This article originally appeared in the NZ Herald.

How much more damage can Fletcher Building do to itself, its 37,800 shareholders, the NZX and the reputation of our business leaders?

Hopefully, most of the damage has been done but one never knows with Fletcher Building as the company falls into big black holes on a regular basis.

The latest saga began on Friday, April 13 when the Sydney Morning Herald reported that “Australia’s Wesfarmers has bought a stake of about 3 to 4 per cent in the strife-ridden construction and industrial materials company Fletcher Building, according to some sources close to Wesfarmers”.

The report went on to state that “there is growing speculation the Perth-headquartered giant has already identified Fletcher Building as one potential acquisition target”.

These comments were clearly speculative — and unlikely to be true — because no one “close to Wesfarmers” would reveal this information and a potential bidder would not want to disclose its position before it had to.

In addition, the newspaper report quoted a Fletcher Building spokeswoman as saying: “We are not aware of a shareholding in the name of Wesfarmers in Fletcher Building”.

Nevertheless, Fletcher Building shares opened at $6.52, 68 cents or 11.6 per cent above the previous day close.

Its shares closed at $6.34 that day with 8.7 million shares traded on the NZX and ASX compared to an average daily volume of 3.3 million shares over the five previous days.

Investors who purchased Fletcher Building shares on April 13 have every right to be aggrieved, particularly if their buying decision was influenced by the Wesfarmers’ story.

Fletcher Building was back in the headlines on Tuesday with an early morning announcement that it would be raising $750 million worth of new equity. This would be through a fully underwritten pro rata issue on the basis of one new share for every existing 4.46 shares at $4.80 each.

The capital raising had a negative impact on the overall market because investors had to sell shares in other companies to participate in Fletcher Building’s accelerated issue.
The $750m raising was huge as only $125m of new equity was raised on the NZX in the first three months of 2018.

Investors are keen to purchase new equity that is used to fund growth but they are far less enthusiastic to contribute capital to fill black holes created by poor governance and management, as has been the situation with Fletcher Building. These rescue capital raisings are usually at a big discount to the previous share price.

Fletcher Building’s $4.80 a share capital raising price compared with its previous closing price of $6.27, a 23.4 per cent discount.

The company’s stock exchange release made it relatively clear that the group’s United States Private Placements (USPP) agreements had been a major driving force behind the large capital raising.

Fletcher Building’s accounts for the first half of its June 2018 year showed that it had $1,150m of USPP borrowings and the company had breached important covenants in relation to these loans, mainly because of its substantial construction losses.

The USPP market provides an alternative source of long-term debt to the traditional bank market without the need for a formal credit rating and the reporting requirements of public bond markets. Most of these funds are supplied by US insurance companies.

The USPP market is often referred to as the market that borrowers go to when they can no longer secure bank debt.

The USPP market is relatively illiquid as far as investors are concerned and to compensate for this USPP agreements have several covenants that can be quite draconian if breached.

These include a requirement to repay loans at a premium to their face values. Fletcher Building’s stock exchange release revealed that the cost of repaying its full $1,150m USPP agreements would be an additional $125m.

The USPP investors would have had access to more detailed information than Fletcher Building’s shareholders, particularly on the group’s construction projects.

The huge size of the capital raising seems to indicate, in this columnist’s view, that USPP investors are not convinced that the group’s construction problems have been fully resolved.

In this columnist’s view, this is where Fletcher Building shareholders have been badly let down by chairman Sir Ralph Norris and his fellow directors.

Companies with USPP agreements need strong governance to ensure that they do not breach their USPP covenants. Norris, as a former banker, should have been completely on top of this issue.

These private placement loan structures can be a major negative, as demonstrated by the collapse of Carillion earlier this year.

Carillion, the large UK construction group, also experienced large project losses and had USPP loan agreements and an exposure to the Schuldschein market, the German equivalent of US private placements.

The other disappointing Fletcher Building news this week was the first indication of problems on its Puhoi to Warkworth motorway project.

This motorway project, which is expected to be finished in late 2021, is New Zealand’s second state highway Public Private Partnership (PPP), after the Transmission Gully motorway project in Wellington.

The new motorway is 18.5km long and has a “net present” contract price of $709.5m.

This week’s trading update stated; “In the infrastructure business, the Puhoi to Warkworth project site team has identified risks and forecast cost increases associated principally with earthworks and aggregate supply on the project.

“The project is a 50-50 joint venture between Fletcher Construction and Acciona. The partners are now working actively on a range of options to mitigate these risks. At this point, Fletcher is reporting a nil margin project.”

Although only 8 per cent of the Puhoi to Warkworth motorway is completed, this statement is a major disappointment because senior management had assured investors that the project would be profitable.

This positive outlook was mainly based on the considerable highway expertise of its joint venture partner, Madrid-based Acciona.

At this stage, it is difficult to determine whether the Puhoi to Warkworth project will make a profit, break even or experience a loss and whether it will be finished on time.

There are also continuing concerns about the completion dates of the New Zealand International Convention Centre and Commercial Bay projects in downtown Auckland.

Fletcher Building also announced this week that it would sell Formica, which was purchased from private equity interests for $1,050m in mid-2007.

The acquisition was funded by $308m of new equity raised from shareholders and $742m of debt.

The NZ company argued at the time that the acquisition was attractive because Formica had a leading market position, favourable industry structure and strong management.

Mark Adamson was listed as President, Europe based in Newcastle. Adamson later became CFO of Formica and then CEO of Fletcher Building.

The timing of the Formica acquisition was a disaster — as has been the case in this columnist’s view with many of the Fletcher group’s strategic decisions — mainly because the GFC was just around the corner. Formica failed to meet its pre-acquisition profit forecasts, although earnings have improved in recent years.

Formica, which is based in Cincinnati, Ohio, will be sold because it no long fits into a group that will now focus on New Zealand and Australia.

Fletcher Building will be fortunate to get its $1,050m purchase price back when it sells Formica.

But the one important issue not addressed this week was the replacement of outgoing Chairman Sir Ralph Norris and general board refreshment.

Norris said he would resign this year but there was no update on his successor.

Why didn’t the board have an internal succession plan for Norris? When is it going to appoint directors with construction contract and USPP agreement experience? Why can’t it attract directors with this expertise, particularly as Norris was paid $435,000 last year?

Fletcher Building’s revival won’t be fully completed until it appoints board members with strong industry experience.