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Opinion: The Government is working its way into a rather nasty bind and faces decisions in the next two months that could define this term of office

Opinion: The Government is working its way into a rather nasty bind and faces decisions in the next two months that could define this term of office

By David Hargreaves

By any rational logic the Government should put the rest of its partial privatisation plan on hold.

Sharemarkets around the world have turned sour. Since hitting a peak on May 13 our NZX 50 Index measuring the price performance of the top 50 stocks has dropped by about 7%. It is true that sharemarkets are fickle and can change in a moment. However, the markets have turned down for very specific reasons. It would be cavalier, bordering on reckless, for the Government to push ahead with plans for further share floats just at the moment.

The Government's problem, however,  is that it is  too heavily committed to the privatisation plan. The plan was a big part of the last election campaign and it is vital to the Goverment's overall strategy. The Government has a 2014/2015 Budget surplus pencilled in that depends, in essence, on the raising of NZ$5 billion to NZ$7 billion from the sale of up to 49% of Mighty River Power, Meridian Energy, Genesis Energy and Air New Zealand (the latter already with about 26.5% public ownership).

I doubt whether John Key and his troops allow time for much introspection. They don't seem of that type. But if there was anybody in the Government prone to feeling regret then at least some of that might revolve around the delay in getting the first SOE float under way last year while legal action over Maori water rights was contested.

The Government won, of course, but that delay might ultimately make the world of difference to the privatisation plan.

The sharemarket roars

The New Zealand sharemarket's performance over the past two-and-a-half years can be summed up thus: In 2011 it went sideways, in 2012 it took off, and in 2013 it continued to fire furiously on all cylinders before seriously blowing a gasket.

The performance of our sharemarket mimicked that of markets overseas. The historically low levels of interest rates around the globe caused investors to look elsewhere for higher returns - and they looked for the dividend yields offered by shares.

Between December 2010 and 2011 the NZX 50 index was virtually unchanged. Between December 2011 and December 2012 the index shot up 24.2%. Between the end of last year and the May 14 market peak, the NZX 50 Index surged another 14.9%.

In the 12-month period to May 14 2013 the market gain was a gobsmacking 31.7%. That 12 month period is crucial. Given its original timeframe the Government would have been able to float MRP before the end of last year and then follow up with Meridian probably in about the March-May timeframe this year that was in the end used for the MRP float.

A more successful float

If the Mighty River Power float had been conducted toward the end of last year there is a good reason to believe it would have been more successful than it was this year, given the very buoyant market conditions at the time.

The other point is, would the Greens and Labour have thought to come out last year with their single electricity buyer policy that, when unveiled in April, no doubt ultimately caused great damage to the MRP float? Perhaps not.

And without the Greens/Labour policy there seems little doubt that far more of the 440,000 people who registered themselves interested in MRP shares would have signed up, remembering that only 113,000 did in the end.

The final MRP price of NZ$2.50 raised just under NZ$1.7 billion for the Government. I reckon a float late last year, with no Greens/Labour policy announcement, could have easily seen the Government get NZ$3 a share, which would have raised a little over NZ$2 billion.

Buoyant conditions

But very importantly also, the MRP shares would have enjoyed months of buoyant conditions after listing, so, the chances are that the price may have fared well. The mum and dad investors would have been happy and they would have lined up for the next cab off the rank Meridian Energy, which could of course then have been sold earlier this year.

Meridian, based on its most recent valuation of NZ$6.5 billion, could  potentially raise around NZ$3.2 billion from a public float in the right market conditions. Had the Government managed to get both MRP and Meridian to the market by now then it might already have in advance of NZ$5 billion to go toward those new state assets and 2015 surplus.

But no.

Now of course the markets globally are in turmoil after the US Federal Reserve's chairman Ben Bernanke said last week that "tapering" of America's money printing programme could start later this year if various economic indicators headed in the right direction. The result has been surging global interest rates  and sliding sharemarkets.

In the time since Bernanke's comments the New Zealand market has fallen by over 2%, while the decline since the market peak of May 13 has been around 7%.

Sagging market

Poor old MRP actually listed on the market on May 10, enjoying just a day or two of the previously buoyant conditions before becoming part of a sagging overall market. The MRP shares are now  10% down on the listing price, which is a somewhat worse performance than the market has had over the same time.

So, the Government now faces the hard decisions about whether to proceed with a Meridian float at all. If market conditions don't buck up considerably then the Government would find it seriously difficult to shift the Meridian shares even if, as has been suggested, it does the float in two bites.

The poor post-float performance of the MRP shares has virtually guaranteed that mum and dad will be very wary about putting their hands up for some Meridian shares. If the demand for the shares is limited, the price will be squeezed down. It is not far-fetched to suggest that by selling Meridian into a depressed market, the Government might get hundreds of millions of dollars less than it would by selling it into a buoyant market. The taxpayer might be severely short-changed.

The proposed sale of 49% of Meridian was announced in the May 16 Budget, with a timing set for "the second half of the year". Sensibly the Government did qualify that timing with "subject to market conditions".

Sign-off

If as is supposed, the plan is to undertake the float in October or November then it is to be imagined the final sign-off by Cabinet would have to take place by early September at the very latest. As some means of comparison, the official sign-off for the MRP float came on March 4, a little over two months before its listing on NZX.

So, the Government has a lot of thinking to do over the next two months.

Might the sharemarket recover sufficiently to allow the float to go ahead?

Well, they are funny things these sharemarkets. You never really know. But it would seem unlikely while the world is dealing with the horrific prospect of the end of its "fix" of cheap mass-printed money.

On the plus side for the Government, It is entirely possible that the US won't achieve the kind of growth this year that the Fed Reserve thinks it will and so the "tapering" might not after all start happening this year. That seems a real prospect.

Problems

But the problem for our Government is that by the time such a possible outcome starts to influence the market it will be too late for a Meridian float this year.

Remember also that our market has risen a heck of a lot. Some stocks are looking seriously over-valued. A period of a least consolidation if not outright falls was always on the cards. I would be very surprised if our market finishes this year higher than it is now.

The most obvious options for the Government appear to be these then:

  • Postpone the Meridian float. This would be both a serious loss of face for the Government and would give it the headache about that 2015 Budget surplus.
  • Go ahead with the float. The dogmatic solution. The Government would be at the mercy of now volatile markets and would run the risk of getting a considerably lower return for the taxpayer than it might otherwise - if markets remain in the doldrums. This in my view would be a very reckless course of action.
  • Go ahead with a partial sale of Meridian but in a different way to the MRP process. The Government could sell a big chunk to a "cornerstone investor" - perhaps an overseas power company (likely to be an unpopular option) or even the NZ Super Fund (likely to be a rather more popular option), with local and offshore institutions being offered a bigger slice of the cake than they got in MRP. This could certainly work, but the abandonment of the mum and dad "first in the queue" policy might prove damaging in the opinion polls.

None of those options look great. Perhaps there is another option, which might be termed the "nuclear option".

If the Government called an election for late this year it could neatly step around having to make a call on the Meridian float. Clearly there could be no float if there was to be an election. So, the Government would get to cancel/postpone the float and have a very valid excuse for doing so.

Assuming a National-led Government was re-elected it could then have a look at a Meridian float next year. The Budget and that 2015 surplus could be revisited on the grounds that much has been changed by having an election and the "forced" postponement of the Meridian float.

Would the Government have an real excuse for calling an early election? Yes, it would and his name is Peter Dunne. The troubles of the former Revenue Minister, while at a surface level problematic for the Government, have given it a gold-plated excuse for an early poll. The country needs stability of Government, National might say, so we need an early election.

Recent opinion polls have been very favourable for the Government. This suggests the Nats would be handily placed to mount an election campaign now.

Anyway, the Government probably has two months to decide on the Meridian issue. But if the markets don't look like making a miraculous recovery then maybe that "nuclear option" becomes more attractive.

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13 Comments

I have heard those in the finance area claiming that if MRP posts huge profits it would be great sign to the market about a Meridian float. I tend to think that if MRP posts huge profits it would actually be damaging to government support as it would highlight the Labour/ Greens case that the market is disfunctional.
I'd reckon the nuclear option of an election is off the table for the moment- If National won, they would need a deal with NZ First (which arguably they have as much chance of getting now). But if they hang on and they get a rise in the polls, and something happens to knock NZ First out entirely, then they would be much better placed.

The Mixed ownership Model as it exists it not fit for investor purpose.
 
Regulatory risk overhangs the value of electricity company shares:  Read more
 
In the case of MRP the possibilities are drastic and do not warrant retail investor participation:
 
Mighty River’s fixed assets had a so-called “fair value” of $5.1 billion at June last year, but the historic cost of those assets was only $2.2 billion. A regulator using historic cost could potentially require a write-down of nearly $3 billion, and a corresponding cut in revenues (achieved by price reductions) of between $300 and $400 million. The shareholders’ equity was just over $3 billion at June 2012; most of this would evaporate as regulation came into effect.

Alternatively, a regulator could allow the company to set its prices to secure a fair return on indexed historic cost, in which case I estimate that the allowable asset base would be $3.1 billion, requiring a write-down of only $1.9 billion (about two-thirds of equity). Allowed revenue would be reduced by roughly $250 million a year. Read more
 

To rip the second hole in the "macquarie model" (of which they seem to have "parked")
You will also know this by the past works of Babcock and Brown and Allco....
These folk brought down by the funding side. Being caught out with debt having equity really just an entry in tax accounts.
 
Here we see what they were chasing (the gaming of the regulator) as the prize that drove revenues, that drove formula valuations, that drove both debt funding and fee generation for the manager.... . 
 
Often aided by the desconstruction of the "limited liability company" structure. ie operatives of the packager/manager being operation exe's of the business operations "being managed/gamed"
 
Locally we see Infratil still running the "model" and flowing the fees toward the chums with often two-hats.... IOHO.
 

Regards an early election - the problem for Nats is if they do call it - they may get back in!!!  Whereas I'm certain they'd much rather do a Muldoon-type hospital pass at this juncture;
 
http://www.interest.co.nz/charts/economy/balance-payments
 
 
 
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Whereas I'm certain they'd much rather do a Muldoon-type hospital pass at this juncture;
 
But not until they have completed more of their agenda.

Laughable. Predictable.

It might be a bit cliched, but, 4 months ago, before the float, I posted the following comment on NBR regarding MRP, and got 18 thumbs down. Howzat.
 
#1 by Otherguy Otherby 4 months ago
This government is setting itself and a lot of peasants up for disappointment. It's an old adage but the saying goes "Sell in May and go away until October" So English and Co go to market at the very worst possible time. For the peasants that is.
http://www.nbr.co.nz/article/govt-plans-14m-mighty-river-share-ad-blitz-...

Worth note is the rapid change in markets.
AFR is talking:

iSelect dismal IPO debut puts damper on market
26 June 2013 | Ruth Liew
PRINT: 26 June 2013 | PAGE 1 | iSelect’s poor debut a damper for new IPOs
iSelect’s dismal initial public offering debut is expected to cast a damper over on an already anaemic Australian IPO market and could impact the prospects of some companies eyeing public floats over the next year.
 
so locally is it back to the drawing board for the chums above?:

Fabienne: Whose financial proposition is this?

Butch: It's an IPO, baby.

Fabienne: Whose IPO is this?

Butch: It's Zed's.

Fabienne: Who's Zed?

Butch: Zed's dead, baby. Zed's dead.

 

Fabienne: Who's Zed?
Butch: Zed's dead, baby. Zed's dead.
 
LOL - Yep, the infomercial has to be better presented than this mash up, to overcome the serious questions about transparency disclosed by the same organ, but penned by an author exercising an inquiring mind.
 
According to Z's results presentation last week, the bottom line profit was 2.3c a litre, up about 10 per cent from 2.1c a litre a year ago.
 
Unfortunately Chalkie can't really tell which bottom line Bennetts was talking about, because there are three to choose from and, after adjusting for current cost, none of them seem to translate to a profit of 2.3c a litre.
 
Making things more awkward is that the results Z talks about in presentations are the ones it does not disclose - we can see the full numbers for Z Energy and for Z's parent Aotea Energy, but not for group company Aotea Energy Holdings, which is where the shareholder debt lies. 
Chalkie reckons this all adds up to a headache for investors thinking about acquiring a few shares from owners Infratil and the Super Fund in Z's partial float, if it happens.
 
The company may be a decent infrastructure business with a good brand, economies of scale and gradually improving margins, but, like talking to someone with a squint, it's hard to be sure which numbers to look at. And if Z is increasing its margins, perhaps it's only because the whole industry is becoming more profitable. And if the industry is becoming more profitable, is it a sign of anti-competitive behaviour that will attract the regulator's eye?
 
Chalkie reckons what we have here is a large probability cloud around an oscillating core, whose value has yet to be determined. When it comes to an initial public share offer, it'll be a tough sell. Read more

And the folk who seem already chocks-away on the flight to list and Fran O'Sullivan's very good friends at that South Canterbury dairy firm
 
http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=1089...
Full marks to Synlait bosses Graham Milne and John Penno for hanging tough in the post-global financial crisis environment and going offshore to find a significant stakeholder ... Fran writes...
 
http://www.synlait.com/about/news/

Synlait Milk Releases Investment Statement and Prospectus
Synlait Milk Investment Statement and Prospectus Make More From Milk
 
A point of interest is:
In fact, Synlait can hardly be described as a Chinese company simply because Bright currently holds a controlling interest which enables it to consolidate the earnings of the NZ firm.
See the constitution, Bright have 4 directors (half) at less than 50% ownership.
Why does NZX let this?
From first read of 200 + page doc, it seems Bright gets infant powder via contract manufacture.... This answers long term Q. what happens to $80 per tin. A nothing, as s/lait never sees it......
We are not sure why Bright don't chip in funds (as - refer to earlier posts, their initial investment was a combination of equity and debt). But make a big dal of keeping ops control..... the conslidate earnings comment is round the wrong way we think....
 

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David,
Good article. I of course see no merit in the floats at all. Being pedantic, the argument that the floats are somehow critical to the government reaching a surplus keeps cropping up. Maybe I misunderstand how the government keeps its books. Once sold, the government will lose dividends; but will save a little in interest. My understanding is that actually the projected dividends are considerably higher than the interest, given the government's correct ability to borrow relatively cheaply. (Never mind that it could actually have printed the money in any case, if the economy was short of the stuff, and our dollar is overvalued, even now according to Mr Key, but I digress).
Even if for arguments sake the interest was the same as the dividends, in usual company accounting there would be no difference to the bottom line. Does the government keep its books differently? Was it looking to book the money for the sale as a bottom line gain? Even though it has lost some magnificent real assets; were they not otherwise valued on the balance sheet?
Or, as we all suspect, are the floats really just an ideological approach to get assets from everyone into the hands of a few, or a view that as a government they are incapable of running commercial entities?
 

Or, as we all suspect, are the floats really just an ideological approach to get assets from everyone into the hands of a few, or a view that as a government they are incapable of running commercial entities?
 

Agree if people who undertake home invasions on elderly women alone can be said to have an' ideology' then yes.

A lot rather depends on what Key's motives are.
A high price for the benefit of the tax payer?  or
A low price for the benefit of his mates who buy it?