Episode 2 of the Curious Kiwi Capitalist Podcast Show

9th August 2019

My guest for this show is David Quigg. David is the head of Mergers & Acquisitions at Quigg Partners a boutique Wellington law firm specialising in M&A and a few other specialist areas.

In this show we’ll discuss M&A from a lawyer’s perspective including:

• publically listed company M&A process and the differences with private company M&A
• a practical approach to buying and selling a company including agreeing on key terms in an MOU (while being careful about what is binding)
• how a fixed auction process is unusual in a private M&A transaction unless it is a large transaction
• NDAs, key clauses and enforecement
• Earn-out briding a price gap but causing problem down the track
• the need for early OIA approval in the case of a foreign investor
• due diligence and retentions
• representations and warranties
• shareholders agreement, including drag-along carry-along and Russian Roulette clauses
• why asset sales (rather than share sales) are preferred by buyers even in larger transactions if possible
• net asset adjustments in a share sale

Show NotesAbout David

David Quigg has a LLM, was a member of the NZ Takeovers Panel for a decade and has an international reputation as one of New Zealand’s top M&A lawyers. Quigg Partners were established in 2000 and now have 17 lawyers. You’d recognise a number of famous international and local company names they have represented over the years.

Links

David Quigg and Quigg Partners

“M&A and Business Sale Legal Process with David Quigg” show notes.

Transcript: M&A and Business Sale Legal Process with David Quigg

Bruce: Welcome David to the podcast.
David: Thank you very much indeed Bruce.
Bruce: Thank you for doing this, it’s a complex area this particular part of the M&A process and I’m sure the law as well. What’s the process that you see and where do lawyers get involved in that M&A process?
David: The first one is probably to differentiate between public M&A and private M&A. Public M&A is a lot more in the public domain. It’s much more regulated by the Takeovers Act or if you’re doing a scheme of arrangement the rules that govern schemes and also you’ve got the factor in the stock exchange listing requirements, insider trading restrictions etc.
Yet private M&A is perhaps less of that regulatory regime and much more contractual and negotiation in private as well. So from a lawyer’s perspective differentiating between those two kinds of Alternatives is quite critical and you’d have to say in New Zealand we don’t have a huge amount of public M&A.
So the the public M&A amount perhaps our last involvement was for McDonald’s in respect of the investment and Plexure that is kind of one-and-twenty as in the public M&A space. Most of the New Zealand transactions is in the private M&A and its contractual based.
Bruce: Yes. Perhaps let’s talk about the simpler process first the private M&A and then at the end if we have time talk about the differences with public. When a client approaches you and they might be selling or acquiring, what’s the process that you see perhaps for a mid market size business, perhaps choose your figure choose your transaction time. And as you go through that process where do they ask for advice?
David: I think the earliest they get the lawyers involved the better. Now, that’s obviously a bit of a self-serving statement.
The beauty of getting the lawyers involved in particularly ones that do a lot of these transactions it is they get those milestones quickly and you make good progress and you can set a realistic timetable. The first one that normally comes up is the discussion about should we have a term sheet, heads of agreement etc?
In New Zealand would strongly recommend that you do because what that does do is get agreement on price. So that’s not legal agreement, that’s a commercial agreement. So all things being equal. I’m prepared to pay $20M say for the tech business that you’ve got. And so what that means is, well, If we’ve got a meeting of minds on that subject to due diligence subject to the documentation, let’s agree to that and let’s agree on confidentiality. So there will be a built-in confidentiality non-disclosure agreement, but also from a probably the purchasers point of view, exclusivity.
So unless you’re going out to Tender, because most of the transactions are private, negotiated transactions giving some form of reasonable exclusivity, 20 working days, whatever at to enable the documentation and the due diligence to proceed. I think that’s one thing that we would notice in New Zealand, our heads of agreement term sheet MOU whatever you want to call it, is generally a lot shorter than overseas.
So we really do concentrate on confidentiality that commitment from both sides, commercial agreement that’s non-binding commercial agreement and respect the price or a formula for how you deal with price and then a binding commitment in respect of exclusivity access to due diligence etc.
And that we would say you can do in two pages. Often if you’re dealing with American experience or Australian that will be up to 10 pages or more. We personally generally New Zealand prefers it shorter because it’s less involves the lawyers. It’s more likely to be able to be negotiated in a week point of view, and enables the clients to get on with the business.
And so that’s the first step.
Bruce: It’s interesting isn’t it, there is many people who only know about a fixed process, so you have rounds or fixed dates as you go through and essentially an auction process, with a group being taken out in the first round, another group taking out the second round, leaving the the first successful possible buyer, and yet that really happens. Perhaps it happens in the public stock market but really it is trying to get, from a sell-side perspective, trying to get the buyers to actually make an offer perhaps at the same time and comparing different offers.
David: I agree that you know, sometimes you get that competitive process that’s generally in the bigger range of the assets.
I mean a recent one was Tip Top obviously was sold in the public M&A space you get that partly depends on whether it’s a buyers’ market or vendors’ market, obviously at the moment, you know, the private equity are significant players in the bigger size transaction.
In New Zealand, that’s great. We just don’t have that many big transactions that can normally justify the tender process or auction process. So most of them particularly in the tech space which we involved in a lot. They are mid-market or at the lower end, you know, 25 million to 50 million and then they are normally negotiated transactions not tender. And therefore you go through the MOU heads of agreement as your first step.
Bruce: So the M&A advisor, the investment banker, has reached out to a foreign big tech company. I don’t know, you represent some big tech companies, they’ve asked the big tech company to sign a nondisclosure agreement.
What are the different clauses in that non-disclosure agreement that are key to negotiation?
David: Well a non-disclosure is mainly that you’ll keep the information confidential and that you’ll only use it for the purpose of assessing whether your bid or not. There’s not been in New Zealand any significant litigation that I’m aware of on confidentiality agreements, there has been overseas particularly in the US, but there again normally quite relatively standard documents these days that you’ll receive the information, you’ll keep it confidential, and you’ll only use it for that restricted use.
Sometimes, where you need to be careful, that there’s a restraint in the confidentiality agreement. That’s not the norm in New Zealand. That may be appropriate, if in fact they’re already a very strong competitor so you’re worried about that they could get that information, the transaction falls over and then they could use it against the vendor effectively or potential vendor.
Bruce: In terms of the term and the indemnity clause what do you find the normal term of the agreement is?
David: Normally now it’s two years. So that that it would apply for two years. It used to be open-ended 5-10 years ago, but there’s a norm that it’s now just two years. I think there’s…sometimes you’re going to have a fight about the indemnity provision. They’re probably in it 70 / 30 percent they’re included. The main thing that you’re looking there for is it’s limited to strict breach obligations. There’s a good argument some overseas parties make that they just don’t give indemnities. To be honest, it’s not a deal-breaker whether it includes a doesn’t include an indemnity. Kind of shifts the onus of proof a wee bit, but other than that, you’ve still got to litigate if in fact you’re looking to enforce them.
Bruce: It’s a key point that no one’s actually taken any action against someone has breached an NDA and, from afar, I think I have seen breaches and I think for more worldly clients understand that is only so much protection they have from an NDA regardless of the fact that it’s a legal agreement.
Okay. So both parties have signed an NDA. Information has been exchanged and then the the acquirer has decided to make an offer, I like to call those non-binding indicative offers NBIOs. I know they’ve got all different sorts of names and perhaps the form of the agreement rather than the name of the agreement what matters here.
What are the key terms in that NBIO we’ve covered some of those already?
David: Well again, it’s priced and is it formula-based, you know, is it structured as a upfront earn-out component?
Again, depending on where you want to see the debate or the time spent our one is to get the commercial agreement that you know, is it going to be all upfront or is it going to be an earn-out based? Earn-outs are an obvious way of trying to split the difference when there’s a vendor that wants you know $10 and the purchases offering $5. So you kind of split the difference and say well we’ll do an earn-out if x y&z happens.
Our word of caution on that is that earn-outs are very easy to say, they are incredibly difficult to document and then also they are significantly difficult to implement, because obviously for the period of the earn out the vendor is as interested in the business as is the purchaser. So there’s that period where the purchase is paid over the fixed amount, let’s say it’s 5 out of the 10 and there’s a two and a half on earn out and yet if it lasts or it’s complicated effectively the business is going to be run more by the vendor to the earn out result rather than to the purchaser who may want to rationalize it put it together with their other business, etc.
As much as a commercial bonus in terms of bridging the gap of price, there is a cost in terms of just how difficult that is how complicated you making it and it really for us as lawyers, it’s fantastic because we don’t shut the file, you know, the file is left open for the period of the earn out because you’re going to be lawyered up for that two-year period. That’s not necessarily good for a purchaser because they want to get on do things to it yet the vendor will want certain restrictions as to what you can do to operate the business during the period of the earn out.
Bruce: The incentives that earn-out creates versus the different outcomes that the two parties are looking for,it’s a good point.
The other issue we see is which line item has been used to drive that earn-out amount whether it’s volume, pretty simple, revenue probably reasonably simple, but earnings, EBITDA, by golly, they can be playing around with so why…
David: And then you get the accountants and you get the games that people play as you say if it’s if it’s a revenue figure turnover figure which is, you know, less likely to be played around with.
But as you say once you get into EBITDA it is so…in the accounting kind of debate on various things of obsolescence or whatever. Can be so variable.
Bruce: Yes. So we have that NBIO, what do you call the NBIO, what’s your standard?
David: Well, no, we we don’t really have a standard….
Bruce: Heads of Agreement
David: Or MOU, heads of agreement, term sheet. All of those are kind of a mixture of them.

Bruce: We’ve reached agreement, often by the way, also that agreement is between the lawyers isn’t it rather than between he vendor and the acquirer, the purchaser lawyers often play a part..
David: We would at that instance, we would hope that the clients are more driving that position because it effectively it isn’t intended that would be a binding arrangement. You’re trying to reach a commercial agreement and therefore our experiences would like to check that we’re not being set up or our client isn’t being set up by, you know, little wxpressions you can put in those clauses or in those agreements I should say.
We would see that as more client lead. When you doing the definitive agreement than the bigger document that’s much more lawyer lead. And would like to try and to get the client’s to hopefully build a wee bit of relationship at that stage because that builds momentum. And it also builds the expectation, which we would see is as very valuable.
We do see that that earlier stage of the agreement, we would raise, you know a timetable so that we’ve got the legal document that’s fine and dandy, but either as part of that or a schedule or something just worked kind of adjacent to that is the timetable.
So are we aiming to close at the end of July? You know, we’re in June now or are we doing it for August/September? So that expectations can be kind of built into the process because without that the the process can kind of meander and that’s not good. One that we were involved with recently our client, which was a very well-versed North American client came to it at the end and saying look, you know, the vendor was getting deal fatigue, you know, we need to wrap this up.
You know, there are small New Zealand, you know tight knit group of vendors they’re getting…so it was a really useful discipline that we you know, we had some very interesting legal issues. But we were given the firm guidance from the client that now is not the time to play legal games that you know, the commercial momentum was now waning somewhat and you had to bring it to a conclusion.
So, you know those kind of sign posts are very useful because everybody wants to either make the deal or not. You don’t want to kind of spend a lot of money and on advisors and then it’s for nought.
Bruce: Though, the intermediaries, whether they’re financial or legal intermediaries, can often take that heat out of that discussion as well I find.
We see two steps from from here from them NBIO, one is they go into due diligence or two is that a little bit more discussion is held and then it goes into a sale and purchase agreement with due diligence after that which depends often on the two parties and their lawyers. What do you see, what’s your view?
David: I’d kind of see them that they would often go in parallel. Often we would say that due diligence starts first, you know before the documentation so that at least you know, you’re not spending all of that time and energy if in fact it’s that unsure that you wanting to go ahead at least get through that process. One that we would put in front of you if you are overseas purchaser, is that also, both those two issues, but also statutory approval or overseas investment office approval also be addressed at the earliest possible stage.
Because if you are an overseas purchaser and you potentially may need overseas investment office approval because of the timing impact of that approval you need to address that issue at its earliest and we would be say as part of the due diligence you should address that at the outset. Because if you are caught and for whatever reason you’re caught by land approval and because under the present regime that takes over six months you can see that that really does upset the transaction timetable because most purchases kind of do not, unless it’s one of a mega deal, and there’s some regulatory requirement, in the US or China or whatever, that puts a big kind the question mark on the transaction itself.
Bruce: So we’ve done our due diligence, hopefully well, possibly delayed and we often see a delay because the acquiring party doesn’t want to spend a large sum of money on due diligence until they’ve reached agreement on many of the key terms.
So you’ve done the due diligence and now you’re at the stage where they feel like, they’ve got sufficient information to close the deal. They ask you to prepare a sale and purchase agreement. What are the key parts of that sale and purchase agreement?
David: So the first one on that one is who are you acting for?
So on a tender, and these are where some of the differences come up, on a tender sale, in fact, it will be the vendor counsel that will prepare the first draft of the agreement and they will have done it quite early on in the process because they want to compare like with like effectively in the indicative bid state.
In a Private M&A, and it’s not going out to tender, the purchaser’s counsel will prepare it. And obviously they want to feed the results of the due diligence into that draft and the critical one is obviously price. So that’s the the main one and then you’re looking at basically issues around escrow or retention.
So because of the use of trusts in New Zealand, that’s probably the one that comes up the most. If its two big corporates to each other there’s not the kind of that credit risk for a potential warranty claim and that’s a bunch of issues about how much you put aside how long you put it aside for what are the caps and collars for the claims?
Then you’re looking at the chunk about the restraint because obviously if you’re buying it on a multiple based you’re at least wanting if possible that multiple to apply to the restraint arrangement that you have and quite a comprehensive restraints in terms of you know, non-compete non-customers non-employees etc.
And then your last one is your warranties. You’ve got 25 pages of what potential warranties that you’ve got plugged into the system. And then you have potentially some attachments which might be you know, new employment agreement new executive contract transitional services agreements those kind of ones but that’s where you’re concentrating your negotiation to try and tease out you know where the pushback is from the vendor.
Bruce: You may also have a shareholders agreement if less than a hundred percent stake has been taken in the company in the case of a private agreement. If you have a shareholder agreement what are some of the key terms and that shareholders agreement, in the private case?
David: So if if you are a partial acquisition and therefore it is a shareholders agreement as well, that actually changes the tone of the negotiation from the outset because in the traditional buy and sell I buy you I run it you say goodbye. You may stay there for a year or two or whatever. But it’s a handing over of the baton. When you going into one where in fact there is a residual shareholding in, you’re both now got your hand on the baton. So in our de Bono hat analogy or whatever you are a lot more less aggressive. So a lot more less dogmatic than a vanilla purchase because you’re going to have an ongoing relationship with them. So even as lawyers, we would say you should be less aggressive much more group hug type arrangement because you are going to have to work out the shareholders agreement. The shareholders agreement will have often what are the supermajority issues? I.e. what the issues which require you both to approve them. You know, is it the business plan is it made your transactions only? Is it how you’re going to in exit the joint venture Etc? Because you’ve you’re turning from a purchase into now a joint venture, and from our experience you should adopt a different kind of approach to get the best result because after you’ve done the purchase you don’t want to have been fighting effectively because you’re now again sitting around the same table trying to get the best result for the joint venture for both parties. So it is a kind of a different approach which we would recommend is adopted and you know, then you’ve also got the kind of say well what’s reasonable for the other side.
What’s the protective mechanism that is reasonable that they have. And then work out, okay, how do we resolve the deadlock? And what’s the clients view in terms of resolving deadlocks? Because none of them are easy, you know, there’re various choices between exit mechanisms, etc. etc. And you don’t really know whether you’re going to be the buyer or the seller at that stage. So you’re trying to put the alternatives to clients and they will then have to choose what best fits their commercial needs.
Bruce: So you have a minority shareholder, perhaps the original owner of the company. They now hold much less than they used to they used to controlling the company. They’ve sold a majority to a to another party that other party perhaps there’s a majority of directors on the board.
What’s the the majority shareholder has decided to sell out a few years later. What are some of the protections that are minority shareholder would have in the case of the majority selling out?
David: So that’s mainly comes down to what’s colloquially called the drag along carry along provision.
And the drag along is basically where the majority and you have to define the majority is able to drag the minority along and sell out. Mainly because it’s prefaced on the commercial position that a purchaser will not want to buy a majority position they’ll or they’ll pay the top dollar for a hundred percent of the business and therefore it’s in everybody’s interest if they want to get the top dollar that they can drag the minority along to sell out and the reverse of that is a carry along.
And that’s where basically the majority do find out that they’ve got someone who’ll take their interest say it’s 75 or 80 percent and the minority don’t want to find themselves basically stranded with a new majority shareholder not getting a right to exit. So they’re allowed to carry along with the major shareholder to exit at that price.
So it’s mainly to kind of agree. What is the percentage that applies there? And in our view it’s best to have those provisions in, they’re good provisions. It’s just getting a commercial agreement, what’s the percentage that’s appropriate and you know, then you can basically play it out.
We will often raise, do you want to have a Russian Roulette type formula and that’s basically where you can issue a notice to buy out and at that price the other person who receives it can turn it on you and buys you out at that price and that is a very, you know, the procedure is set up so that it’s a fair price that’s stated. Obviously, it works best with two basically equal financial players because they both got the financial ability to buy or sell. But again, what you’re desperately wanting is to avoid a situation where there is a majority in a minority and they’re effectively at war with each other within the marriage and that’s what it is, but there’s no way of getting any resolution. The minorities decided just to be as obstructive as they can and, that’s obviously the majority’s view on life, the minority believes the majority is just trying to bully them in respect of every proposal and as being you know not taking any fair regard of the interest of the minority and everybody’s lawyer up.
And it’s just costing a huge amount of dead money. There’s no value being created effectively other than a lot of heat, but there’s not sufficient light in terms of saying the business is actually hurting by this cost it needs to be stopped. So if you can agree that exit mechanism often you go to the kind of the employment scenario where you go off to mediation and you know, you try and strike a deal that way but again, that’s an expensive process. But we do recommend that the clients think through how deadlocks are going to be resolved. What is the best mechanism or mechanisms in place?
What are they comfortable with and even to think outside the square? That basically would it be possible that we agree neither will sell for a standstill period of let’s say three or five years and then outside that standstill period free transfer can be given so that there’s no restrictions because if you’ve got pre-emptive rights that kind of kills value and would the clients be prepared to consider that as an alternative.
Now often clients won’t but again trying to press the the clients. How would you like the disputes to be resolved? What’s a mechanism that you can live with because often unfortunately, there are disputes and as much as we gain from those disputes, there’s not quite the commercial benefit, that is the cost.
Bruce: Another dispute would be capital dilution where the majority shareholder believes or the business does need more capital, but the minority shareholder doesn’t want to match the capital that the majority of shareholders putting in. So another good example of a dispute that could happen without a properly drawn shareholders agreement and good advice. Going back to the sale and purchase agreement. One other issue that may come up is working capital.
So you strike an agreement on the price, but the price of oil will often, we should also talk about share versus asset sales as well, though the price will often include an amount of working capital that then would be altered post at settlement or the closure of the agreement. Perhaps let’s break those into two why do people choose asset sales versus share sales even for a for a good size mid market company and how, in both cases is working capital addressed?
David: So as you say its an excellent point the debate about whether it’s shares or assets. Our majority of clients are purchasers and we would always say, you know, can we do it as an asset deal, because the beauty of an asset deal from a purchasers point of view is we only take over the liabilities that are specifically defined as assumed liabilities.
We don’t take over the risk of historical tax so we don’t have to do due diligence to the same degree in the area of tax at all. And you only take that future risk under your watch going forward. From a vendor’s point of view they like the share arrangement because basically they give you the box, they sell you the box and it’s got the nice toys in the box, but it also has the historical heebie-jeebies that may or may not be in the box. But basically it’s all your risk and particularly tax because tax can come up, you know, five six years down the road and we’ve had that happen in reality. So from a purchaser’s point of view we like assets, vendor and our New Zealand tax, no capital gains as such, prefers the shares and as you pointed out Bruce it is a wee bit more challenging to do assets the bigger the deal bigger the size of the business etc. But we say it’s a very valid issue to deal with, particularly, if you’ve got an historical problem with the vendor, even four five years back. We would also have had recent examples on it where the client was halfway through doing a share one and although we had tried to convince them to go down the asset route because it was only a relatively modest acquisition of about 10 or so million, and they had a death a workplace death. And of course we immediately then said to the purchaser stop. You know this needs to switch to an asset deal because the problem that we would get if we bought the share deal is although the death was on the vendors watch we would inherit that under a health and safety one, so if we had a death in the future it would be two strikes.
So for liability personal liability, etc, etc we disparately wanted to ring-fence the issue of the death to the company and therefore we did not buy the shares we bought the assets. Looking to buy it, you know should buy assets and you know, no no no, this is had no problems for the last 35 years and then the experience was that the client decided they’d buy shares and then five years down the road there was a knock on the door and it was Inland Revenue doing an audit in respect of it and not only the problem that you’ve got there is all of the people had gone. So it was five years down the track. There was no one who had any corporate memory of doing that particular tax return.
Even if in fact a dozen eventuate in a claim, you’ve got a truckload of cost and management time on a non-productive event, which wasn’t on your watch kind of thing. So but I accept that, you know, the bigger the transaction that makes it a wee bit more challenging.
Bruce: Do you find that somewhere during the process the sellers representatives, whether the M&A people or their lawyers, say your client, the purchaser, please provide evidence of funds and if it’s financing please provide a letter from the financing company saying that will provide funds do you see that?
David: Only rarely to be honest mainly because thankfully our purchasers are mainly big well known purchasers, but I have had that where they the purchaser was a virtually an unknown entity private overseas.
And I would recommend that that’s not an unreasonable request particularly, if it you know significant acquisition. The vendor doesn’t want to go through all the cost and the agro only to then find out that basically, the purchaser is a phantom and it’s not realistic that they’re going to be able to, fund it at all.
So if you’re a purchaser and you are not listed or you’re not of a suitable size, I think you’ve got to accept that that is a reasonable request and you’ve got the then try and deal with what reasonable evidence can you provide that a person who’s you know is looking to spend quite a lot of time and money entering negotiations with you to show you bona fides.
I mean, it’s a wee bit like, you know if you’ve got a big flash car and someone knocked on the door and you had said I would look I’m you know interested in your Mazarati, personally I just have a Volkswagen so no one would ever have to spend a lot, but if it was a Mazarati you’re not going to just let anybody give it a spin. You want to know that they’ve got that preferably interest but even more important that they’ve got the lot.
If it’s a hundred K car, if an eighteen-year-old turned up you’d say on your bike unless you can show me why I think that you should or could you know buy it for a hundred K.
Bruce: Point I’d make is that for purchases who aren’t famous having a very good website is very helpful. You can provide a lot of substantiation to any offer they make .
We should return to working capital sounds so boring working capital, but it can be a heck of a thing. So in an asset sale of course, it’s the stock that will be counted in effect, at some stage, at settlement. In the case of a share sale talk through the mechanism
David: there.
So as you say working capital is often a component in a share sale and as you say, it’s kind of their link to the same things that clients use the term working capital, you know, I’m happy to pay you say 50 million dollars on the assumption that you’re going to leave working an agreed level of working capital and in some ways you’re happy with that at the term sheet or the MOU because they’ve agreed the price.
Now when you come to do the definitive agreement, you’ve now got to get this defined, you know agreed working capital amount and that’s where to be honest it does help to get the accountants involved in that stage because as a as a lay person you know working capital is you know that gross assets minus gross liabilities effectively.
And then basically we have that and then you have the schedules as to how you’re going to calculate it and it’s our view in our recommendation that those schedules are as detailed as possible and that there are model working capital calculations in the schedules so that there’s you know on the basis of their price that they agreed to pay 50 mil.
Here is the working capital figures with the historical part of the figures all filled in and then there’s going to be the working capital adjustment calculation in respect of the next schedule and there’s a blank schedule but all the headings are all in there and even more importantly the assumptions are in there like stock. If it’s 90 days, it’s obsolete blah blah blah blah blah, but you get all of those details by the accountants. Preferably the ones who are actually going to do the calculation so we don’t get a mismatch of who prepared and who actually does it, all of those agreed at the same stage because like you if you that is the area where there is most likely to be a disagreement. If it’s an asset deal, it will be around stock. And if it’s a share deal it will be around the calculation of working capital. So you better to have your argy-bargy doing those schedules, but preferably not only in words, but doing it with a set of statements in the schedules with numbers in it one with historical so you can see what happened in the past, and how it was treated and then one is the form that you’re going to use on closing effectively.
Bruce: I’d also say that even at the NBIO stage, it’s good to have some description of how working capital be calculated, we’ve had the odd one where there’s no description at all and just means that in theory the vendor can strip the company just before settlement and take all that Capital which would be a heck of a lawyer’s bill further down the track I’m sure.
How about you? What was your what was your journey to this point?
David: Well, I basically was through University and then I went to a national firm or it wasn’t a national firm at the very beginning but at that stage quite a few years ago now they then started to be a national firm and I’ve got to admit my interest was in perhaps more of the public M&A.
So it was our I happened to do one of my Master’s paper on the defences against takeovers. And in those days I put my hand up to do that kind of work in the office and there wasn’t too many others who were interested in that area. So was bought up on the Hawke’s Bay Farmers Meat takeover and then that developed into doing work with with Ariadne Brierley’… all of those. Mr. Judge Mr. Brierley kindly came to my university seminar as my guest speaker and I interviewed a lot of people. I got a lot of help from US law firms who freely gave their documentation and information on takeover to compare the different takeover type rules etc. So I developed that at the early stage.
I was very fortunate to be appointed to the takeovers panel for when it was established and spent ten years on the takeovers panel, which was again fantastic because you actually got the be involved in policy issues. So the policy issues behind equal treatment, you know fair price has been great.
And yet underlying that is the public M&A is you kind of do three or four a year at that space but you will have five or six private M&As going on. Why I like them is the negotiation you get to meet the other side you get to meet the other clients. You got to negotiate with your own client, and then you’ve got to negotiate with your lawyer on the other side. It helps if they are an experienced M&A lawyer on the other side, there’s no doubt about that. But you can get a variety of people and I very much enjoy the the cut and thrust of that negotiation.
And also you learn a terrific amount about the business. So, you know, if you’re doing due diligence on Tegel chicken, you’ll learn about you know, the difference between, freezing chicken and fresh chicken and I remember doing on Tegel many many years ago.
I was blown away that basically when I was a child, it was all frozen chicken with everything that you got yet it all moved to fresh chicken and the margin on fresh chicken and the margin on cutting a breast, you know up as opposed to a whole chicken is huge. So you learn to all about that in the industry and in Tegel, their big contract was KFC.
So if you didn’t have KFC the business would have been dead. So you kind of quickly learnt where does the legal and interchange or intersect with the business? And where can you kind the protect? So for someone like Tegal basically, you wouldn’t pay anything significantly for that business unless you got the KFC supply contract because it underwrote the whole amount of the business.
If you said wheres the growth we could export chicken. No, you can’t kind of it was particularly in those days, it was virtually impossible to export. Because of the way the shelf life and the issues about disease and chicken, etc, etc.
So it’s that kind of combination between interesting law and interesting commerical environment which attracted me me to the area.
Bruce: Customer concentration issue if there KFC’s the the center of the valuation of the company!
And you’ve always lived in Wellington or have you lived elsewhere?
David: No, no always lived in Wellington.
So I was brought up. I did go to Christchurch. I started a degree in engineering from at the outset or engineering intermediate at Vic went to Christchurch and then had to ring up my parents to say that I couldn’t see myself doing engineering for 30 years and I’d switch and then I came back here. I was a term late so I then worked at a law firm just basically delivering stuff, doing Court filing doing basically anything whether it was dry cleaning deliveries or collection and then went back to University finished and then join one of the larger Wellington firms at that stage and then, it then decided to become part of KPMG legal now 20 years ago or 19 years ago. That’s when we set up the boutique firm that we’ve got at the moment that’s been going for 19 years which focuses on corporate M&A and employment, and I do that with my team and other colleagues do the M&A corporate, and we’ve evolved into particularly assisting overseas clients and their special needs.
Because the the ones that mainly buy and it’s mainly, although everybody kind of thinks that it’s more agricultural based in New Zealand, that’s not quite true in the M&A space because we’ve still got co-ops and they don’t do so much transactional work at all. It’s actually in the tech space. So New Zealand does have a very good name in Tech and overseas companies particularly US companies look to do what’s called bolt-ons of getting Tech and seeing if they can commercialize them internationalize them. The New Zealand entrepreneur has found that difficult. The exception is, Mr. Drury and the Xero, they’re the exception to the rule. It would be lovely if there was more of them who could make that but you know, we’ve just done one where a Nelson tech has sold out to a North American. for about 30 40 million, set up 10 15 years ago and there no other option really, you know, it’s not big enough to list. You can’t even, challenging market to list in New Zealand anyway, so they’ve sold out to another industry player obviously paid a price acceptable to the vendors and the few individuals behind that and hopefully. The client can take it to the next level.
Bruce: Thank you for your time, much appreciated, that was very interesting
David: Pleasure indeed Bruce.
Bruce: We didn’t get too complex either we covered the main points I think.
David: We’ll leave you to work and help the clients on that challenging area of working capital, which I’ve got to admit I very much interested in understanding, you know, do not have an accounting background but yes clients are very liberal in their use of the phrase but it’s a lot more complicated than they they’re just the ad lib, yep, we’ll do a working capital adjustment or an NTA adjustment it does, and you as you say you can get really shafted if effectively you don’t pay attention to the detail.
Bruce: I have seen aggravation both ways on working capital that’s for sure. Thank you again

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Episode 1 of the Curious Kiwi Capitalist Podcast Show

4th August 2019

My guest for this show is Sir Eion Edgar KNZM. Sir Eion recently retired as Chairman of Forsyth Barr, a firm he was with for almost 50 years with the last 20 as Chairman. There are few people who know more about the New Zealand public capital markets.

In this show we cover the evolution of the public capital markets including:

• the history of the various stock exchanges and their change in structure

three things to improve the capital markets

Show NotesAbout Sir Eion

Sir Eion is well known for his time at Forsyth Barr but he is also a skilled private markets investor and philanthropist.

He famously invested in a potato business called Mr Chips which he sold for a handsome profit (Sir Eion and family are on the NBR Rich List) in 2008. Currently he is chairing Hawaiki Submarine Cable as well as investing through his family business the Sinclair Investment Group.

But most in Otago (an area I lived in for many years) know him for his philanthropy. He is the chair of the NZ Dementia Prevention Trust, patron of Diabetes NZ, NZ Football Foundation, NZ Sports Hall of Fame, Queenstown Trails Trust and ShelterBox NZ. He was the driving force behind the building of the Dunedin Indoor stadium and so many other local charitable causes.

But I know him best for his service to NZ Snow Sports. Not only does he support snow sports athletes through his foundation but he essentially bought a version of the winter olympics (he is a past NZOC President) to New Zealand through the Winter Games NZ. It’s here where I saw him in action, the diplomat, the businessman, athlete’s biggest fan and sports fanatic—if there is ever a role model for aspiring business people it is Sir Eion.

Sir Eion recently retired as Chairman of Forsyth Barr. He is formerly Chancellor of the University of Otago and Chairman of the New Zealand Stock Exchange. He was also formerly a Director of the Reserve Bank of New Zealand, the Accident Compensation Commission, Mt Cook Alpine Salmon, and Vero Insurance New Zealand Limited.

Links

• Sir Eion Edgar and Forysth Barr

NZ Public Capital Markets with Sir Eion Edgar show notes

Transcript: Public Capital Market Interview with Sir Eion Edgar

Bruce: Thank you, Sir Eion for for doing this interview this episode about the public capital markets much appreciated. I’m sitting in your house here in sunny Queenstown looking across Lake Wakatipu. And I must say this is a fantastic view in a fantastic location.
Sir Eion: Not hard to enjoy life when you’ve got this outlook.
Bruce: The agenda for today is just to go through the evolution of the public capital markets. Of course, mainly that is the NZX, but there seems to be other things that are happening as as welll, we have the other other exchanges and we seem to have a attempts to create secondary markets as well. I’m leaving ahead of myself.
What I what I might do is just start off generally and. Move into the decades because Sir Eion you’ve been around since the 70s, you have seen it all, and talk how those public capital markets have evolved over that period of time, but firstly what’s the role of the public capital markets
Sir Eion: The public capital markets play a key role in capital formation in New Zealand without them it would be very difficult to float and raise and attract new industries, but particularly it allows for greater participation in so many of these business sectors. So an absolute key has changed over time as we’ll discuss but there’s still a very important part in raising equity in New Zealand.
Bruce: It must have started a hundred hundred fifty years ago. Just down the road both in the Otago gold fields and through the Dunedin Stock Exchange I believe.
Sir Eion: The first two stock exchanges were in Dunedin in 1868. The first two stock exchanges were formed and of course principally to raise money to search for gold that also early listed companies included banks, stock and station merchants, they were some of the early companies and insurance companies all had public shareholders, but the driving force early on was to raise money to search for gold.
Bruce: Where did the money come from? Who were the investors back then?
Sir Eion: Investors were across the board principally wealthy merchants. People who had come to live in Dunedin and had followed the hunt for gold and obviously saw there was more money to be made in supplying goods to the goldminers– lot less risk, and as a consequence of that those people built up capital and then and we’re prepared to invest in these new entities.
Bruce: Leaping forward a hundred odd years. You came on the scene and wasn’t 19…
Sir Eion: I joined…I’d always follow the share market from when I was 12, so that’s 63 years ago 62 years ago, but my father had followed the market closely so through it was a dull day when through our post box at home we didn’t get an annual report or some company information. So I followed it and bought my first shares when I was 12 and so followed the market from then was involved with share clubs when I was at University. Worked for Forsyth Barr in the holidays and then joined full-time after first work for a stockbroker in Auckland and ’69/’70 had two years there with him called Henry Hay, one of the old established firms went to London worked for two years at the stockbroker there and came back November ’72. Joined Forsyth Barr went into partnership from the 1st of April ’73 and joined the stock exchange at the same time.
Bruce: Tell me about how the stock exchange was structured back then?
Sir Eion: Yep. There was five stock exchanges in New Zealand in those days Invercargill, Dunedin, Christchurch, Wellington, Auckland. Each had individual members and you’re a member of that Stock Exchange and you paid a fee to become a member and it was run by a board of elected… I think at the time I joined we had 40 members in Dunedin and obviously Invercargill was smaller and Christchurch larger and in those days we exchanged…while we had a call over twice–ten o’clock and 3 o’clock–to exchange his you also sent telexes to our agents in Christchurch, Wellington, Auckland, we didn’t do much with Invercargill and would place orders on those exchanges, or through our agents there, so equally they would come to us because there was some shares in some particular companies were more popular and had a greater sort of liquidity in the main market like company like Helenstein’s which was based in Dunedin. So there’s more likely that buyers could get shares there so gradually that evolved we went from sending telegrams to telexs and gradually then used to ring. And that was quite interesting experience because you would have to book your phone call… if I wanted to ring the Wellington exchange at 10:20, at 10 the market would sort of give established. I would have to book that the day before and I wanted to make a call at 10:20 and then I call it to Auckland at 10:30. So it was a very slow…and Forsyth Barr were the first party in dunedin to have a telex so we had this great benefit of sending encoded form to buy shares to our Wellington Auckland agents and particular.
Bruce: I’m thinking of high-frequency trading in the…
Sir Eion: Very low frequency in those days!
Bruce: Was there arbitrage opportunities…
Sir Eion: There was and there was some brokers did do that arbitrage was more in dealing in the UK. We actively would send messages over night and often there was a pricing differential of shares that were based were quoted both in New Zealand and the UK and so there’s sometimes a bit of Arbitrage there in some Brokers a lovely guy called Jock Laidlaw who was a lovely old established stockbroker, he followed that Arbitrage pretty carefully and particularly stocks like National Mortgage and that were quoted both in London there was often a two or three penny margin something on it. But if you’re doing volume, you could make that but you’re obviously at their buyers and sellers.
Bruce: That was almost a 12 hour rather than a 12 millisecond moment of arbitrage.
And back then the fees that that Brokers were charging on the capital on the stock exchange were…
Sir Eion: The fees were, depending on the liquidity and volume, but they were around 2%. And obviously if the volume went up it droped to one and a half to one percent, so and then there was sometimes fees on top of that Stock Exchange fees, but two percent was the sort of accepted norm. And you know, transactions were most cases relatively small 500 pounds or something wasn’t so many big transactions in those days, of course because the currency was obviously had a higher value than before inflation took hold.
Bruce: In terms of the buyers and sellers in the market, was it more institutions more retail
Sir Eion: A mix there was the old established life companies, you know, the AMPs, Norwichs you know, National Mutual all those who always in the market because they as part of the capital requirements or when they’re investing funds for life insurance.
They were there, individuals were quite prominent. There’s quite a lot of private clients who love the market. I had one magnificent doctor who followed the market very actively he would do an operation and then come out and still in his gloves apparently would get his nurse to dial my number and he would place a couple of orders and then go back and do another operation and then repeat ring up and see what had happened. So it was we had some active clients but a lot of people would just followed the market and talk. So in the 70s was a relatively quiet market and we went through a couple of periods where the market was out of favor and where Forsyth Barr did well we actively help people with fixed interest investment to which helped cover the costs.
Bruce: The market of course much much different now with … a bull market and thinking more of the pricing in the market and the seventies that did seem to struggle a bit, was there much of a private market around back then? No PE firms of course, but was there some form of that type of capital?
Sir Eion: Not really most people if they’re wanting to raise Capital they went…look there was private funds established particularly forestry, there was several forestry funds set up. People put money in taking a sort of 20 year view but most of the money raised and shares were all listed on the stock exchange, as that was where the liquidity was and where investors felt safer because of audit requirements, Stock Exchange requirements…it was a very well regulated market.
Bruce: And I could still place orders on the international stock markets, so that’s..
Sir Eion: All of the Brokers had agents in predominantly the UK but also overtime at built up some interest in South Africa, obviously a lot more in Australia. Australia by far was our biggest market, most New Zealanders owned Australian shares whether they be BHP or the bank’s, big insurance companies, AMPs. So New Zealanders held shares in Australian companies some of the UK and some of the US and the odd one in South African mining shares but predominantly Australia, UK, and to lesser extent the US.
Bruce: Diversification was known back then I think in terms of diversifying your portfolio. But I think it was the very very start of building up diversified portfolios.
Sir Eion: Yeah but even then people did tend to be quite diversified. I mean, I think there was 200 companies also listed on the stock exchange, maybe more and therefore you could have quite a diversified portfolio and that’s something we always encourage you didn’t want to have all your eggs in the same the banks and insurance companies or so people tended to diversify their portfolios.
Bruce: Listings took off in the 80s, which we should get to shortly but, compared to now was there the same number of shares listed, the same number of companies listed on the stock exchange.
Sir Eion: Interestingly with the reduction in numbers in recent years probably still be a lot more listed then than there was now but certainly we went through a period in the 80s when people said you could float a rusty bucket particularly in ’85 when the numbers of listed shares doubled. I would say at least those four or five hundred companies listed on the stock exchange. Now along the were pretty fly by night and attracted speculation. Whereas, the sort of old traditional companies carried on there was mergers, rationalizations, but people predominantly invested in the quality end of the market, but some people love to have some speculation and you know, the Brierleys of the world started as one of the companies that people speculated and gradually got respectability has acquired more and more companies itself.
So it became a much bigger Beast. So no, and equally they had investments. Most of our clients probably would have had at least 20 but often up to 40% of their investments in Australia. Because of the scale and quality of the companies over there.
Bruce: Before we started recording you talked about Muldoon’s mistake. What was that? Well
Sir Eion: The Labour government I think it was ’79 introduced effectively KiwiSaver–an equivalent–and that was a wonderful initiative because it was sort of compulsory saving so people were required to money aside and it was the sort of a New Zealand superannuation fund there and it started acquiring assets became an investor in the market, bought properties, and then when Muldoon came to power, he canceled that didn’t like it because it was a Labour initiative. And that was a tragedy because whenever Labour brought it in, well received and when Muldoon came to power he canceled it and we’ve seen the difference we’ve now got a well-established KiwiSaver and superannuation funds but the Australians did it about the same time as us and have continued it and it has helped their capital formation very significantly.
Bruce: So in 1984 the Labour government came that came in the New Zealand economy was about to fall off the cliff and now Sir Roger Douglas started to do all sorts of things with different parts of different sectors. What did he do in the capital markets.
Sir Eion: Well, he did an enormous lot I mean one can, on your point, was he took away all the subsidies? And there was subsidies and everything whether it was a skinny sheep scheme, you know your paid to have sheep on the land. There was importers were all protected.
So anyone had import licenses had a margin to sell retail. It was just… He scrapped all those, and also obviously took the view that the government didn’t mean to own everything so didn’t need to own the railways. It didn’t need to own compete with the private sector. So he freed up a lot of assets which obviously encourage the Capital Market significantly because those companies were sold down into, in most cases listed entities. So that was a great help to the capital markets and there was also a confidence that people had in the reforms that he instigated that encouraged people to borrow money to invest. So it was the most significant change markets took off people had money. And were keen to invest and so we went through a period getting increasingly active from sort of ’85-’86 until it’s sort of gone into bedlam during that time.
Bruce: What did he do, or the Labour government do in terms of–or it might have been the industry–in terms of stockbroker and stock exchange?
Sir Eion: Well, several things happened firstly there was the rationalization of the stock exchanges.
Invercargill had linked with Christchurch, and then there was a recognition that we should have a National Exchange.
I think that happened in ’84-’85 so we became one stock exchange as an overarching. We still had our local exchanges, but with representation on the national body and I always remember, my first–I took over as chair of the need in stock exchange in ’87–and my first meeting of the National Exchange, which Robert Wilson another prominent Dunedin stockbroker was the chair of the NZ Stock Exchange, and my first meeting was October 20th, 1987 the day of the crash in New Zealand as a consequence of the big fallout in New York and 19th of October.
Bruce: We should get back to that as my view is that that has led to long-term damage to retail investment in the stock market.
Sir Eion: Yeah significantly.
Bruce: Around about the same time was there a technological change as well?
Sir Eion: There was subsequent to that and I’ll talk about that that really happened ’88-’89.
We changed several things 1 the requirement of the buyer to sign a share certificate and then getting rid of share certificates. And obviously screen trading, all very significant changes, but going back in ’85 things started to get more active following the Labour party’s changes and then ’86 it started to really take off and everyone wanted to invest in the market and prices increased.
And it was interesting in Forsyth Bar, we stopped taking new clients in about June July 1986. The market was so busy and the paperwork required was falling behind that we took the view that we were struggling to service our existing clients. So it would be irresponsible to take on more clients because you well, we were very unpopular with this exchange, but the wonderful thing about it was that meant our paperwork was up-to-date. When the Crash happened we at least we obviously had a lot of outstandings because we’re waiting for deliveries from other Brokers at least our own house was in order. And that stood us in very good stead post the crash but people were just everyone wanted to invest and if you went to a dinner party or wherever you went to the pub or anything, the only topic to discuss was the share market was amazing and share clubs were formed, everyone had to feel like they had to have a piece of the action.
Bruce: I was at College during those times and by golly even I was owning shares in the making a handsome profit thinking that I was the stock picker of the century because everyone was
Sir Eion: When the market was going up it was pretty hard not to be a winner. But of course there always comes rainy days and that was, you know, unfortunately people fine to invest your money, but to gear it up was the tragedy that happened to so many people they…and the banks were happy to lend and so it became a double edged sword of compounding people say exposure.
Bruce: In terms of the participants during those those boom years, well during one set of boom years because we will have had many since. What was the mix of participants, obviously institutions but within institutions where their investment funds starting to increase their…
Sir Eion: Yeah, three things happened one a significant increase in retail. Everyone had to be you know, I think it’s just this where the more than 50% of population owned shares which is amazing but also fund managers set up outside the traditional life insurance companies and that the insurance companies generally who were the big investors. We started to see funds set up saying, you know, we can do it better for you. You put your money in here and we’ll put them balanced portfolio and do it.
So those funds built up quite a lot. And you know, some of them are still around today, but a lot of them saw the opportunity to collect people’s savings and it suited a lot of people because they didn’t understand didn’t have the time or traveling so they said look better to leave it to someone who knows what they are doing.
Bruce: In seventies we talked about the diversification being across Australia the UK may be a bit of the US, but more difficult and many stocks within the New Zealand Stock Exchange.
By the opening of all the world developed world economies were many more countries being added into that diversification?
Sir Eion: No, in fact through the 80s probably most investors just concentrated on New Zealand. The old time investors long time still had this year’s had Investments offshore, but the big growth was in the New Zealand market. People could see it they can understand it was performing well, so why would you take your money outside? In fact, it was probably a swing back into New Zealand.
Bruce: Are there any investment funds that were trading back in the boom years of the 80s that are still around today?
Sir Eion: Not that I can think of because most of them Consolidated or were taken over by bigger players.
I wouldn’t I couldn’t think of any that are still around from those days. I mean apart from obviously people like the ACC. The NZ Super, but the private funds most of them have morphed into I mean, there are still some significant funds like the Fisher funds a quite a few of those Milfords but all those but they are all new entities. None of them were around in the eighties.
Bruce: Yes. So we had Black Friday wasn’t it?
Sir Eion: No Black Tuesday which was a consequence of the Monday in New
York.
Bruce: The stock market fell…the drawdown over the coming weeks was incredible…
Sir Eion: Yeah, I mean what happened on that first day on that as I said, it was my first Stock Exchange board meeting we were getting reports and you know, the Brierleys had started at five dollars something they suddenly were four dollars and by the end of the day, they were two dollars.
So the sort of highly popular highly geared stocks fell very significantly. The Chase Corporations all those Equity Corps and that fell very significantly because and that was partly because a lot of investors in those stocks had borrowed money against it. So they are either knew themselves or the banks were telling them. You know, we need, you haven’t got any Equity now, so you need to sell everyone thought. It would probably oversold rallied slightly next morning. It’s a bit by the end of the second day at and fallen a bit further. It had its many risers, but by the end of the week, it was lower and sort of stumbled along those levels for quite some time as people had to realize stocks and there’s other people realize they had no equity and panicked.
Bruce: Our Stock Exchange during those years increased much faster than Australia and therefore it fell a lot more…
Sir Eion: A lot more New Zealand Market fell more than anywhere else in the world and took longer to recover.
Bruce: Why did it rise so much further than the other stock exchanges?
Sir Eion: I think fashion. I mean it was people felt they had to be in it and I remember a lovely old man rang me from Christchurch I met and he said now I’m sick of going to Rotary and everyone they want to talk about the share market and I’ve never been involved had my own business, but he says you better buy me some shares. So he sent down half a million dollars and said buy some shares. I said you sure you really want to? This was early ’87 and he said yeah yeah no look it’s not a lot of money relative to his worth and you know, so we invested it for him and then he rang up a couple weeks later and he said we better buy some more shares those ones have done alright, so I think he spent another 1/2 million and of course six months later or so the market fell. Now in his case, he only did it because in some ways he was sick of not having anything to talk about as he said that rotary it was the only topic on the table and he’d go to the golf club the same thing.
So in some ways everyone got caught up in it which you know, and so rational common sense went out the back door a bit. So that was a pity, in his case, he was being still quite prudent, you know, he was probably worth 20 million or so, so he wasn’t really betting the Bank. Whereas a lot of people were not only investing their money, but they were borrowing money. Which obviously compounded their problems.
Bruce: We are in one of the few Industries where people buy high and sell low the behavioral economics of
Sir Eion: Yeah, I mean and not always but I mean certainly in those days people were felt they had to be part of it. So they did buy in the top quartile of the market. We got criticized for suggesting people sell out of markets stocks like Equitycorp we thought it got overpriced and suggested people sell at around seven dollars or something.
They went to eight or nine and we were criticized but. And didn’t get many thanks when they fell to $2 so there was quite a lot of people just couldn’t accept that the market just couldn’t keep going even though the multipliers, you know, the P/Es were getting stupid and you know, but it was hard to explain to people. They said no no everyone else is buying.
Bruce: A true bubble. During the GFC people who held on within…I can’t remember the number of years but after only a few years, you probably know yourself they they came back to where they were.
It might not be a fair comparison. I’m showing my lack of knowledge about the NZX history but from the the peak in ’87., when did the stock market recover? How many years did it take to get back.
Sir Eion: I’m not certain that at least seven eight ten years. It took a long time and in some ways it was very hard to compare because a lot of the stocks never recovered went broke. And so, you know, it was only some of the traditional quality companies that ever recovered the Fletchers of the world, old established. But you know, we saw the demise of the Equitycorps, the Chases, you know, Robert Jones fell significantly it recovered eventually, but you know, a lot of the corps as they were Equitycorps Chase corp, became corpses.
Bruce: We’ve come through the Black Tuesday we’ve had a…not a generation close to a generation of people saying that’s enough. I won’t enter the stock market again.
Sir Eion: Peoples’ loss of confidence carried on a lot longer. I mean there’s people 20 years on still wouldn’t trust the market and you know in some ways understandable they’d lost money. So didn’t want to trust it and as alternative investments came up property became very fashionable and that was helped by the tax structures.
And the ability to borrow and write the costs off. So those things you know, in fact as we all know, you know, the property market in NZ has got totally over weighted as far as a sensible area to be invested in it, but you couldn’t go wrong. a. you could deduct it in the values keep rising and you were getting a tax deduction so made it attractive place to be.
Bruce: We didn’t have super like the Aussie did in the ’70s. We burned a large number of people and ’87. We then became enamored with especially residential property and like you say there was government incentives around that sort of thing..
Sir Eion: Well tax incentives, there was a way it was structured the meant could deduct all your borrowings against your rental income made it very attractive.
Bruce: You can see the history building up here, but not everything was bad.
The technology came in as you point out to me and ’88 that led to much easier trading for all sorts of different investors whether the retail on institutional and I imagine your back office suddenly became much easier as well?
Sir Eion: I mean the significant changes and I was fortunate to be involved.
The stock exchange was firstly we went from requiring share transfers to be signed by the seller, then the buyer then delivered and paid. To a what was called a scriptless system where there was no transfers in all settlements took place three, well, originally five days after the transaction. It was all automatic and then it eventually came down to three days.
So the efficiencies were unbelievable and then the other major change was of course, we went from callover system, we all went down to the stock exchange called and scrippys wrote the price up and then changed it and you bid higher lower or whatever it was until it was all on screen and so the efficiency and the volume of transactions went through the roof.
The best example of that was when after the stock exchange, obviously, paid out all the funds it had in it’s Fidelity funds and we had to pay for the cost of the changing the system to scriptless and then obviously bring in screen trading we charge a transaction of something like $15.75 a transaction by the time I stood down from teh Chair we had that down to 75 cents.
So that was because of the much increased volume in the more efficiencies that came about so the was a significant change and improvement and obviously change the back office of members of the stock exchange very considerably and became a lot more enjoyable whereas it was pretty frustrating particularly when you had clients ringing wanting to know where their share certificates were and you were waiting for it from another broker.
Then you have to when you did get it you had to get them to sign it and everything and they had often already sold it on so you then have to live …look all those things changed with screen training and particularly change to scriptless. So it was just registered, you never had to sign that made a significant difference and a lot lot more
efficient.
Bruce: The fees were coming down for the retail investors to trade and yet they were they were leaving them the market because of
Sir Eion: Well, they just didn’t have the confidence and which was a tragedy because you know, in those ten years after there’s obviously some very good value and the more experienced investors did have the confidence to go back in they saw that the companies were performing. well, so a lot of people did very well out of it, but for a lot of people a they didn’t have the spare capital, they didn’t want to borrow. So they sensibly stayed out of the markets and then got the confidence in property and could obviously borrow against that had an asset they could see and understand so you could understand it.
Bruce: We haven’t talked about IPOs. In the ’80s of course, it was extraordinary. In the ’70s were you having the same sort of conversations back then as as we are now?
Sir Eion: There as still there was interested in obviously in capital markets one existing companies wanting to expand would want to have cash issues to raise extra capital and then we had companies coming to the market all the time.
I mean there was not in the mid-80s obviously that you know those new companies being flooded every week, but through the 70s, you know. The might be as a as a firm Forsyth Barr we’d be involved in three or four floatations and obviously be involved with other Brokers and other things.
So look, I’m not sure the exact numbers but there might have been 20 or 30 floats a year, so there was always people wanting wanting to raise capital.
Bruce: And in the 90s, how did the listings go in terms of numbers?
Sir Eion: Again, it slowed down considerably, a lack of confidence and also companies themselves were taking a more cautious approach. Do we need extra capital are we better to sell off part of our business too if we want to do something new. So corporates themselves were more conservative and obviously we sad to see the rise of Private Equity Funds who were saying well if you need some capital will put it in and so a lot of private enterprises who traditionally would have come to the market, said, no let’s just raise some money privately.
So Private Equity Funds built up significantly in that time investing the and of course they had a time frame usually of sort of 5 to 8,9 years where they wanted to hold it and then realize it, and sometimes then their way of exiting was to float. And so we still did have but often it was the second stage from being a private enterprise attracting outside capital and private equity and then floating after that.
Bruce: I’m not sure if it’s a myth or if it’s real, this idea of a funding gap a capital funding gap in New Zealand.
It’s applied to two sectors: Venture Capital, we have seen the recent budget trying to just address that and lots of detail to come on that one, and we’ve also seen it described for mid-market companies those perhaps less than a hundred million market cap. Do you think through the decades you’ve been involved that truly has existed for for that size company?
Sir Eion: Yes, I think, two things have happened.
The compliance costs of being a listed company, with its auditors all these things have increased and therefore the attractiveness of being a listed company has decreased.
And the second factor obviously, which is compounded that was the rise of private equity funders.
Who said well, why would you waste your time listing we can give you the money you need. And therefore you don’t have to have all these compliance requirements which have become a lot more onerous. As you know, now the FMA with the Securities Commission required greater disclosures. It meant a lot of people said, do we want to stand up in their underpants?
So that reduced…and company directors said do we want to be involved and you know quarterly requirements are at least six monthly you’ve got to do all this at it did the compliance requirements considerably increasing put off a lot of potential listed companies or proposed listed companies.
Bruce: Are compliance obligations any stricter than overseas comparable
Sir Eion: markets?
No, I mean the one area that’s really worrying people a bit now is our health and safety requirements and for listed companies that has become Draconian. I think that’s probably greater than most overseas, and the example is it all comes back on the directors not on management.
So for example if I was a director of a listed meat company. I would have to as a director physically inspect every one of our operations go right through those companies now, you know and and not only any substantial company you have to the directors have to physically inspect every one of your outlets.
Now that is I mean I was talking to a prominent company director they were going to take three weeks to get round all of their outlets. Now that’s just gone overboard. I mean no question health and safety needs to be there, but it should be management. It’s their responsibility and directors need to be saying you produce, you know, tell us you have complied.
So I think some of these things have gone too far and I think that will be a bounce back because it’s just making people saying why would I want to be a director and equally just the timeframes that’s requiring which is a cost.
Bruce: And as you come down from 100 million market cap to lower mid-market by golly the compliance costs…
Sir Eion: Yeah, very difficult to raise money for a listed company, I mean we have seen them in that 50 million level but basically, you know, the latest listing which is coming up next week, Napier Port will have a market cap of around 450 million. So the listed sector of it will be over 200 million. That’s the practical size, but I wouldn’t think it would be worth going to the market if you weren’t going to have a market cap of at least 100 million.
Bruce: They also talk about the lack of research in less than a hundred million size companies, ought to call them mid-market perhaps. Is that also driving the well firstly driving the price down for those that are listed. And for those who want to be listed and can’t see getting any research coverage, is that also affecting the the lack of listings?
Sir Eion: Totally, in fact one of the requirements we’ve seen in Forsyth Barr unless you’re going to…it’s not worth being listed unless you’re getting coverage by at least one broker, but hopefully two and that’s one of the reasons you’ve seen now in some of these more recent listings there’s been two lead managers two joint managers. To ensure that there’s at least two stockbrokers covering it because of unless you’re getting coverage and someone critically analyzing companies, how do you get a good steer of whether it’s a good investment or not? So I totally if you can’t get coverage it makes it very hard for a listed company and you see a lot of the little companies now struggle away because there’s no one following them.
You get some enthusiasts might do some homework on it and follow it but and on the other side for the stockbroker if they’re going to put the energy and resource in their research team into doing that needs to be some reasonable turnover. Yes, but it doesn’t justify so it’s being pragmatic and you know, we spend suppose as a firm six seven million on research. Well, if you’re going to spend that money you want to see there’s some activity in the in the stocks.
Bruce: And then terms of those mid-market companies, then they have all sorts of issues with the public capital markets have another option in terms of of private equity and and perhaps other institutions that are making direct investment. Is there a true funding gap there even outside the public capital markets and the private capital markets as well?
Sir Eion: No, look, I think there is in the venture capital space there always will be because you know how much could any sensible investor put in the startup sector. And we haven’t got that depth of capital that want to fund these things like the Americans who have got all these funds that just will take a blanket approach investing ten and hope on one or the ten-bagger and a couple of others will break even and so they take that on a risk.
We haven’t got that level of capital in New Zealand to do that. So they struggle you’ve got to have a very good story. In the mid caps, there is certainly plenty of money around from private equity as substantial funds there who are looking for opportunities because they want to get the money out. They don’t mean any fees until I get the money out. So there’s a natural enthusiasm to invest. Having said that, they have to perform or otherwise, they won’t attract money the next time round. So there is a natural hedge there that you have to perform if you’re going to keep attracting money. So to get you to be a listed company, you need to be above those two levels and that’s why your hundred million is probably at the bottom even now of where a listed company needs to be.
Bruce: Going back to the stock broking community back in the 90s during that time there was a move from selling a particular security to also selling a portfolio of investments so offering either investment funds or advice or at least on diversifying when did that really start and in how quickly did it take off.
Sir Eion: We probably were the leader in it Forsyth Barr we set up what was called PPM private portfolio management it came from, I’d seen it when I worked in London, in ’71 and ’72 and Michael Devereux had the idea in the late sort of ’70s early ’80s, we set up private portfolio management. So we would manage a person’s portfolio and that suited people because one some of them didn’t have a real interest but recognized a need to have part of their investments in the share market, so they were delighted someone else would do it for them.
Or secondly, they traveled and didn’t have time to follow and they were you know, so we built that up and over time and really after the ’87 crash people are lost the confidence in their own ability so it increased. And we’ve continued to build that up. It’s now up to about 8 billion we manage for clients and that’s invested predominantly in sharemarkets and fixed interest and some of it in private equity. So the larger funds that we manage some might be a couple of million we might put 5% of that into private equity. And 30%, depending on what the client wants and there’s no prescribed everyone is an individual fund, we do the paperwork hold the stocks and applying trust at nominee. So they don’t have to worry about all that they just get their report quarterly on what’s happened. They don’t like it, they can exit, there’s no cost of entry or exit. So that has become very popular. So, and other Brokers do the same. So there has been a big buildup in that sort of managed funds.
Bruce: People would do stock-picking individually and talk to the broker and obviously get the broker’s opinion, the broker would suggest stocks to them, then there was a slow move towards offering diversified portfolios. How quickly did they happen over the decades in New Zealand and Forsyth Barr?
Sir Eion: It just started quite slowly and then gradually as people got more confidence in it and as our advisors got confidence in it, obviously, they promoted it more and it built up and it’s continues to expand quite dramatically. I think what appeals to people is one no paperwork. They don’t have to worry about should they be making decisions. So they get a quarterly report telling you exactly what’s happened. They have continual access if they want to discuss anything because we have a second service now where they have to be consulted in any changes the first one private portfolio managers, they left it to the broker to do it, equally if they didn’t like it they could tell the broker or get the money back or get the shares transferred back to them whereas a second service private portfolio service is they get consulted on everything. So they feel they’re still in the loop, but don’t have to worry about any of the paperwork.
So it’s the ability to get rid of the paperwork just get a nice summary or record what’s happened. End of the year they get the income everything done sent to the accountant and everything. So all those hassles get taken away. So that’s one of the reasons its popular. They feel they’re still involved and have got the right to do anything they like but equally then they can go on a three-month overseas tour or two months or something not worried that they missing out on something?
So that’s why it’s become very popular and is increasingly so we’ll probably next year or so go through 10 billion.
Bruce: We’ve moved around a bit through the decades leapt backwards and forwards a little bit, what we have missed out is the KiwiSaver introduction that was correcting Muldoon’s mistake to go back to your description and has introduced a lot more saving and loans into the markets.
Of which small proportion stays in New Zealand, of course, what other big things can New Zealand, the New Zealand government, New Zealand Finance industry, what other large things can we do to improve the capital markets do you think?
Sir Eion: I think the three things.
Firstly that in the formation of the KiwiSaver and the New Zealand Superannuation fund.
What, even way back when I was involved in the stock exchange, of having a little much larger percentage invested in New Zealand. When they set up the New Zealand superannuation fund they said eight percent should be in NZ equities. unlike the Australians who sort of required at least 20%. And they took the long-term view that as a substantial fund, you know, the risk appetite should be spread across the world.
Once you get to a hundred billion, you can understand that but in building up to that we should have had a greater percentage in NZ. And that would have significantly helped our capital markets and we worked would have probably decreased the borrowing costs in New Zealand by about half a percent.
So we’ve had a very significant effect, but their advisor said no set it up like that forever. Where’s we think over time it should have changed, so I still believe that there is an under weighting in NZ equities and fixed interest. Which would help our markets considerably and lowering the borrowing costs.
That’s one, the second thing is, and we’re seeing a bit of rationalization now of it was based in several sort of smaller exchanges and everything, of rationalizing the one exchange and having better coverage of those exchanges and that is as we talked before about whether people will do the research, but I think that will encourage more interest in the market and we’re seeing a bit already.
There is several parties talking of listing this year. And so that will encourage.
The third aspect is the attractiveness of New Zealand as a venue for international investors, that has been very good slowed a bit, but provided we go through, you know, as markets are slowing a bit now or the confidence in our business sectors reducing that. If that recovers, which I think it will, then there will be more overseas investment wanting to come to New Zealand because it’s still on a yield basis on a governance basis. We are very well regulated and you know, a quality of our companies is very good that will attract overseas investment will again increase the market cap.
Those three factors.
Bruce: Thank you, Sir Eion your time is much appreciated. That was fascinating. We went through 50 years?
Sir Eion: Yes ‘ 72 to no, no, sorry, well, it is more than 50 years because I started investing when I was 12. So 62 years, but I’ve been actively involved, obviously at Forsyth Barr since ’72 joined November 72 so in three years time it’ll be 50 years. So 47 years.
Bruce: Thank you very much again much again.
Sir Eion: Absolute pleasure.

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Episode 0. Introduction to the Curious Kiwi Capitalist Podcast

1st August 2019

The Curious Kiwi Capitalist podcast is about the New Zealand capital markets and the people in them including:

• asset allocation and portfolios
• private business capital structure
• business valuation
• M&A process
• behavioural finance
• capital allocators
• private equity
• venture capital
• alternative investments
• investment strategies and how we apply them from NZ (e.g. passive, active, factor based,
• savings vehicles including ETFs, PIE funds and KiwiSaver
• managed investment fund CIOs
• hedge funds
• IPO and NZ
• NZX
• ASX
• banks, non-banks, reserve bank, investment banks
• financial advisers
• due diligence
• negotiating a sale and purchase agreement
• …whatever takes my fancy really, it’s my curiosity after all

It is for investors and capital allocators, business owners and investment bankers, financial advisers and wealth managers, venture capitalists and angel investors, finance students and their professors… it’s about the NZ finance industry.

I speak with New Zealanders who have real insight into NZ capital markets. We talk about history, about how they got here, how they think our capital markets can be better and their views about family, politics, rugby, wine…

It’s not a lecture or a journalist’s interview, just a friendly discussion about them and their views. It is about their own finance industry journey, their own thoughts—not a staid business interview.

As an M&A Adviser and previously an Authorised Financial Adviser, I’m in the unique position of operating on the sell-side (M&A) and the buy-side (financial advice and investment planning). The industry is fascinating and I hope I can bring out all that is interesting in this podcast.

The post Curious Kiwi Capitalist Podcast Introduction appeared first on .

The Curious Kiwi Capitalist podcast is about the New Zealand capital markets and the people in them. I speak with New Zealanders who have real insight into NZ capital markets. We talk about history, about how they got here, how they think our capital markets can be better—and anywhere my curiosity takes me. It is for investors and capital allocators, business owners and investment bankers, financial advisers and wealth managers, venture capitalists and angel investors, finance students and their professors... it's about the NZ finance industry.