the Crown remaining the largest single stakeholder in the listed asset. The above said, Government assets aren t immune from the industry structure they inherit, and private sector involvement can only achieve so much. Air New Zealand is a notable example of a well-run business subject to private sector disciplines (eg share listing) that still faces the formidable challenges of the airline industry. 1 Year Relative Performance of IPO's Contact Energy: Total Return since IPO % Contact Energy % % 90.00% Auckland International Airport Queensland Rail Telstra (T1) CEN NZ Market 70.00% 50.00% 30.00% % % % 0 week 1 week 4 week 7 week 11 week 14 week 18 week 21 week 24 week 28 week 31 week 35 week 38 week 41 week 45 week 48 week 52 May - 99 May - 01 May - 03 May - 05 May - 07 May - 09 May - 11 Source: JBWere ISG, Datastream, IRESS Source: IRESS, Datastream JBWere Investment Strategy Research All figures in NZD unless otherwise advised 4

5 The four trans-tasman examples of Government IPOs have, on balance, a reasonable track record of relative return (above left). The average day 1 return across the four companies was 16.7%. The average year 1 return was 63% - helped by exceptional returns from Telstra. Contact Energy started slowly, but has been a good long term investment The relative return of Contact Energy was unremarkable in the first year. However as our longer term perspective shows, buying and holding an attractive business will usually reward investors over time. Contact Energy has returned ~9% per annum since listing, with takeover offers from both cornerstone shareholders (Edison Mission, then Origin Energy). The performance of Telstra is also of interest to us, inasmuch as the sell-down came in three tranches. The fact that the first Telstra sale (T1), came with the knowledge that further stock would be released in future probably gave the Australian government a strong incentive to price the offering sharply. This has some parallels with the MOM program: the Government will presumably be averse to over-pricing the early offerings for fear of undermining demand for companies later in the pipeline. That said we would caution against overplaying this assumption particularly in the context of Telstra returns. The Telstra IPO came when the Tech bubble was reaching a crescendo, so the 168% 1 year return should be seen in that context (Telecom New Zealand was trading around $8 at the same time!). Owning Mixed Ownership: The Portfolio Context June 2012 saw two important developments for New Zealand Capital markets. Firstly, farmer-shareholders voted to allow outside investors to own shares in Fonterra. Secondly, parliament passed into law the Mixed Ownership Model legislation. Both should provide local investors with interesting portfolio decisions over coming months and years. We believe large, liquid IPO s of businesses with a profitable track record should be considered for inclusion into equity portfolios From JBWere s perspective, IPO s are a critical part of a healthy capital market. A dearth of quality IPOs of scale has meant investors have not needed to consider how initial public offerings fit into medium term share portfolios. However, we believe large, liquid IPO s of businesses with a profitable track record should be considered for inclusion into equity portfolios. Accordingly, where possible, JBWere s Investment Strategy Group intends to assess IPO s for model portfolio inclusion prior to listing. This will be contingent on appropriate financial information being made publicly available in a timely manner something we expect will be the case with the MOM program. JBWere s philosophy on equity ownership is founded on the question: is the investment suitable for owning over at least two years? We find asking this question usually also addresses issues of quality, value and industry structure. In the case of upcoming IPO s, this will also be the question we ask. Whether or not our tenure of ownership actually stretches for that time period or longer is another matter. In the case of IPOs we will augment our own view with external research as it becomes available. The sample below is a purely illustrative example of how Mixed Ownership investments might fit into our portfolio framework. JBWere New Zealand: Sample Balanced Portfolio Company Code Price (NZ$) Weight P/E (x) Growth 1 Net Yield 2 Imputation GUINNESS PEAT GP. (NZE) GPG $ % na na na na INFRATIL IFT $ % % 4.5% 100% FREIGHTWAYS FRE $ % % 5.2% 100% SKY CITY ENTM.GP. SKC $ % % 5.1% 65% FLETCHER BUILDING FBU $ % % 6.2% 50% TRADE ME TME $ % % 4.4% 100% RYMAN HEALTHCARE RYM $ % % 2.8% 0% PORT OF TAURANGA POT $ % % 3.6% 100% TELECOM CORP.OF NZ. TEL $ % % 7.0% 90% MIXED OWNERSHIP ASSET 3 MOM $ % % 5.0% 100% Balanced Growth Portfolio 16.2% 4.7% NZSX50 Portfolio Index % 4.6% 1: Forecast per annum earnings growth over next two years. 2: Forecast net yield for na: Not forecasted, 3: For illustrative purposes only Source:JBWere, GSNZ Research estimates Date of prices: 27/06/2012 JBWere Investment Strategy Research All figures in NZD unless otherwise advised 5

6 General Disclosures This document comprises general advice only. In preparing it, JBWere (NZ) Pty Ltd ( JBWere ) did not take into account the particular investment objectives, financial situation, goals or needs ("financial circumstances") of any particular person. Accordingly, before acting on any advice contained in this document, you should assess whether the advice is appropriate in light of your own financial circumstances or contact your adviser. The disclosure statement for your JBWere adviser(s) is available on request, free of charge. This communication is being furnished to you solely for your information and may not be copied or redistributed to any other person. It is provided on the condition that you keep it confidential and do not copy or circulate it in whole or in part. In particular, the information may not be redistributed outside of Australia and New Zealand via or otherwise. For the purposes of the Financial Advisers Act 2008 ("FAA"), the content of this document is of a general nature and is intended as a source of general information only. The distribution of this document is not a "personalised service" and, to the extent that it contains any financial advice, is intended only as a "class service" provided by JBWere within the meaning of the FAA. JBWere and its respective related entities distributing this document and each of their respective directors, officers and agents ( the JBWere Group ) believe that the information contained in this document is correct and that any estimates, opinions, conclusions or recommendations contained in this document are reasonably held or made as at the time of compilation. However, no warranty is made as to the accuracy or reliability of any estimates, opinions, conclusions, recommendations (which may change without notice) or other information contained in this document. To the maximum extent permitted by law, (but, in respect of our clients, subject to the applicable terms and conditions of our engagement with them), the JBWere Group disclaims all liability and responsibility for any direct or indirect loss or damage which may be suffered by any recipient through relying on anything contained in or omitted from this document. Note: The NZX50 Portfolio Index comprises the same constituents as the NZX50 Index but limits the weight of any one security to 5% of the index market capitalisation. The NZX50 Portfolio Index was developed to provide a representation of what retail investors are likely to hold in a portfolio. Certain excerpts contained in this document are sourced from a Goldman Sachs research report. This document has been prepared by its authors independently of Goldman Sachs New Zealand, Goldman Sachs Australia Pty Ltd or a Goldman Sachs U.S. Group Entity (collectively, referred to in this paragraph as the Group' ) and the Group (and each member of the Group) takes no responsibility for its contents. The authors, JBWere ISG Group, JBWere Pty Ltd and JBWere (NZ) Pty Ltd have no authority whatsoever to give any information or make any representation or warranty on behalf of the Group or any director, officer, partner or employee of the Group or any other person in connection therewith. In particular, other than as indicated in the document, the opinions, estimates, and projections expressed in the report are entirely those of the author(s) hereof and are not given as an agent of the Group (or any member of the Group) or any other person in connection therewith. Disclosures concerning Goldman Sachs Australia Pty Ltd research appear at Goldman Sachs U.S. makes important disclosures at Copyright JBWere (NZ) Pty Ltd Auckland Telephone Level 38 Facsimile Vero Centre Freephone Shortland Street Auckland 1010 Christchurch Telephone (03) Level 6 Facsimile (03) HSBC Tower Freephone Worcester Boulevard Christchurch 8013 Wellington Telephone Level 4 Facsimile NZX Centre Freephone Cable Street Wellington 6011 JBWere Investment Strategy Research All figures in NZD unless otherwise advised 6