New Capital Market makes it easy for enterprising companies

By Peter V O'Brien

Friday 7th September 2001

DO-IT-YOURSELF INVESTING

Take the gamble and go down the highways and byways of investment

Investors who want to do their own thing rather than handing money to managed funds have a wider range of potential investment than professional managers.

They also have a wider range of risks, but that is irrelevant if individuals are prepared to take the chance and go down the "highways and byways" of investment.

Professionals have to stick with shareholdings or interest-bearing securities in big organisations to preserve the ability to liquidate investments quickly and take another opportunity.

Individuals have more flexibility, subject to risk, and may decide to buy shares in small companies for long-term holdings, deal in unlisted stocks and non-standard debt instruments, and engage in counter-cyclical activities.

Professional managers usually acknowledge the validity of the counter-cyclical concept (buy when everyone sells; sell when they buy) but rarely practise it, because they are wedded to benchmarks.

Just as well. If everyone was counter-cyclical there would be no counter-cycle; the negative would become the positive.

Investors got a new opportunity to investment in small companies in May last year when the Stock Exchange introduced its New Capital Market (NCM) system that was supposed to make it easier and less costly for "enterprising companies to raise capital and for growth-oriented investors to participate in new business initiatives."

That was what the Stock Exchange literature said, among other things, but it is worth noting that all the 11 NCM companies (now 10, after one moved to the main board) were listed last year. At the time of writing no other company has signalled its intention to utilise the NCM procedure.

Possible reasons for that situation will be considered later, after looking at what the system was supposed to do.

The Stock Exchange's publicity pamphlet on NCM companies sets out the steps from the initial idea to full listing.

Business people with enterprising ideas and good reputations for an NCM company under guidance and review from the NZSE and NZSE member firms;
The company is a shell with capital which is used in acquiring business assets;
The company produces a New Capital Market offering document for an offer of shares to the New Zealand public;
Capital is raised and the company is listed on the NZSE with an 'NC' designation;
The company completes a key transaction as the basis for its business growth. The company is listed on the NZSE with an "NM" designation;
The shares are tradeable on the NZSE and the company graduates from the NCM to full listing when its market capitalisation reaches $10 million;
If no key transaction is completed within 18 months, the company may be wound up and removed from the NCM."

While publicity pamphlets are usually written in a short, snappy style as opposed to detailed rules, it is useful in the current context to quote it, because it is designed for individuals.

Maximum is $1 million

Those individuals should take professional advice if they have doubts about NCM investment but at least in the short term, the Stock Exchange publicity can be taken as a guide to what the organisation thinks about its initiatives.

The exchange says standardised documentation is available on its website to simplify the listing and capital-raising process for companies and to reduce costs.

Share offers are presented in a standard offering document. Capital raised from the public is an amount between $400,000 and $600,000. The company promoters contribute between $200,000 and $600,000. The maximum is $1 million after the initial public company's growth.

The key transaction's minimum value is $1 million.

A key transaction is defined as an acquisition, arrangement, amalgamation, merger or reorganisation the company undertakes to achieve growth and to improve current or future profitability of its business. It must be located in New Zealand or Australia.

No more than 30% of invested funds can be spent on company administration costs until the key transaction.

Key transactions are subject to independent valuation and audit reports and NZSE approval. Shareholder approval of 75% or more of issued capital (excluding the promoters) is required for a key transaction to proceed.

The exchange set out the nuts and bolts of offers, saying:

An initial offer price of 50c for shares;
Initial shareholding by public investors limited to no more than 2% of shares issued in the IPC;
Offers are limited to New Zealand resident investors. There are no restrictions on additional purchases once shares have been listed;
Investors invest initially on the basis of an NCM offering document setting out the company's structure and intentions, risk factors, the NCM rules and a description of the directors and officers;
The promoters acquire their shares at not less than 25c and are required to hold them over a three-year period after the key transaction.

That is what the exchange thinks about its NCM, but the concept and its application so far raise several questions, some practical and others more philosophical.

The table lists the 10 companies with NCM or NM designation designations, the price on August 24, the highs and lows for 2000-01, the number of shares on issue and the market capitalisation at August 24.

(There are other companies smaller in capital and market capitalisation terms than some in the table, but they were listed before the NCM regime came into force.)

The number of technology stocks and their price fluctuations were notable, given the volatility of that sector over the past two years.

Selector Group, which was an NCM company before graduation to the exchange's main board, is another technology stock and has not performed particularly well.

It was 3.2c on August 24, compared with a 2000-01 high of 72c and a low of 3.1c.

The exchange's idea that "NCM companies offer opportunities for growth-oriented investment" and that capital for such companies "enables them to turn enterprising ideas and new initiatives into growing businesses" must be based on long-term operations.

The total market capitalisation of the 10 companies in the table was just under $34 million on August 24 and one - CableTalk - accounted for $10.8 million of that amount.

The remaining $23.2 million can be compared with the total capitalisation of the New Zealand sharemarket, including the New Zealand-based content of overseas companies, of $52.23 billion on August 24, or $43 billion if one removes Telecom's $9.52 billion distorting influence.

Raising new capital

Companies start their growth with an increase in trading revenue arising from demand for their products or services.

As demand increases they seek more capital (the basis of the NCM regime) from either existing shareholders and/or placements to new shareholders.

Raising new capital after initial listing is usually done through rights issues or issuing new shares to new shareholders, either for cash or as full or part payment for acquisitions.

Irrespective of which method is used, the price (actual, in the case of cash issues and "paper" in the case of shares issued for acquisitions) must be related to the market price.

That fact would inhibit at least short-term, and probably medium-term, growth for many of the companies in the table.

Initial expenses can be relatively high when related to the capital raised. Rocom Wireless' report for the nine months ended December 31, for example, showed the company had two million shares on issue and capital of $800,000.

Shareholders' equity was down to $647,000 at balance date, because the company had costs of $139,000 associated with the IPC.

The company's key transaction was the acquisition of Rocom.

It raised another $1.8 million in a second public offering in February and said costs in respect of completion of the key transaction and the second offering were anticipated to be "in the order of" $300,000.

Rocom is not a company scraping about to earn a dollar.

Its key transaction company has been in operation for 14 years and has forecast earnings of $480,000 for the year ended December, 2001.

The point is that costs of $439,000 in relation to capital raised and the key transaction is a high proportion.

NCM companies may have a place in equity markets, irrespective of how small they are when they start.

Most companies, even those heavyweights that were not reorganised SOEs, began humbly.

Carter Holt Harvey, for example, is now a combination for three groups, each of which started life as small, private family companies, the first two in sawmilling and selling timber and the third in metal products.

So there is nothing wrong in starting small, but it takes a long time to get big, unless a company has an aggressive acquisition programme.

Inability to handle numerous acquisitions within one's existing framework can be a serious problem, leading to a weakened structure, as shown in recent cases such as Advantage Group, and costly remedial action.

The NCM sector (see profiles in separate story) has been quiet for some time, with no new listings, although brokers apparently receive steady inquiries about the procedures.

It remains to be seen whether the NCM system has run out of puff, is just taking a breather while potential participants hold off to see what happens to the current crop of companies or has competition from other outlets, such as companies on the unlisted market.

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