By Mark Lister*
The National Party’s widely publicised Mixed Ownership Model (MOM) for certain state owned assets now appears very likely to be implemented following National’s very strong showing in the elections and the pending formation of Government.
The scale of this change relative to the size of the existing New Zealand sharemarket would be significant. The next few years, as the MOM programme rolls out, have the potential to be transformational for the New Zealand market, and for local investor’s share portfolios.
The Government intends to extend the mixed-ownership model (which currently exists for Air New Zealand, currently listed on the share market with the Government as majority owner with a 74% stake) to a further four state owned energy companies, namely Mighty River Power Limited, Meridian Energy Limited, Genesis Energy, and Solid Energy New Zealand Limited. In addition, the Government intends to reduce its existing shareholding in Air New Zealand to 51%.
The Government has announced a number of key conditions for the programme, should it go ahead. The first is that it will maintain majority control and ownership in each company by continuing to hold 51% of each. It has also signaled that New Zealand investors will be at the front of the queue. The programme is anticipated to take several years to complete, with the model to be extended to the first company sometime during 2012.
The Government has outlined that the proceeds from the MOM programme will be reinvested in its ongoing funding of new public assets including broadband, schools, and hospitals, reducing the requirement to borrow from international bond markets. Initial estimates from the Government suggest that the MOM programme will generate between $5 and $7 billion for the Crown.
A 30% boost
If this is the case, the results will be transformational for the New Zealand market on completion. The local sharemarket has a current value of around $40 billion. With the total value of the MOM assets included (including that which would still be held by the Crown) this value would rise by around $13 billion to $53 billion, an increase of around 30%.
On a sector basis, the weighting to the electricity sector would increase significantly, from around 9% of the index to about 28%, and the weighting to other sectors would decrease.
This would probably lead to many investors and Kiwisaver funds reviewing and tweaking their portfolios, if only to ensure that the exposure to one sector (in this case electricity) wasn’t too dominant. After all, even a very stable industry that provides key infrastructure such as energy is not without risk. The transmission grid can fail, the weather plays a big role and regulations may change the landscape. Much like Australia, which has become a market dominated by mining and banking stocks, New Zealand would be dominated by electricity companies. However, I don’t think there will be too many issues caused by having a dominant sector in this way.
Most investors and Kiwisaver funds have the ability to invest in New Zealand, Australian or global shares and would consider their portfolio as a whole, rather than in isolation of one geography. They might use New Zealand to gain their electricity sector exposure, Australia for mining shares and the United States for technology companies, for example. It is very early days and details on structuring, pricing and other considerations are limited at this point, but the investment opportunities across the companies in question appear attractive.
The three electricity companies have strong existing market positions due to the incumbent nature of generation assets, they are profitable businesses and they have the potential to grow earnings at least in line with economic growth. Solid Energy also has a strong portfolio of energy assets, and a track record of growth. Air New Zealand, the smallest of the deals given that it is already listed, is less suitable for conservative smaller investors given the nature of the airline industry.
However, it remains a good, well-run business and the interest from larger institutions and existing investors will be solid. The Government has indicated that it sees 85-90% of the shares sold as part of the process going to New Zealand investors. This would obviously include Kiwisaver funds and other large wholesale investors, although I suspect that the Government will have no trouble at all generating significant levels of interest and participation from retail investors.
Biggest IPO since 1999
The last big initial public offering (or IPO, which simply means when a company moves to being listed on the sharemarket) we had in New Zealand was Contact Energy in 1999. The Crown sold 60% of Contact to the public for a total price of $1.1b. The offer was very successful with smaller retail investors, and attracted them in large numbers, with a lot of them staying invested for a long time as well. Over 270,000 investors’ pre-registered for the public offer in Contact and many of these were first time sharemarket investors.
The IPO generated domestic retail demand in excess of $1b and it is estimated that approximately 88% of the pre registration demand was for share parcels worth less than $3,000. This turned into a total of 229,000 actual retail applications for shares in Contact, with an average of just over $4,000 per application. In November 1999, six months after the IPO, 170,000 investors still held 1,000 shares or less.
Today, Contact still has a relatively large number of small shareholders, probably in the vicinity of 80,000, many of whom have retained their shares since the IPO. According to Reserve Bank data, at the end of 2010 New Zealanders had a whopping $98 billion on deposit with registered banks.
Five years before this, the corresponding number was $55 billion. One explanation for this 61% increase in bank deposits is undoubtedly investor concern over the economic environment, but I would suggest that it is also due to the lack of investment options we have in New Zealand. The finance company sector has disappeared, property looks uninspiring and our sharemarket is tiny with a limited number of good quality high-dividend paying companies.
KiwiSavers to get a slice
Given the returns that are currently on offer for bank deposit rates, some of that $98 billion will probably quite happily gravitate toward the $5-7 billion of energy company shares that there is to go around. This time around we have Kiwisaver as well, the impact of which shouldn’t be underestimated. As at the end of September there was $10.5 billion in our national Kiwisaver accounts, 45% more than the $7.2 billion that we had a year before.
Kiwisaver contributions and balances will continue to grow over time and providers will welcome more local options for the investment of those funds on behalf of the 1.8 million kiwis that have a Kiwisaver account. During similar sale processes in Australia we have seen retail incentives put in place, such as loyalty rights where investors receive a top up of additional shares for remaining on the register for a period of time.
This would enhance the potential investment return for local retail investors and could be an approach that the Government may consider using. From a broader perspective, the MOM programme provides an important boost to our local market and the companies that are proposed to be a part of it look like good quality holdings for retail investors. Given their defensive, cash generative attributes, they have the potential to deliver sustainable tax-efficient dividends.
*Mark Lister is Head of Private Wealth Research at Craigs Investment Partners. His disclosure statement is available free of charge under his profile on www.craigsip.com. Craigs Investment Partners were Crown Advisor for preparatory work prior to the election. This column is general in nature and should not be regarded as personalised investment advice.