Strategic Finance

In early 2010, I became interested in the collapse of the finance company industry in New Zealand. This was a period in time when the financial institutions, known as finance companies, relied on the public buying their debenture investments to fund them and found they couldn't renew their maturing investments. Fundamentally, there were insufficient new investors in the country to take up the debenture investments on offer. This situation led to the widespread collapse of pretty much the entire finance company industry.

What interested me, was that huge numbers of New Zealanders had illiquid bank deposit-style investments (known as debentures) with these companies that had lost the ability to repay their investors and were waiting for finance company assets to be liquidated so that they could be repaid. In most cases, it was forecast to take years for this liquidation to occur.

Financial assets in this situation are known as ‘distressed assets.’ Sometimes there is a secondary market that investors can sell on. For example, you might pay $1 for a debenture security, have the company you invested in run into a problem and then cut your losses by selling your face value of $1 security on the secondary market for 50c. At least you've got some money back.

With the finance companies, there was no secondary market. In some cases, the directors of the finance companies were misleading their debenture investors by assuring them that as assets were liquidated, they would get back most or all of their original investment despite it being patently obvious that this was not the case.

My thinking was that I would establish my own secondary market by writing directly to the investors in these companies and offering to buy their debenture investments at a discount to face value (that discount being calculated based on my research into the state of the particular company's loan book).

The finance company of particular interest to me was a company known as Strategic Finance, which from memory had about $300 million of debenture funding from about 20, 000 investors. It seemed to me that this was very much a situation where investors were being misled by the Strategic directors as to how much of their investment they would get back. I had also become aware that well-known Kapiti Coast Financial Advisor, Chris Lee, had a lot of his client's money invested in Strategic (Chris Lee for reasons that aren't clear was something of a sucker for putting his clients into dud finance companies).

I decided to offer Strategic investors a 10c in the dollar cash payment for their Strategic debentures and accordingly made an offer on this basis. This infuriated the Strategic directors who were keen on maintaining the repayment illusion for as long as possible and terrified Chris Lee, who no doubt was suddenly receiving a lot of concerned phone calls from his clients. He quickly tried to cover his tracks by advising the media that the offer from my Trust should be ignored.

The obvious question is, how could it be? I was entitled at law to make the offer if I wished, the offer was legally made, a considerable number of Strategic investors were then paid 10c in the dollar for their investments, what was the problem?

The offer was successful, I think I got about $1.2 million face value at 10c per debenture. I was gradually paid 22c in the dollar for them by the liquidators of the company over the next four years.

It was a nicely profitable exercise, but you can see what the underlying difficulty is if you want to enlarge this type of offer, you've got to front up with a lot of cash to make the initial purchase, then hope you've got your calculations right and that you'll get it back again over time.

There's Got to be a Better Way

What interested me next was a company known as DNZ Property Group. This property investment company had been formed by rolling all the individual property syndicates promoted by Doug Summers Edgar's old ‘Money Managers’ outfit (more like Money Mis-Managers) if the truth be known!

Money Managers had promoted a lot of unlisted, illiquid property syndicates which owned a single property. As time went by many of the syndicates had started to perform poorly, so their solution was to weld all the individual syndicates together into a single company and list it on the stock exchange. The investors in these syndicates had already been issued with shares in the new DNZ Property Group in lieu of their syndicate interests.

There was no ‘price discovery’ around these shares. Many of the investors had been involved for years and grown tired of the situation and the shares didn't trade on any market, however, what interested me, was that the shares would start trading on the New Zealand Stock Exchange (NZX) a month later.

My thinking was, I'd make an offer directly to shareholders to buy these shares before the shares started trading on a public market. I'd have a clause in the offer document entitling me to register the shares into my offering Partnership's name before I had to pay for them. Once DNZ started trading on the market I could sell enough shares to pay for what I'd bought and keep the remainder (I'd calculated an offer price substantially less than I thought the shares would trade at).

This is exactly what happened, I made not one but two offers in quick succession, received a good level of acceptance, sold enough to pay for what I'd bought and kept the difference which, my recollection is, was worth about $1.3 million. The paperwork costs of producing and mailing the offer was about $7,000 so, at the end of the day, it had been a very good day at the office.

There's Got to be an Even Better Way

Well, all this was getting pretty exciting. Starting a few months earlier with a few thousand dollars of capital I now had shares worth $1.3 million that I could sell and convert to cash any day I liked and until I sold them, I was getting a dividend of about $100,000 a year. I set my sights on bigger things.

What I now planned, was an all-out assault on all the big names of the New Zealand stock market. With this plan, I'd offer to shareholders in the tens of thousands, what I was prepared to pay. I'd calculated that even a thin level of acceptance could turn out to be very profitable.

The DNZ offer had attracted a fair bit of media comment and I anticipated that would ramp up to a new level with this new plan. My lawyers and I set to work in the couple of months before Christmas 2010, requesting copies of the shareholder registers from the target companies. We weren't required to say why we wanted them or what we intended to do with them. But behind the scenes, the paper-based registers which contained the names, postal addresses and quantities of shares owned by the individual shareholders were being converted by a data processing company into a computerized mailing database. It's quite common for a major New Zealand public company to have up to 50,000 individual shareholders, so digitizing the database was essential.

To try and limit the anticipated media frenzy, I thought we would mail the offer in the December 2010 Christmas / New Year break (the offers were actually dated December 27, 2010).

My recollection is that this series of offers involved seven major listed NZ companies and at least 200,000 letters. Not that it was any sort of problem producing letters on an industrial scale. The paperwork was all printed, pre-populated with the shareholder's name and address and the amount being offered for their shares and inserted into the envelope together with a pre-paid return envelope for acceptances by NZ Post's mass mailing firm.

There was a bit of difficulty with NZ Post's ability to get all the letters into the right letter boxes at the right time at this time of the year. NZ Post and their mailing firm solved this issue by printing the whole offer in mid-December, then breaking the print run up into the various postal zones and distributing the mail out to their distribution centres so it would be on-site and ready to go on December 27, 2010.

Everything went to plan, the mail went out, and lots of acceptances were received. I'd used a different Limited Partnership to make each offer, so the media were confused. The various companies' directors and management were at the beach.' Many stockbroking offices throughout the country (manned by a couple of office assistants because of the time of the year) reported their phones ringing off the hook as shareholders phoned their brokers to find out what the offers were about.

The latest series of offers had lifted overall profits, after deducting the costs of making the offers, to about $3.6m.

All this money-making was starting to get the media and “the big end of town” and their lobbyist mates at the country's most prominent commercial law firms very worked up. Their attitude — you can't have someone make a whole lot of money literally overnight from an entirely legal idea — it's inconvenient to us and it's got to be stopped!

The corporates soon had the country's most prominent commercial law firm (Trapman Chip?) on the job, beseeching the Government to change the law asap. Backed up with written submissions to the Commerce Select Committee, riddled with distortions and self-interested one-sided arguments, intent on bending a compliant Minister of Commerce to their will.

A New Type of Offer

The success of the Christmas 2010 series of offers had got me thinking even more.

I didn't think the success was repeatable, because there were only a limited number of NZX-listed companies worth offering on and I felt that I'd bought the shares of those shareholders willing to sell.

What I was thinking about, was offering to buy shares for substantially more than the current market traded price but buying them on deferred payment which would compensate for paying above market prices. I'd offer to buy the shares, receive acceptances, immediately transfer the shares into my offering partnerships' names and then pay them off in instalments.

I'd make a calculation between the offer price and the instalment period, so it would be like shareholders receiving an annualized return of about 8% pa on their money while they waited for the payments to come in. The instalment period I was aiming for was to pay for the shares in 10 annual payments over 10 years. I'd have ownership of the shares in the meanwhile and could cash them in if I wanted and reinvest the money elsewhere. All I had to do was make sure I invested the money carefully for a higher return than the payments I was up for to the vendor shareholders.

Offer documents were prepared for a simultaneous offer on half a dozen of the NZX's largest listed companies and on March 15, 2011, the offers went out. The success was incredible. I think I received over 1200 acceptances for shares with a current market traded value in excess of $7m.

Well, this was all too much for the Financial Markets Authority (FMA). I'd taken legal advice on the wording of the offer documents and it was hard to see that there was anything wrong with them but in no time at all the FMA was flying around issuing orders and filing court documents.

This culminated in a High Court hearing, where the judge, effectively decided that people entering into binding contracts (which is what the agreements to sell shares were) didn't have to read what they were signing or agreeing to and that he should take it upon himself to release the shareholders who accepted from their contracts on the basis that ‘the above market offer price was not matched by equal prominence being given to the fact that payment is deferred’.

I have it on pretty good authority that this decision dismayed a large number of the NZ legal fraternity. Think about it, how does anyone or any business enter a customer into a binding contract if they can't rely on the terms and conditions (the famous small print) attached to the contract? You go to rent a car, you probably know what the daily rate is, when did you last read the small print? You just accept that you'll be bound by it. You take out insurance on your house, you know what the annual premium is, when did you last read the small print in an insurance contract? Do you think the courts will help you if you later say you didn't understand what you were signing? Fat chance! They'll say you should have read it first.

It gets even worse. The offers my partnerships made to shareholders didn't really contain any ‘small print’. The offer document was a single A4 page with the offer printed on one side and the terms on the other in a normal, easily readable font. The first paragraph of the terms was titled ‘Payment’ and went on to explain that you would be paid in annual instalments over 10 years. Paragraph three clearly recommended you take advice before accepting the offer.

I was immediately asked when I was going to appeal this terrible decision and the answer to that was, “I wasn't.” Because of this court decision, I'd become concerned that the FMA would try to overturn the earlier successful offers. Neither I nor my lawyers could see any grounds for them to attempt this but given the decision on the deferred payment offers, who knows!

In discussions with my lawyers who were talking to the FMA, it was agreed that if I didn't make any further deferred payment offers and didn't appeal the court decision, then they would take no steps on the earlier offers (not that they had any steps to take). I'd made a lot of money fast and I was out of there.

South Canterbury Finance

At one point in the off-market offers business, I'd become interested in the listed bonds and preference shares of Alan Hubbard's ailing operation known as South Canterbury Finance (SCF). By this time SCF had become infected with the malaise spreading through the New Zealand finance company industry and their bonds and preference shares were changing hands at a significant discount to their issue price (this is what can happen when investors doubt the financial health of the parent company). In SCF's case, there was good reason to view the listed bonds and preference shares with suspicion. SCF was involved in a battle for its very survival and in desperation had installed a financial hired gun by the name of Sandy Maier as its Chief Executive.

Here was I, looking to offer the bond and preference shareholders 10 or 20c in the dollar, in the face of the SCF financial mayhem and there was Sandy Maier, thinking I was about to make an offer, warning, in the media to be wary of any offer from my partnerships and advising the bond and preference shareholders to take professional advice if they received such an offer.

He went on to say in the same article, effectively that “all was well and SCF was seeking to bring on board fresh equity by August 31, to bring it back in line with its Trust deed”.

Talk about misleading! Within a year SCF had collapsed completely and the bond and preference shareholders lost everything. Of course, in Sandy Maier's eyes that was preferable to them getting 10 to 20c in the dollar from me. I believe that SCF went on to cost the NZ taxpayer over six hundred million dollars as the government guarantee for the debenture investors was called upon.

Conclusion

If you have read all this you're doing pretty well and you'll have a fair idea of what's involved with an off-market offer or as the media termed it ‘low ball’ offer. Through that Christmas/New Year period of 2010 and into 2011 the media seemed transfixed by this business. Perhaps there wasn't much else going on in the country, I think I stopped counting after the first 50 articles, what a media beat up! John Key was Prime Minister at the time, and I recall thinking halfway through 2011 that I had had more press than the Prime Minister that year. That takes some doing!