Brian Gaynor: Under-stocked market is a warning

Stock exchange chief executive Mark Weldon has given a timely reminder that the sharemarket's shrinking capitalisation should be a warning for policy-makers.

His words came after Feltex was sold to Australian company Godfrey Hirst, Bacardi bid for 42 Below and Woolworths entered the battle for control of The Warehouse.

Weldon's comments are important because sharemarkets play vital roles in economic growth and wealth creation in free enterprise economies, and a shrinking market is a bad sign for economic prospects.

Figures compiled by the World Federation of Exchanges show the NZX well behind most other sharemarkets, particularly over the past 12 months.

The past 10 years have been a great period for economic and sharemarket growth. The total capitalisation of the federation's 51 member sharemarkets rose from US$17,124 billion at the end of 1995 to US$45,209 billion at the end of August this year.

The Warsaw Stock Exchange, which has grown more than 25 times to US$117 billion, had the highest growth rate for the decade; the Philippine Stock Exchange, which declined from US$59 billion to US$49 billion, was the worst-performing market.

There is a strong relationship between economic and sharemarket growth. Ireland and Korea, the two best performing OECD countries over this period, had strong stock exchange growth, whereas the Tokyo sharemarket and Japan's economy both performed relatively poorly.

Only the markets of the Philippines, Malaysia and Thailand have grown more slowly over the past 10 years than the New Zealand market.

In the past year, the capitalisation of the NZX has fallen 17.2 per cent, by far the worst of the 51 exchanges.

The highest growth markets over this period have been Shanghai, up 58 per cent, Jakarta, up 55 per cent, and Warsaw up 52 per cent.

The total capitalisation of the NZX declined 11 per cent over the past 12 months.

Since December 1995, its value has risen 15 per cent.

The NZX now has 1/1220th of the world's total sharemarket capitalisation compared with 1/535th in December 1995.

The other feature of the NZX is that the average value of listed domestic companies has remained virtually static since December 1995.

The average value of 36,858 companies listed on the 51 exchanges was US$1227 million at the end of August compared with an average of US$636 million for 26,936 listed companies at the end of 1995.

There are several reasons for the NZX's small growth. They include:

* Financial organisations, particularly banks, have grown strongly, whereas most of New Zealand's major financial groups have been sold to Australian interests. For example, the combined market capitalisation of the two Irish banks, Allied Irish Banks and Bank of Ireland, is nearly 15 per cent greater than the total value of the NZX.

* New Zealand directors and shareholders are quick to accept takeover offers. As a result, many of our big companies have been acquired by foreign interests.

* New Zealand has an open door policy on foreign ownership, whereas other countries have ownership restrictions on important assets. Australia severely limits overseas interests' ability to buy banks and media companies.

* The NZX is dominated by former Crown-owned enterprises. Former Government or quasi-Government owned companies including Telecom, Contact Energy, Auckland International Airport and Vector make up nearly 40 per cent of the NZX50 gross index. These companies are often subject to regulation, which reduces value creation.

* Attempts by several large companies - including Telecom, Air New Zealand, The Warehouse and the former Fletcher Challenge group - to expand overseas have run aground. The good news is some companies, including Fletcher Building and the two Fisher and Paykel companies, have been more successful overseas.

* The NZX was hopelessly governed in the 1990s and did not act to restore investor confidence after the 1987 crash.

* New Zealanders have a stronger appetite for housing than the sharemarket. This is partly because of a lopsided tax system that strongly favours property. As a result, New Zealanders have 76 per cent of their gross assets in residential property compared with 60 per cent in Australia and 38 per cent in the United States.

* New Zealanders are poor savers and have little superannuation money available for sharemarket investment. Compulsory superannuation has been a huge boost to the Australian sharemarket, and the country has A$545 billion of superannuation assets compared with $19 billion in New Zealand. This is A$26,400 for every man, woman and child in Australia, against $4700 for each New Zealander.

* New Zealand doesn't seem to have the same desire as other countries to create great business dynasties. We don't have the equivalent of a Packer or Murdoch or Lowy dynasty as in Australia. The last big listed family-controlled group was Fletcher Challenge, which had to be broken up after it overstretched itself.

Many of New Zealand's more successful and entrepreneurial business people cash up early. Craig Heatley was a good example of this at Sky Television.

The takeover offer for 42 Below is an excellent example of this phenomenon, and it also epitomises the strengths and weaknesses of the New Zealand sharemarket.

In 2003, 42 Below issued 31 million shares to the public at 50c each, plus one free warrant for every three ordinary shares to be exercisable at 50c

The original shareholders were earlier issued 90 million shares for $1.98 million or 2.2c a share. The main original shareholders were managing director Geoff Ross with 41.4 million shares and Grant Baker with 24.3 million.

The company always maintained that one of its main objectives was to create a powerful brand and sell out to a major international drinks group.

In this regard, it was extremely successful - Bacardi offered 77c a share even though 42 Below has never made a profit.

But why has 42 Below, like so many New Zealand companies, become an incubator for overseas investors? Why are Ross and Baker selling out at such an early stage?

Is it because they were issued shares at 2.2c each and will make a huge profit at the 77 cents a share offer price?

Is it because they believe it is too difficult for a New Zealand company to conquer world markets on its own?

Is it because there isn't enough risk capital available at home to finance a worldwide growth strategy?

Ross and Baker are to be congratulated on their success. But it would have been great to see 42 Below become a worldwide success as a NZX-listed company with all the benefits coming back to its home country.

* Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management.