Brian Gaynor: Hodgson's choice saves Unlisted's neck

Commerce Minister Pete Hodgson saved Unlisted from the guillotine this week when he said the new sharemarket would not be regulated.

This completes a process that was initiated last year by the former Minister of Commerce, Margaret Wilson.

Wilson was adamant that the new market should be regulated. A media statement, issued on December 15, quoted her as saying: "Unlisted should offer its investors the protection of securities law so that they are kept fully informed about their investments and are protected from the likes of insider trading."

But only two of the 25 submissions supported regulation. These were from the NZX, an Unlisted competitor, and the Securities Commission. Several organisations, including 13 companies trading on Unlisted and the Institute of Directors, opposed the move.

Hodgson believes there is not enough evidence that Unlisted will harm New Zealand's securities markets. But he said Unlisted will continue to be monitored because retail investors might not fully appreciate the differences between it and the NZX.

He also said the Unlisted market would be regulated in some form in other countries and "should trading volumes increase significantly, or concrete evidence of investor confusion arise, the issue of regulation may need to be reconsidered".

Hodgson's decision means investors can continue to buy shares through two totally different markets.

Unlisted is a small market, with a total capitalisation of just under $1 billion, which is completely unregulated. By comparison, the NZX has a total value of $62 billion and has a high level of investor protection.

The NZAX, or alternative market, which was established by the NZX in November 2003, is similar to Unlisted. NZAX attracted its first listing a few months after Unlisted was established by M-co, the operator of the New Zealand electricity market.

The biggest difference between the two markets is in the area of regulation. The NZAX is subject to continuous disclosure requirements, related-party transaction rules, director disclosure requirements, substantial security notices, insider trading regulation, listing rules, broker regulation, Securities Markets Act oversight and Securities Commission supervision.

As Unlisted is subject to none of these requirements, investors in the NZAX have a far greater level of investor protection.

The NZAX is run by the NZX, which has a sharemarket capitalisation of more than $100 million. The NZX has to make a full disclosure of its financial position and major shareholding changes.

By contrast, Unlisted is run by Efficient Market Services, which has only 988,974 shares on issue and its shareholders are difficult to determine from public records.

In terms of listings, the NZAX has 23 companies with an average market value of $20.7 million, whereas Unlisted has 21 companies with an average capitalisation of $44.3 million.

Thus the average size of an Unlisted entity is more than twice that of an NZAX company, even though the former is supposed to be small company orientated.

It is difficult to compare the returns of the two markets because Unlisted does not compile a performance index. But the performance of NZAX has been relatively disappointing.

The NZAX gross index has risen 17.2 per cent since it was established on November 17, 2003. Over the same period, the NZSX10 gross index has increased by 40.1 per cent, the NZSX midcap gross index by 41.8 per cent and the NZSX small company gross index by 46.0 per cent.

One of the best ways to assess the two markets' performance is to compare the share prices of the largest companies. As far as the NZAX is concerned, the six largest companies represent 56 per cent of total capitalisation while the six largest Unlisted companies account for 68 per cent of the market's total value.

In the past 12 months the share price performance of the largest NZAX companies has been: Just Water, 27 per cent; Zintel, minus 34 per cent; Plus SMS (formerly RetailX), minus 47 per cent; Livestock Improvement, minus 4 per cent; NZ Wool Services, minus 10 per cent; Oyster Bay Vineyards, 41 per cent.

The performance of the largest Unlisted companies over the past 12 months has been: Skyline, 19 per cent; Rangatira, 7 per cent; St Laurence notes 5 per cent; King Country Energy, 27 per cent; NZ Rural Property Trust, 20 per cent; Open Country Cheese, 55 per cent.

These figures demonstrate that the largest NZAX companies have not done as well as their Unlisted contemporaries or as well as the broader NZX market. In the past 12 months, the NZAX index has fallen 7.4 per cent while the NZSX50 gross index has risen 20 per cent.

But, when it comes to trading volume and liquidity, the NZAX is well ahead of Unlisted. In the past 20 business days, the NZAX has had 628 trades compared with 142 on Unlisted. NZAX has had 14.8 million shares traded worth $4.2 million whereas Unlisted has had only 1.3 million shares traded with a value of $1.3 million over the same 20-day period.

There is relatively little trading in Skyline and Rangatira, the two largest Unlisted companies. Since June 30, only $34,627 worth of Skyline shares and $17,100 Rangatira shares have been traded. In the same period, $219,817 of Just Water and $24,200 of Zintel shares have gone through the NZAX.

One of the other disadvantages with Unlisted is that companies may come and go as they please, whereas NZAX companies are unlikely to delist because they don't like what is happening to their share price.

Jim Scott's Aquiline Holdings joined Unlisted at the end of 2004 and its shares immediately traded at $9. This was well below the $20 price the company had set for the January to June 2005 period (Aquiline set its share price before joining Unlisted).

When Aquiline's share price dropped to $5, Scott decided it was time to remove his company from Unlisted. The Hastings-based company hasn't issued a press release since March 2, whereas it made more than one a week during 2004.

But the most important difference between the two markets is the level of disclosure. Skyline's profit release for the March 2005 year was extremely brief and only contained the pre-tax and after-tax earnings figures.

The company doesn't release half-year figures and its website hasn't an investor relations section or copies of annual reports. It is extremely difficult to find information on Skyline.

By comparison, there is extensive information available on Just Water through its own and the NZX website. The Just Water site has copies of annual and recent interim reports.

The water company has made 13 announcements to the NZX this year whereas Skyline has made only one.

Most Unlisted companies have a higher level of disclosure than Skyline but there is no requirement for them to make any market announcements. If an Unlisted company is performing badly, it does not have to keep investors fully informed and there is the potential for insider trading as these regulations do not apply to Unlisted.

This week's decision has saved Unlisted but it is important to remember that it is far more risky than the NZX and its NZAX market because of the absence of regulation and disclosure requirements.

Disclosure of interests; Brian Gaynor is an NZX shareholder and an executive director of Milford Asset Management.