Blue chips languish in the internet revolution

Friday 10th March 2000

NEVILLE BENNETT explains the finer points of the new-look sharemarket

There are many blue-chip companies simultaneously reporting a satisfactory year and concern about their share price.

Shareholders, especially the institutions, are demanding the release of capital which they can invest in more exciting growth areas.

For example, BP Amoco recently announced record profits, high prices and sales increases. Despite these results, and oil prices high enough to justify increased exploration programmes, BP Amoco yielded to shareholders, who wanted to withdraw capital for its business, by announcing a buy-back of 10% of its shares. Merck Chemicals proposes to spend a record $US10 billion on share buy-backs. Unilever, which has made excellent profits for decades, is similarly confounded by its low share price and proposes to lay off 25,000 staff to increase profitability.

There are many examples of top 40 New Zealand listings where share prices are languishing despite good results.

Carter Holt Harvey, the huge wood products and paper manufacturer, is languishing near its lows despite good profits and the sale of its Chilean operations.

Its recent acquisition of choice Australian assets has not impressed investors. Brokers say many investors expected a bonus to mark the firm's centenary; when Carter Holt did not oblige, they dumped the share.

The case of Telecom, the largest New Zealand share by market capitalisation, is especially instructive. Its share price fell below $8 recently despite a yield of 8% and good growth in its mobile sales and its internet portal.

Initially the market particularly disliked Telecom's acquisition of a majority share in Australia AAPT but when that company was revalued as an internet stock, Telecom's share price rose to over $9 in one day.

It is not often a blue chip gets a 20% rapid increment these days.

Indeed blue chips have softened because of interest rate concerns while technology stocks thrive, buoyed by the curious notion that, as their cost of capital is near zero, they are unaffected by interest rates.

So the market seems to be telling many quite successful companies to undertake a partial liquidation. Investors want to recover capital from stodgy, profitable companies so they can get instant riches by investing in feisty tech companies.

There is something of a collapse in the share prices of old fashioned blue chip companies that actually make something and do it well.

But internet shares have boomed. The Financial Times recently observed, "The spread between the more favoured and less favoured stocks in the FTSE 100 is the widest for 35 years and four times what it was in 1985." Similarly the 21% rise in 1999 of the S&P500 was propelled by merely 31 successful shares.

Naturally, the composition of the indices is changing rapidly. The promotion of Microsoft and Intel into the Dow Jones industrial average (displacing Chevron and Union Carbide) has slowed the submergence of the Dow.

It illustrates my point to note that Whitbread (a huge British brewer with sales of $US5 billion) is about to be displaced in the FTSE 100 by Baltimore Technologies, whose sales are less than $50 million.

Investors have always been somewhat fickle but what is happening now seems to be a tremendous revaluation of the future.

In the past many investors considered many aspects about a share, including its price history, its dividends, its price-earnings ratio and its net tangible assets. These analytical tools have been almost entirely discarded.

Technology shares generally have a short but extremely positive price history. Their price growth is exponential. Investors no longer look to buy on lows but to buy and hold, for most dot coms have only an upward trajectory.

Dividends are not a factor, as few dot coms produce any earnings, much less a dividend. Their assets are often intangible rather than real.

So the traditional tool of analysis that survives is pricing a share on its sales or projected sales. Needless to add, most of the dot coms project "sky is the limit" sales.

Pity the directors of "ordinary" companies. Until recently their concerns were to strain every nerve to keep ahead of competitors and cut costs. Their antennae had to be tuned to predatory companies that might launch a hostile takeover.

Now their shareholders are sending a confusing message: "We can get a better return on our capital than you can: give me some back."

One response by some managers is "why list?" Many companies in the US are going private in response to a sharemarket obsessed with the internet. Private buyouts (excluding takeovers) surged to $US20 billion in 1999 from $US8 billion in 1998.

However, this amounted to only 165 buyouts in comparison to 550 listings.

Nevertheless, the trend toward "management buyout" is a rational response to a situation where many shares are languishing near their lows. Usually firms list to increase their ability to raise cheap capital and perhaps to offer options to employees. These reasons are at a discount at present low share prices. Hence firms such as Donaghys are going private.

Pity, too, the institutional investors. Those who found "value" for their clients have underperformed in comparison to the tech-weighted growth funds and especially the index-based Nasdaq funds. These "underperforming" managers have often been compelled against their better judgment to buy tech stocks. This additional demand for tech stocks has boosted their price, for funds, index trackers, especially, have to pay fancy prices to obtain these tightly-held small volume assets.

Having bought tech stocks, the funds then dump out of favour stocks, often good blue chips, thus reinforcing the preference for "new economy" offerings.

Although privatisation is a more appealing option than previously, many established firms may find greater market approval for announcing a change in direction, especially toward e-commerce.

Some minor New Zealand companies have already abandoned mundane activities (in timber or salmon, etc) and have been rewarded with amazing share prices and a great ease in raising capital.

On a sceptical note, I expect daily to see an enterprising company listing "for a purpose not yet to be disclosed." Such a company listed in the South Sea Bubble 280 years ago.

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