Brian Gaynor: Why the Vector float will be a winner

The long-awaited announcement that Vector will list on the NZX has been greeted with great enthusiasm.

This is understandable because the last three IPOs (initial public offerings) of former publicly owned companies - Contact Energy, Auckland International Airport and Capital Properties - have performed particularly well.

There is a now a widespread view among New Zealand investors that they will get a better deal from New Zealand politicians than offshore private equity funds and other vendors.

When one compares the performance of Contact Energy, Auckland International Airport and Capital Properties with Feltex, Vertex and Frucor this is an astute perception.

Details of the Vector float are sketchy but it will raise between $600 million and $1 billion for a 25 per cent stake. As the accompanying table shows this would place it between Contact Energy and Westpac New Zealand, the country's largest IPOs since 1999.

The most important point about IPOs is the ability of the issuer to achieve or exceed its profit forecasts. In this regard the recent issues by former publicly owned organisations have been successful.

Contact Energy, which had an IPO at $3.10 a share in 1999, forecast net earnings of $65.5 million for the September 1999 year and achieved $155.4 million (climatic conditions were particularly favourable for its generating activities).

It predicted $78.4 million for the September 2000 year and achieved $97 million (all forecasts in the table are for the last forecast period contained in the prospectus).

The beauty about big floats, particularly Contact Energy and Auckland International Airport, is they are extensively covered by sharebroker analysts. This means that the forecasts are carefully scrutinised and the information flow to prospective investors is extensive and independent.

Investors, particularly individual investors, are far less likely to make major mistakes when all the major broking houses have committed resources to assess an IPO.

Auckland International Airport was another former publicly owned organisation that exceeded its profit forecasts. The company predicted net earnings of $40.9 million for the June 1998 year and achieved $41.1 million then predicted a drop to $35 million for 1999 and reported $42.4 million.

The airport has been one of the market stars as its shares were issued at $1.80 and it has had a capital repayment in 2002 (seven in every 25 shares were cancelled for the payment of $1.80 per cancelled share) and a recent four-for-one share split.

Another advantage of the partial sell down of former publicly owned companies is that they perform much better under the listing model.

Air New Zealand and Tranz Rail are obvious exceptions to this rule but 100 per cent of these entities were sold to private-sector interests who subsequently on-sold shares to investors.

The Crown has also underpriced assets when selling, particularly Contact Energy and Auckland Airport.

Capital Properties exceeded its profit forecast but this was somewhat of an illusion. The company forecast net earnings of $11.3 million for the March 2000 year and achieved $13.1 million.

But the prospectus forecast had no provision for property revaluations. In the 2000 year property values were written down by $19.7 million so the bottom line result was a loss of $6.6 million compared with the pre-revaluation profit of $13.1 million.

AMP NZ Office Trust fell well short of its prospectus forecast, which included a revaluation prediction. The trust forecast a net operating surplus of $32.5 million for the June 1999 year, and achieved $36.1 million, but it had a revaluation loss of $18.9 million compared with a forecast gain of $13.3 million.

AMP NZ Office Trust has never recovered from its poor performance in the 1999 year.

Pumpkin Patch is a completely different story as net earnings are expected to be well ahead of forecast and its share price has more than doubled from $1.25.

The company predicted net earnings of $15.3 million for the year to July 31, 2005, but it achieved $12.5 million for the first half, just 18 per cent short of the full-year forecast. Management is now predicting that net profit after tax will not be less than $23 million for the full year.

Pumpkin Patch is the dream float. Any company that substantially outperforms its prospectus is assured of delivering top-class returns to shareholders.

At the opposite end of the scale are Feltex, Frucor and Vertex, three sell downs by overseas private equity funds (although Freightways has been a successful former private equity fund float).

Frucor and Vertex, which were both sell downs by Sydney-based Private Equity Partners (PEP), fell well short of their prospectus forecasts.

Frucor forecast net earnings of $8.8 million for the June 2000 year, compared with $3.2 million in the previous year, and $20.4 million for the June 2001 year. The bullish outlook was mainly based on the anticipated success of the energy drink V.

PEP executives were asked a number of times at the IPO presentation about the reliability of the 2001 $20.4 million forecast. They were adamant that it was achievable, yet the outcome was only $11.7 million, 43 per cent below forecast.

Although Frucor performed well below expectation shareholders were saved by a $2.35 a share takeover offer from Danone, compared with the $1.50 a share issue price.

V's earnings contribution was below expectation but it was one of the main reasons why Danone was interested in Frucor.

Vertex - PEP's other NZX float - also fell well short of its profit forecast.

A Securities Commission report on Vertex was highly critical of the prospectus on the grounds that it was likely to mislead investors, but shareholders have the opportunity to get most of their money back through the current takeover offer.

The Feltex debacle is the worst major IPO in recent times because its share price has fallen further, in percentage terms, than either Frucor or Vertex.

Management is blaming market conditions, analysts are pointing their fingers at management, shareholders argue the directors are responsible and after last year's annual meeting one director criticised the organising brokers.

The truth of the matter is that the company is not particularly attractive, it operates in a difficult sector and, given these factors, the issue was too big. Also, profit forecasts were too optimistic and there was little independent analysis of the company at the time of the issue.

Feltex is probably oversold at yesterday's closing price but it may take a while to recover as Leverage Equities Custodians, the holding company for shares held by margin traders, has been a substantial shareholder and the company is unlikely to attract a takeover offer at anywhere near the $1.70 offer price.

One can confidently predict that Vector is more likely to be a Contact Energy than a Feltex. The power network company is well run, has a strong board, operates in an attractive sector and there will be a large amount of independent analysis to assist potential investors.

The only problem is that there will be far more demand than supply as shares will be made available to nearly 300,000 Auckland Consumer Energy Trust beneficiaries, to Vector bondholders, and there is the prospect of a takeover for NGC that will include a Vector scrip component.

That is the problem with all IPOs - there are plenty of shares available in the poor floats but few available in the good ones.

Vector is assured of a highly successful IPO. All it has to do to achieve post-listing success is to ensure it exceeds the prospectus forecasts.

* Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.