Broker self-interest hampers the stock exchange and economy

By Brian Gaynor

Investment


Media interest is always great in a public stoush between prominent businessmen. This week's war of words between Eric Watson and stock exchange chairman Eion Edgar was no exception.

Eric Watson opened the bowling when he told the Business Herald that the New Zealand Stock Exchange was moribund and boring. He blamed this on conservative sharebrokers and complacent companies and said the exchange "has to get aggressive through promotion of the equities market".

Most investors would agree with Mr Watson's comments. The following day Eion Edgar went in to bat for the stock exchange.

He said the exchange was one of the most efficient in terms of costs per transaction. He also said the new market for smaller companies would encourage growth-oriented organisations to list.

Mr Edgar said more privatisations and a compulsory retirement savings scheme would boost the market, but his main point was that the sharemarket reflected the New Zealand economy and "if our economy is going nowhere, then the market doesn't tend to perform".

It is difficult to disagree with the latter argument. The poor performance of the economy is having a negative impact on the sharemarket but, unlike other businesses, the exchange and its members have been slow to adjust to the dismal economic growth.

This is particularly true of the new issues market. The initial public offering (IPO) market is an excellent indicator of the strength of the economy and the sharemarket. Strong economic growth encourages company formations and a buoyant sharemarket allows these companies to raise capital.

This money is used to create opportunities, jobs and growth. In other words, a strong economy and sharemarket feed on one another.

The United States is at present experiencing these phenomena with the economy, sharemarket and IPO market all booming. In the past 30 months, the Dow Jones Industrial Average has risen 73 per cent, the Nasdaq Composite Index 115 per cent and almost three new companies are listed on New York stock exchanges every working day.

The Australian economy and sharemarket have also been relatively healthy. Since the beginning of 1997 the All Ordinaries Index has risen 17 per cent and there have been 150 new domestic floats.

Unfortunately, on this side of the Tasman the economy, sharemarket and new issue market are particularly lethargic. In the past 30 months, the NZSE40 Capital Index has fallen 6 per cent and there have been only 14 new listings. New Zealand has had just one new float every two months compared with five a month in Australia.

With the exception of Auckland International Airport and Sky Network TV, the performance of these new issues has been extremely disappointing. A $1000 investment in each of the 14 companies would have produced a capital profit of $290 - or just 2.1 per cent - at yesterday's closing price.

This pathetic return is not going to attract new investors to the sharemarket. The return has been boosted by the takeover of Sovereign, a share buy-back at 50c by Pacific Capital Assets and the back door listing of Southern Capital through CBD New Zealand.

The new issues market in this country is used as an exit strategy for existing shareholders instead of a vehicle to raise capital for expansion and growth. The float of Colonial Property Trust, Contact Energy, Auckland International Airport, Capital Properties, AMP NZ Office Trust and Restaurant Brands are obvious examples of this.

In the past 30 months Ryman Healthcare, Nobilo Wines and Sky Network TV were the only productive companies to raise funds for expansion through the new issues market. Nobilo Wines was the first export-oriented company to list since Affco in March 1995.

The new issues market is giving a clear message; there is little investment in the non-property productive sector, particularly in export industries. This has negative implications for the future performance of the New Zealand economy.

It raises the question: if the poor state of the economy is adversely affecting the sharemarket, why are Eion Edgar and other members of the stock exchange not advocating a change in economic policies?

This is where broker self-interest comes to the fore. The more influential stockbrokers and investment bankers are unwilling to criticise the Government because they might be excluded from the next big privatisation of a state-owned asset.

The other big question is: why do many IPOs have aggressive profit forecasts and high price/earning ratios in a low-growth environment? Ryman Healthcare and Restaurant Brands were obvious examples of this.

There are a number of similarities between the two companies:

\EE Merrill Lynch was an organising broker of both issues.

\EE The two companies operate in highly competitive domestic industries with good growth potential.

\EE Both prospectuses were optimistic and emphasised the low level of penetration of their sector in New Zealand compared with the US.

\EE They had aggressive profit forecasts and relatively high price/earnings ratios.

\EE The two floats had indicative price ranges, Ryman $1.50 to $1.80 per share and Restaurant Brands $1.80 to $2.20 per share.

Restaurant Brands shares were issued at $2.20 and quickly rose to $2.65. The stock plunged to $0.64 when sales figures fell below forecasts and the company reported a net profit for the November 1998 year of just $8.1 million compared with a prospectus forecast of $13.9 million. The company's share price rose 8c yesterday in response to a good interim profit.

Ryman Healthcare should have learned from the Restaurant Brands experience and produced a less aggressive profit forecast and offered its shares at a lower price. The high price and optimistic forecasts discouraged investors.

The bad taste from the recent Contact Energy issue also had an impact, as many potential investors were concerned that overseas investors would be given a large number of shares which they would quickly dump on the market.

These factors had a negative impact on Ryman. The float was undersubscribed and the shares were issued at $1.35, well below the indicative price range of $1.50 to $1.80. It is difficult to know whether the promoters were greedy or Merrill Lynch offered poor advice. Ryman could have been a successful float if the profit forecast had been more conservative and the issue price was fixed at $1.25 a share.

Mr Edgar is correct when he says the poor performance of the economy is having a negative impact on the sharemarket. But his analysis is incomplete; sharebrokers must take some of the blame.

The new issue market is an important vehicle to attract new investors and to raise capital for companies. The market is lifeless because of greedy promoters and overpricing. Sustained interest in IPOs will be achieved only when new issues are realistically priced to reflect New Zealand's low economic growth rate.

The stock exchange's new market for smaller companies is one bright light on the horizon. But brokers should be careful - investors will quickly lose interest if the new issues are too expensive.