Why Shares Are Like Sugar

By David McEwen

Saturday 21st April 2001

Sometimes it helps to remember that investments are governed by the same economic laws as everything else.

One law states that a product or service is only worth what someone else is willing to pay for it.

Investors often forget this and put their financial assets on a pedestal, immune from reality.

The latest example of this can be seen in the criticism of companies issuing shares to institutions at a discount to the market price.

Two large listed companies have done this lately, raising many millions of dollars in capital by selling shares at around 8% less than their recent value.

This has caused a bit of tut-tutting by those who believe small investors are being disadvantaged. While it would be nice for everyone to be able to buy shares at such a discount, the marketplace doesn't work like that.

Let's imagine for a minute that those shares were bags of sugar. Don't purchasers of sugar pay less if they buy in bulk? Do customers buying a kilo bag at the dairy complain if they don't get the same deal as those who buy it by the container load?

The same principle applies with shares. A business that wants to raise $20 million, as a large property investment company did a couple of weeks ago, will find it quicker and easier to sell a few blocks of shares than, say, several thousand. The cost of organising, promoting and implementing an offer to all shareholders, raising as little as a few hundred dollars at a time, would cost more than simply giving a discount to a few major buyers. That would be a waste of shareholders' funds.

Institutions taking up a large block of shares are effectively buying in bulk and understandably demand a discount. The company's job is to make sure that discount is as low as possible.

Admittedly, this process means small shareholders miss out on a benefit. However, the institutional buyers are typically unit trusts or pension funds, whose beneficiaries are another group of small investors anyway.

The same principle applies to transactions on the stock exchange. Buyers and sellers are constantly negotiating to reach a mutually agreeable price. Large blocks of shares are sometimes sold at a discount to the market because there is an excess of demand over supply. At other times, major parcels of shares are sold at above market prices because a buyer or buyers particularly want to own an influential stake in a company.

This 'premium for control' has been abused in the past but will be curtailed by a Takeovers Code that comes into force on July 1. A key element of this code is that anyone goes over a 20% ownership threshold in a listed company then has to make an offer to acquire at least 50%, with all shareholders having an opportunity to sell at the offer price.

This code will bring New Zealand into line with most major markets. It will also eliminate some of the overly favourable deals for a small group of powerful or well-connected investors that have marked a number of takeovers in recent years.

Fortunately, the does not remove the ability of the market to set an appropriate price for differing parcels of shares.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. He is commissioned by the New Zealand Stock Exchange to write an independent personal investment column. He can be reached by email at davidm@mcewen.co.nz.

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