NZX CEO Mark Weldon says the corporate is well-placed to withstand short-term weakness in the market
Over the past couple of months I have spent most of my time raising money for the communities and people of Christchurch.
In that time I have spoken with a very wide range of people. Perhaps the most memorable was a wizened, Yogi Berra type on the East Coast of the United States who, when I was speaking about the earthquake, said to me, "Son, never forget, no matter how many times we stand at the plate, Nature bats last."
I have been reminded of this comment a number of times as I watch with interest the dance hall days of exchange mergers, proposals, counter-bids, and other shareholder-driven corporate transactions in the global exchange landscape. As we saw recently with the ASX, the Government and the stakeholders hold the big bat, and they bat last.
When the Australian Government stopped the ASX takeover by the Singapore Exchange, it showed clear as day that, while many exchanges believe that they are "only a corporate", this belief is not widely held at government level - in both small markets like Australia, and large ones like Canada and the US. The shareholders own the operator, but the stakeholders have veto rights on the future of the market.
What is also clear is that those exchange businesses that have looked to sell themselves - while they may sit on top of great markets - are generally running business models based on reality-stretching assumptions such as "liquidity will keep growing at 15 per cent for the next 15 years".
This strategy, combined with delayed capital expenditure on systems, has put some of these companies in quite a box.
Having said that, if you look at the 75 per cent odd EBITDA margins of the ASX, these are pretty damn comfortable boxes - but strategic boxes they remain.
So, what about NZX? We cannot control the market, so we have chosen as a company not to be reliant on it. As those who watch us closely will have noticed, equity market transactions are now at around only 5 per cent of total revenue at this point, and our economic reliance on this volatile earnings stream is low.
We can benefit on the upside from a great equity market - and we continue to work very hard to make that a reality - but we are not harmed by weak levels of volume such as we have seen over the past few years.
What this means for management, the board and the stakeholders is that, as a corporate, NZX is not in a position of being forced into doing any particular deal.
We now generate substantial free cash flow, and we can therefore both re-invest to stay competitive (as the $40 million spend on new systems and business lines over the last three years shows), and pay significant dividends to shareholders.
Strategically, compared with where we were eight years ago when the ASX takeover fell over, we can make our own decisions, we can fund those decisions, and any short-term weakness in the capital markets does not imperil our ability to invest and provide services to the local stakeholders and customer groups. Being a forced seller is a bad move - and we are not that guy.
So, having taken the downside risk out, and ensured that we are here to provide capital raising, transaction, clearing and settlement services for the long-run, how does the future for NZX look?
Well, it looks pretty good actually. As the CEO of one exchange said to me recently, "NZX has turned itself into a balanced commodities and securities franchise."
Our biggest David and Goliath story is, without question, dairy futures. This year we have traded more than 400 times, while the comparable products on CME (US), Eurex (Europe), and Liffe (UK), have traded ... not at all.
We clearly have the best product, and while we do not yet have the depth of participant and fund manager support that is like oxygen to those established futures markets, it is growing, and will be core to our offering to the New Zealand economy in the future.
This matters. New Zealand is a small nation that is not only subject to substantial exchange rate volatility, but sells its products almost entirely into export markets - which are the most volatile of all. Dairy, for example, is the world's second most volatile agricultural commodity.
To be able to provide risk management tools to our most important sector is a really good thing, and will be good for the economy - which is what is needed to sustain the long-term relevance of the franchise we run in our home country.
In the more traditional equities and bonds markets, on a five-year view, things are looking the best they ever have.
We have a new regulator with a governance structure that makes sense, and a remit that will give investors the confidence they need to invest.
Competitors to the capital markets have rebalanced thus:
* Those parts of the finance company sector, which sucked a good $14 plus billion chunk of usually small investors' money into undisclosed property speculation, have struck out;
* We have a property market that now has realistic and appropriate long-term prospects: decent returns slightly above inflation, based on the idea of a long-term hold;
* As the property bubble has burst, so too has the private equity bubble. The valuations paid based on "the magic of private equity" and the spate of bankruptcies, unfortunately proves this.
And inside the market, the companies are largely healthy, largely cashed up, and just need a bit more confidence to nudge this cash into investment action, which will be healthy for the market. Similarly, liquidity has bounced back, with the last two months the best months of trading I can remember in recent times.
So what about SOEs, and all the other government stuff that is crouching, full of potential, outside the market? Well, there are a couple of things the Government does need to look at first.
One is they absolutely need to remove the frankly weird tax issues from New Zealand shares, and level the playing field with overseas shares.
The other is that regulatory certainty needs to be a strategic priority - including the Overseas Investment Office. Back in 2002 when I started at NZX, waivers and rulings were never published so no one knew how the rules could be interpreted. Now, after eight years of publishing them, there is a high degree of certainty on nearly every rule, which has lowered the cost to businesses.
The Overseas Investment Office is the opposite of this. It is, at best, murky.
Let's take PGG Wrightson as an example. We have the Government's chief scientist extolling the economic benefits to New Zealand of R&D in strategic industries, yet our major private sector, research-led business in pastoral agriculture - the PGW seeds business - passes the OIO test without any transparency into the test applied, meaning it can be cheerfully sold off to overseas interests.
We are left guessing as to how and why the critical IP of this seeds business falls below any sensitive asset threshold, given that New Zealand currently leads the world in pastoral agriculture.
Given that the SOEs are in regulated industries and they want to sell shares to retail investors, the government needs to nail both the tax and the OIO issues quickly.
However, the really big opportunity with SOEs is the mixed ownership, Air New Zealand type model.
Done well, this represents the chance to revolutionise the culture of New Zealand. Timed perfectly with the advent of the Financial Markets Authority, which will give new investors the confidence to participate, and combined with the continuation of KiwiSaver, there is an absolutely tremendous opportunity over the next few years to change the ownership game permanently for New Zealanders.
We cannot expect the Government to do it all. They can chuck the basketball in the air, but it is the private sector that has to finish the dunk. It can be done. But what it will take is not just the Government, but a belief in New Zealand - with matching long-term choices - on the part of the private sector.
At one recent event in Singapore, a prominent Kiwi complained to me that the only calls he took from New Zealand bankers nowadays were asking him to find Chinese buyers for anything agricultural. To really get New Zealand going and growing, it is going to take more imagination and fortitude than this.
Back to NZX. We have strategic options as a corporate, and the cash flow to both reward shareholders and make long-term investments for our stakeholder group. Like Nature, we aim to always bat last, from our home base, which is New Zealand.
