NZX summary Via Elevation Capital
Seth Klarman: A Bubble Warning From The Past
§ NZX operates a monopoly-like business that retains the ability to at least grow in line with GDP; however,
§ The business has suffered from ill discipline over the past five years, with operating margin declining by over 50%, and total
return to shareholders of +22.5% significantly underperforming the NZX50’s +105.1%.
§ While the Agri data and publishing businesses have in the past been strong contributors to profit, the publishing landscape
has changed, and NZX was slow to react;
§ The significant acquisition of SuperLife has also suffered from a lack of focus on costs and opex investments subsequent to
§ The Board has pulled one of the two levers available to them and replaced the CEO. The new CEO now has the opportunity
to clearly articulate a strategy for improving returns and profitably growing the business over the long term;
§ It is our view that NZX is worth ~NZ$1.44 a share assuming the following steps are undertaken:
Ø Immediate remediation of the cost base to return the business to its prior mid-30’s operating margins;
Ø Review strategic alternatives for the funds management businesses including the potential sale of the business to a
specialist global player;“
Warren Buffett: If You Own A Good Business, Keep It
Ø Handover regulatory functions of the markets business to the FMA;
Ø Develop a credible plan with growth options for the business or become a “utility”;
Ø Return NZ$20M to NZ$30M in capital to shareholders via a tax-efficient buyback at present prices; and,
Ø Further broaden board member skill-sets with international investing/exchange experience as well as business
NZX Limited (NZX:NZ, Market Capitalisation NZ$278M) operates various capital markets within New Zealand providing trading,
post-trade and data services, as well as a central securities depository. As New Zealand’s only registered Securities Exchange, the
Group operates multiple ‘markets’ including the NZX Main Board (NZX), NZX Alternative Market (NZAX) and the NXT. NZX also
operates several other markets on behalf of third parties such as the New Zealand electricity market under long-term contracts from
the Electricity Authority and the Fonterra Shareholders’ Market on behalf of Fonterra. As of 30 April 2017, total debt and equity
listing across NZX’s exchanges held respective market capitalisations of NZ$26.6B and NZ$119.9B.
ATTRACTIVE BUSINESS MODEL
NZX has a near monopoly in the New Zealand primary listed equity and debt markets. Core market operations represent 68%
(NZ$52.9M) of Group revenues and include initial/annual listing fees, data fees, and trading & settlement fees. One of the most
attractive qualities of NZX’s core markets business is the consistent nature of its recurring revenues. Notably, the Group’s annual
listing fees, which provide a robust platform for NZX to leverage future growth. To this extent, attracting new businesses to list on
their platform is a key imperative to driving sustainable long-term growth.
DESPITE MONOPOLISTIC CHARACTERISTICS THERE EXISTS A COMPETITIVE ENVIRONMENT
The advent of new technologies has contributed to the globalisation of business and capital flows, vastly changing the competitive
landscape for stock exchanges. In response, leading stock exchanges have restructured their businesses, pursued foreign company
listings and explored M&A opportunities/strategic alliances. This has resulted in renewed focus on improving product offerings
(IPOs), listing standards, fee structures, and regulation. In contrast, NZX has remained relatively insulated from such pressures,
providing little impetus for increasing efficiency or promoting its business. Left unaddressed; such factors may support an exodus of
larger New Zealand companies to ASX. As it stands, NZX/ASX dual-listed stocks account for 9 out of the 10 S&P/NZX10
constituents, and approximately 60% of the S&P/NZX50 constituents.
ASX’S COMPETITIVE ADVANTAGE
Economies of scale and network effects significantly contribute to liquidity and market depth; where studies have revealed size and
liquidity to be the top considerations for new businesses seeking to list on an exchange. As at December 2016, listed entities on NZX
had a total market capitalisation of ~NZ$115.5B, versus ~NZ$1.8T of total market capitalisation on the ASX; while trading volumes
were similarly low at 37% of market capitalisation versus 72% of ASX. The comparatively small market/trading volumes of NZX place
it at a substantial disadvantage when competing for new listings, leading to a vicious cycle. Offsetting this, and highlighting in our
opinion a failure to “communicate and sell” effectively, are the higher multiples NZX listed companies currently fetch versus global
peers across the broad industry spectrum and the higher than average forward multiples the market continues to trade at which
should make listing in New Zealand attractive. (Forsyth Barr in a report dated 12 June 2017, currently estimates the 12 month forwardweighted
PE multiple for the New Zealand market to be 19.5x, or +10% above the five-year average).
Your Essential List of 7 Productivity Hacks and Time Management Tips
CONSOLIDATION OF MARKETS
It has been well publicised that despite strong equity market performance, NZX currently lacks a meaningful IPO pipeline. In 2015,
NZX achieved a total of three IPOs while 2016 was similarly underwhelming with the IPOs of Tegel Group, Investore Property and
New Zealand King Salmon. However, one has to acknowledge that this is the experience globally, predominantly as a result of
regulatory creep and the growth in private equity funding which allows companies to stay private longer. Jason Zweig in the Wall
Street Journal on 23 June 2017 – using the chart (below), highlighted the declining number of listings in the US capital markets since
Source: The Wall Street Journal1
The new SEC Chairman according this Reuters article [ http://www.reuters.com/article/us-usa-sec-ipo-idUSKBN19D1S2 ] is also
investigating why IPO volumes in the US have declined by as much as one third since 2015.
NZX management has also made attempts to try and create an attractive environment for smaller companies to list. Launched in
2016, NXT was developed as a marketplace for fast-growing, small and mid-sized businesses. NXT is intended to provide SMEs with
the necessary capital required to expand their business in addition to creating a viable runway for SMEs to graduate to NZX’s Main
Board. Its reception thus far has been underwhelming and as at December 2016, NXT had a total of four listings with no apparent
pipeline for growth and one of the four recently announcing a proposal to delist. While alternate exchanges have proved successful
overseas (such as the FTSE AIM in London), it is our view that the small size of New Zealand’s capital markets makes it hard to
justify the existence of three separate equity markets (the Main Board, NZAX and NXT). It is worth considering that ASX, which is
approximately 16x the size of NZX, continues to run a single equity market. We assert that companies listed on NZAX and NXT may
be better served under the umbrella of NZX’s Main Board with a simplified rule set for small-cap listed companies – e.g. for
companies with a market capitalisation below NZ$ 25.00 million.
REVIEW REGULATORY FUNCTIONS
We recognise that self-regulation has its benefits, including an overall increase in regulatory resources and an ability to leverage
inside knowledge/expertise of industry professionals. However, we suggest there exists significant benefits toward adopting a
government/statutory model similar to that of the ASX. Such a centralised approach promotes efficiency and reduces the
duplication/layering of regulation, including supporting infrastructure and oversight activities. We further suggest that the FMA
would be better positioned to deliver more effective regulation as a single agency, as it would have broad jurisdiction over all market
participants; avoiding conflicts of interest between NZX’s commercial functions as a “for-profit” entity, and their position as a
regulator – we point to the significant costs associated with regulatory functions while disciplining your own customers counteracts
relationship building activities essential to all businesses. We suggest that transferring regulatory responsibilities to the FMA would
rebalance NZX’s competitive position relative to the ASX, which currently has a cost advantage due to their adoption of a
government/statutory model in 2010. Finally, it is our belief, that New Zealand is well suited to this model due to the small size of its
market – traditionally, one of the major headwinds for large complex markets wanting to adopt centralised regulatory models has
been the overwhelming resource required to do so; this is simply not the case for NZX.
COSTS UNDERMINE RETURNS
The biggest failure in our opinion for NZX over the past five years has simply been that increases in expenditure have consistently
outpaced revenue growth and weakened NZX’s bottom-line performance. Over the past five years, the Group’s operating margin has
more than halved, declining from 38% (FY2011) to 18% (FY2016). As a result, NZX ranks as the worst performing exchange when
observing Revenue, EBITDA and NIAT generated per employee across a broad peer group (on an unadjusted basis). To put this in
perspective, in 2016, NZX generated NZ$0.10M in EBITDA (unadjusted) per employee whereas ASX generated NZ$1.41M – some 14
times greater. In addition to labour costs, several loss-making ventures and cyclical IT expenditures have compounded NZX’s
profitability problems. Going forward, reducing costs, driving operating leverage and increasing efficiencies must be a primary focus
for Management. We are aware that 2016 marked a transitional year for the Company with substantial one-off costs being incurred.
While the removal of these costs is expected to be a key driver for improved performance in 2017 (refer Appendix #1 for a breakdown
of these costs), we maintain that there remains significant scope to reduce expenses further through a range of productivity and
efficiency initiatives in relation to their net worth.
SUGGESTIONS TO THE NEW CEO & BOARD FOR UNLOCKING VALUE
1. IMMEDIATELY REMEDIATE COSTS
The business has been poorly managed over the past five years with operating margin declining by over 50%, and total
return to shareholders of +22.5% significantly underperforming the NZX50’s +105.1%. Immediate remediation of costs
must occur to return the business to its prior mid 30’s to low 40’s operating margins.
2. REVIEW STRATEGIC ALTERNATIVES
While both SuperLife and Smartshares are highly scalable businesses, it is unclear that NZX is the highest value owner of
these businesses. Therefore, NZX should consider strategic alternatives including the potential sale of these businesses to a
specialist global player. There exist other smaller businesses within the NZX that should also be reviewed for divestment –
e.g. FundSource and NZ Farmers Weekly. NZX should also undertake a review as to whether retaining regulatory oversight
is in the long-term best interests of both itself and shareholders.
3. DEVELOP GROWTH OPTIONS OR BECOME A “UTILITY”
We believe NZX should assess how it can position itself to capitalise on new and emerging models for sourcing growth
capital such as crowd-funding and peer-to-peer lending which would leverage NZX’s expertise as a ‘platform manager’ and
be more suitable to the SME marketplace than NZX’s current NXT marketplace. This could provide NZX with a valuable
source of future Main Board listings and aid in the overall development of the capital markets. If the Board and
Management do not consider this an option, then we suggest NZX should be run as a utility – focus should be placed on
right-sizing costs, achieving world-class operating margins (after capex), and returning all excess capital to shareholders in
a tax-efficient manner.
4. ACCRETIVE CAPITAL RETURN TO SHAREHOLDERS
With NZX’s strong balance sheet, predictable cash flow generating capabilities, and the present low interest rate
environment, Management can create value for shareholders by conducting a highly accretive NZ$20-NZ$30M stock
buyback. For example, if NZX source term debt at 5%, buying back shares trading at a gross yield of ~8% is compelling.
5. FURTHER BROADENING OF BOARD MEMBER SKILL-SETS
International investing experience (including knowledge of and participation in/on other international exchanges) as well
as business development skills are lacking from the current Board and this needs to be addressed. We also believe some
level of ownership or responsibility for an ownership stake in NZX should be a function in selecting new directors to ensure
an alignment of interests with Board members and Shareholders.
Full PDF below