Thinking small is keeping us small

Where would the NZX be without Fletcher Building and its impressive chief executive, Jonathan Ling?

Ling set the sharemarket alight on Wednesday with a $1 billion deal to acquire the American-based Formica Corporation.

When Fletcher Building relisted on Thursday, it had a market capitalisation of nearly $6.7 billion, compared with $4.1 billion when Ling became CEO in August last year and a mere $800 million when former chief executive Ralph Waters started in June 2001.
This remarkable increase in shareholder value has come from strong governance, a growth-oriented management team and several astute acquisitions.

The Formica purchase was announced shortly after depressing developments involving ING Property Trust, Tourism Holdings and Sky City Entertainment.
Last week ING Property revealed it had deferred plans to expand into Japan because its unit-holders believed “New Zealand real estate entities are best to continue investing locally”.

Domestic investors adopted this typically cautious approach even though the trust would draw on the huge worldwide property expertise of the ING Group.
On Monday, Tourism Holdings chairman Keith Smith told the NZX the company’s independent directors unanimously recommended that shareholders accept the $2.80 offer from MFS Living and Leisure because it “is the most value-creating option available to shareholders”.

On Tuesday, SkyCity chief executive Evan Davies announced 230 staff cuts, $33 million of cost reductions and the potential sale of Adelaide Casino, New Zealand cinemas and its 40.5 per cent stake in the Christchurch Casino.

The news was greeted positively by most sharebroking analysts even though it amounted to downsizing the group.

The developments at ING Property, Tourism Holdings and SkyCity are a more common feature of the NZX than Fletcher Buildings’ Formica purchase.

New Zealand listed companies are extremely small and are growing much more slowly than in most other countries.

The average market value of all NZX listed companies was US$331 million at the end of April compared with US$237 million in December 1995.

This ranked us fourth from the bottom in percentage growth, ahead only of the Malaysia, Thailand and Tokyo stock exchanges.

The poor performance of NZX companies has not been the result of currency movements as the NZ dollar has risen from US65.3c to US73.5c since the end of 1995. Average company value growth has been even lower in NZ dollar terms.
The average size of an NZX listed company is now only 22 per cent of the world average compared with 24 per cent in December 1995.

The other feature of the NZX has been the small increase in the number of listed domestic companies, from 135 to 149, since December 1995. The NZX now has only 0.4 per cent of all listed companies compared with 0.8 per cent in 1995.

The poor performance of the Malaysian market, in terms of company size, has been mainly because of a huge increase in total listings from 523 to 1016 since 1995.

The number of Tokyo listings has risen from 1714 to 2394 over the same period, while the Thai market peaked at the end of 1995, slumped badly during the Asian crisis and has never fully recovered.

The recent developments at ING Property, Tourism Holdings and Sky City clearly demonstrate why our companies, and the number of NZX listings, are growing extremely slowly.

The listed sector is not making a significant contribution to the country’s economic growth because there are far too few Jonathan Lings and Fletcher Buildings.
When ING Property launched its Japan strategy on April 4, it posted an impressive presentation through the stock exchange. It clearly enunciated a low-risk strategy that would use the local experience of ING Real Estate, and be earnings-per-unit-positive with an initial target of $200 million.

This proposal would be welcomed by investors in most other countries.
Some institutional shareholders were opposed to the strategy, reflecting their conservatism and lack of vision. Property is a cross-border activity and a lot of foreign money is invested in New Zealand.

If New Zealand shareholders take a negative attitude towards sensible and conservative international expansion plans, our companies have limited growth opportunities.

The offer for Tourism Holdings has been recommended by independent directors even though MFS Living & Leisure is smaller than the target company and the New Zealand group has a relatively low ev/ebitda multiple.

A full analysis of the Tourism Holdings offer cannot be made until the independent appraisal report is issued on Monday but the ability of overseas investors to anticipate higher growth prospects for our companies, and to make successful takeover offers based on these perceptions, is a major contributor to the NZX’s poor performance.

The market’s positive response to Sky City’s downsizing is called the “7 per cent rule”. This rule is based on Wall St’s widely held belief that companies announcing major staff layoffs experience an immediate 7 per cent share price appreciation.
Broker analysts respond positively to these layoffs because their share price valuations rise when lower staff costs are dropped into their financial models.
But recent studies show that these gains are short-lived as cost-cutting erodes morale and affects operations. In other words, cost-cutting is a short-term strategy that is unlikely to have long-term benefits.

The most surprising aspect of SkyCity’s announcement is that the group’s board allowed chief executive Evan Davies to make the downsizing announcement when he is responsible for most of the problems identified in the review.
Surely the best option would have been to find a new chief executive with a fresh and positive view of future prospects and agree to downsizing only after this person had determined there was no other option.

The SkyCity situation clearly demonstrates that one of the reasons our listed companies are growing relatively slowly is because boards are reluctant to replace poorly performing chief executives.

An important indicator of management competency is the clarity of announcements and presentations to the stock exchange.
ING Property made a clear case for investing in Japan yet large unit-holders blocked the proposal.

But this week’s SkyCity stock exchange release was vague and short of detail. It was difficult to understand when and where the $33 million cost- cutting would occur, or the current trading position of the struggling Auckland VIP operation.
The Fletcher Building presentation on the Formica acquisition was informative and detailed. It presented a compelling case for the purchase and investors responded accordingly.

This is the group’s fourth major recent acquisition following Laminex for A$660 million ($725 million) in November 2002, Tasman Products for A$230 million ($253 million) in September 2003 and Amatek for A$530 million ($582 million) in March 2005.
Fletcher Building has shown that a clear and well-executed growth strategy can create enormous shareholder wealth. The NZX and the domestic economy are underperforming because there are too few Fletcher Buildings and far too many cautious investors and directors as reflected by ING Property, Tourism Holdings and SkyCity.

Average Listed Company Size – The NZX has the small ones