Shareholders benefit from better capital control

By Peter V O'Brien

Friday 5th April 2002

Equity investors have benefited from 1993 Companies Act provisions that increased the techniques available for efficient corporate financial management.

Procedures before the overdue revamp of company legislation were effectively limited to cash issues, with or without premiums over the antiquated concept of par value, bonus share issue, special dividends, share splits and benefits arising from friendly or hostile takeovers.

Tortuous rules controlled reductions of nominal and/or paid-up capital. Price appreciation after share splits were, and are, illogical market aberrations.

There is no valid reason that splitting one share priced at, say, $10 into two should result in each of the latter commanding $6 on the market in the absence of any alteration to perceived future profitability.

Arguments that a split increased the marketability of stock, attracting more small shareholders, are nonsense.

Marketable parcels depend on price. The higher the price the lower the necessary trade.

The same comment applies to bonus issues but in both cases hearts often overrule minds.

Legislative changes in 1993 allowed companies to buy their own shares - commonly referred to as "buybacks" - redeem shares, cancel them and provide financial assistance for the purchase of their shares. The last was a serious offence before the 1993 act.

It is useful to consider the philosophical bases of the old rules and the new regime before moving to analysis of examples arising from the latest act.

The New Zealand Companies Act 1995 was based on the UK Act of 1948, which was the result of a report from a 1937 royal commission.

An 11-year delay in the UK was another example of Corporal Hitler's effect on all aspects of life in the 1930s and 1940s.

The overall thrust of commonwealth legislation went back to the late 19th and early 20th centuries. New Zealand produced a Companies Act in 1908 in line with the UK Joint Companies Act of 1888.

Both statues were based on the idea that creditors were the most important people, or organisations, to be protected against the machinations of company promoters and directors.

There were degrees of importance between different categories of creditors, a view still entrenched in company and individual insolvency legislation and case law.

Secured creditors came first. Mortgages over real estate ranked ahead of charges over chattels (plant and equipment).

The primary, fundamental status of land and the buildings on it has been at the core of UK legal systems from feudal times.

That principle moved over to the position of lenders to industrial enterprises. Lenders were legally superior to borrowers.

The borrowers tended to be companies in the late 19th century and their status as corporate "individuals" (subject to the judicial fiction of "lifting the veil of incorporation") led to reinforcement of creditors' rights.

Unsecured creditors (apart from the later development of contractors' liens legislation, now also requiring drastic overall) and staff were down the pecking order.

Shareholders were at the bottom. They were considered to have examined matters soberly, in line with the other legal fiction of a "prudent person's" actions, and taken a risk.

So much for the potted, gapped history, which may have academic and practising lawyers and social historians spluttering in their fine wines this weekend. No letters please.

The rise of professional directors and executives coincided with the growing amorphous impersonality of large companies.

Organisational structures became self-perpetuating, creditors were often cosily involved in the system and the shareholders (the "owners") became another legal fiction in the sense of supposedly controlling the company's activities.

The clichéd "defining moment" came in 1987 when the investment world blew up.

Some people around the world did prison terms for their activities. Others should have but got away with excesses on the grounds of unfortunate incompetence, naivety or the ability to hide behind corporate structures.

The fallout hit the banking industry but also gave shareholders improved rights and companies the chance to implement more efficient capital management techniques.

We got the indirect result that the introduction of better capital control procedures produced potential benefits for shareholders.

The longstanding cash and bonus issues, share splits, gains from takeover bids and special distributions still occur. Buybacks and capital cancellations supplement them, although it should be noted there is a distinction between a buyback and a capital cancellation/ redemption.

Listed companies operated buybacks over a defined period, usually up to 12 months, at a price related to the market price on each trading day.

Cancellations/redemptions are one-off deals under conditions set with the approval of shareholders at special meetings

An example of that procedure and the effect on a company's financial structure is examined in the article below, using Ports of Auckland's share cancellation proposal as a case study.

Recent capital change activities:

Cash issues
Affco, 1:5 at 25c each;
Broadway, 1:3 at 25c;
Cabletalk, 9:1 at 50c;
Eldercare, 1:7.5 at 16.5c;
Metlifecare, 2:5 at 85c;
Mooring Systems, 3:2 at 50c;
Selector, 2:1 at 4c;
Vending Technologies, 1:10 at $2.50;
Kirkcaldie & Stains, 1:2 at $3.50
Share split
Sky City, 2:1
Special distribution
Tasman Agriculture, about $80.5 million after liquidation of the company (a technical arrangement)
Buybacks
Dairy Brands, eVentures, Evergreen Forests, Ryman Healthcare, Michael Hill International. There are continuing buybacks in Australian-based companies, with considerable investment interest from New Zealanders, notably banks such as National Australia and Westpac.
Takeover proposals
Frucor, Otter and Bendon (the last yet to be decided at time of writing). Normandy's offer for Otter Gold Mines was effectively a lifesaver for the latter's private shareholders.
Cancellation/return of capital
Ports of Auckland (see case study below); Port of Tauranga, 1:8 - $67 million.

Some proposed schemes came unstuck.

Edison Mission Energy's bid for Contact Energy was an example. A failed bid resulted in acceptances being cancelled. Some individual shareholders who accepted may be unhappy at the outcome, but institutions and the thousands of individuals who declined were obviously satisfied to keep their perceived undervalued stakes.

Investors have no show of outguessing company officials about cash issues. The astute can assess the likelihood of potential buybacks, share splits, redemptions/cancellations and special distributions.

They need a knowledge of appropriate corporate financial structures or to be able to get them from brokers' analysts.

Companies used to take pride in freedom from debt. That was a hangover from the days when a citizen's worth was based on unencumbered assets.

Lenders now scramble to hand out access to debt on the basis of "excellent credit history."

They hit back quickly when borrowers have trouble with repayments or reducing outstandings below credit limits.

Modern financial analysis accepts the view that a totally debt-free company can be an inefficient user of capital resources and a mismanager of the enterprise.

Statements from Ports of Auckland quoted in the case study reflect that outlook.

Comments from our readers

No comments yet