Brian Gaynor: NZX still not within a bull's roar of ASX

The bulls are roaring and the two major Australasian stock exchanges announced bumper profits this week.

The Australian Stock Exchange (ASX) boosted net earnings by 18.8 per cent for the first half of its June 2005 year while the New Zealand Exchange (NZX) raised its net earnings, before non-recurring expenditure, by 89.3 per cent for the 12 months to December 31.

Their operating margins (ebit to revenue) were also impressive. The ASX raised its ebit margin from 46.4 per cent to 48.8 per cent and the NZX from 25.1 per cent to 32.8 per cent.

Investors have reacted positively to the strong profit performances as the ASX's share price has risen 30.4 per cent in the past 12 months and the NZX's 32.2 per cent.

The big question now is whether the NZX is merely riding the bull market waves or whether it can still grow even when market momentum slows.

The NZX is tiny in an absolute and relative sense. At the end of 2004, it represented just 0.11 per cent of the world's sharemarkets in value terms compared with 0.19 per cent at the end of 1995. Its total capitalisation relative to New Zealand's gross domestic product (GDP) is 44 per cent compared with 120 per cent for the ASX and an average of 80-plus per cent for the world's sharemarkets.

On a population basis, Australia is five times larger than New Zealand and, in GDP terms, it is 6.3 times bigger.

But as the accompanying table shows, the ASX is more than 15 times larger than the NZX in terms of group revenue and earnings, market capitalisation and trading volume.

This is mainly due to New Zealand's continued reliance on primary production, the overhang from the 1980s bubble and the inept governance and management of the NZX during the 1990s.

The good news is that chairman Simon Allen and chief executive Mark Weldon have narrowed the gap between the NZX and ASX, but there is still a long way to go before the Australian bourse is no more than 10 times larger than the NZX.

Stock exchanges make their money from a number of sources including listing fees, market trading volumes and the sale of information.

Listing fees are extremely important as they represent 25 per cent of the ASX's revenue and 35 per cent of the NZX's income. New listings are the lifeblood of a bourse as fees have an initial and annual component.

The ASX's listing fee is between A$6710 and A$133,100 per annum, based on the market capitalisation of a company, whereas the NZX charges between $10,000 and $180,000.

Although 2004 was a bumper year for the NZX with 29 new listings, it was still well behind the ASX in terms of net companies added. The New Zealand market added 23 companies, after six removals, whereas the Australian bourse had 109 net additions.

One of Weldon's biggest challenges is to convince more New Zealand companies to list as there are only 192 listed domestic companies compared with 361 at the end of 1987.

In terms of market capitalisation, which has an impact on listing fees, the ASX also had a better year. In 2004, the total value of Australian companies listed on the ASX rose by A$213 billion or 27.5 per cent whereas the NZX's total capitalisation increased by $11.5 billion or 22 per cent.

The other main source of stock-exchange revenue is trading and clearing. This represents 59 per cent of the ASX's revenue but only 26 per cent for the NZX.

Trading volume is the NZX's weakest area as in the six months to December 31 it had a daily average of only 2575 trades - at an average income to the exchange of $6 a trade - whereas the ASX had a daily average of 79,915 trades, at an average income of $5 a trade.

The ASX has a well developed derivatives market, mainly options contracts, and also has a large number of listed warrants. The NZX is weak in these areas and one of Weldon's objectives is to develop an options market and encourage brokers to list more warrants.

He is also endeavouring to raise market volume through direct market access, which allows large institutions to have access to its trading system, and is hoping that tax legislation changes will encourage short selling.

What are the odds of Weldon achieving a big increase in trading volume?

They are quite good when his initiatives, Government plans to encourage savings, the ASX and Irish Stock Exchange (ISE) are taken into account.

The ISE had total share and fixed interest turnover of 144.8 billion ($264 billion) in 2004, whereas the equity and fixed interest turnover of the NZX was only $27.5 billion in the same period.

The ISE figures demonstrate that the NZX has the potential to grow its trading volumes as Ireland has the same population as New Zealand.

The sale of market data, which represents 11 per cent of ASX revenue and 17 per cent for the NZX, is a relatively low growth area. Weldon still believes there are opportunities in this area and is hoping to convince several Australian information suppliers to buy data from the NZX.

The Wellington-based exchange is not relying solely on additional listings and higher trading volumes to generate growth; it is also expanding into fund management and registry services.

Although the Fonz issue raised far less than expected, the NZX has nearly $200 million under management. This forms a good base to launch additional exchange-traded funds.

It has also formed Link Market Services, a 50/50 joint venture with ASX Perpetual Registrars of Australia, which has bought BK Registries of Ashburton. This operation probably has limited growth prospects because Computershare has a stranglehold on the New Zealand registry market.

A disappointing aspect of the NZX's result was the number of analysts and stockbrokers who want the NZX to curtail its expenditure and investment and have a 90 per cent dividend payout ratio. This is in spite of the fact the company has proven it can grow the revenue line far more quickly than the expense line and the domestic stock exchange suffered badly from under-investment in the 1990s.

Surely one of the main objectives of shareholders and analysts is to encourage executive teams to invest, particularly when they have demonstrated they can create value and the organisation still has a long way to go before it achieves the revenue and earnings of its peer group.

But the good news is that the NZX should be able to pay a 40c fully imputed dividend in the years ahead; the 40c dividend for the December 2004 year is a special dividend because the company is generating over $4.5 million in operating cash flow, has $20 million in the bank, no debt and the 2004 dividend costs $5.1 million.

The 40c special dividend was just the right call. It indicates that the NZX can pay a high dividend but the board hasn't committed the company to such an extent that Weldon can't take advantage of wealth-creating investment opportunities when they arise.

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