The Experts

Paul Rickard
+ About Paul Rickard

Paul Rickard has more than 25 years’ experience in financial services and banking, including 20 years with the Commonwealth Bank Group in senior leadership roles. Paul was the founding Managing Director and CEO of CommSec, and was named Australian ‘Stockbroker of the Year’ in 2005.

In 2012, Paul teamed up with Peter Switzer to launch the Switzer Super Report, a newsletter and website for the trustees of SMSFs. A regular commentator in the media, investment advisor and company director, he is also a Non-Executive Director of Tyro Payments Ltd and Property Exchange Australia Ltd.

Follow Paul on Twitter @PaulRickard17

AGL’s Vessey needs to fall on his sword

Thursday, July 19, 2018

AGL shareholders should be demanding that the Board sack CEO Andy Vessey. And if the Board doesn’t act, then shareholders should be lining up to change the Directors at the AGM later this year.

Vessey’s intransigence over the Liddell coal fired power stations has cost shareholders billions of dollars. This year, AGL shares are down by 11.5%. Since reaching a high of $26.52 on 8 December, they are down by 18.7%. And $3bn has been wiped from AGL’s market capitalisation.

AGL Share Price July 17 to July 18

AGL’s nearest listed competitor, Origin Energy, which owns the Eraring coal fired generator and has a similar retail energy business, has seen its share price rise over the same period. It closed yesterday at $9.38 compared to $9.13 on 8 December.

While there is a little bit of “apples and oranges” in comparing AGL and Origin and there are also other factors at play in the fall in AGL’s share price, an inescapable conclusion is that AGL’s position on the closure of Liddell has hurt it. AGL has no friends in Government, few friends in the public and the regulators are gunning for it.

AGL’s posture on Liddell, initially insisting that it had to be closed, then refusing to consider a sale of the plant, and then glibly dismissing an offer from competitor Alinta Energy and Chow Tai Fook Enterprises with “AGL has determined that the offer is not in the best interests of AGL or shareholders” has infuriated the Government, sections of the media, the public and the regulators. The charge that AGL was closing Liddell to protect its generating margins on its Bayswater and Loy Yang A power stations was widely levelled.

Some went further, accusing AGL of price gouging. Former Prime Minister Tony Abbott labelled AGL’s decision not to sell the Liddell coal-fired power station a “strike against the national interest”.

So is it any wonder that the ACCC’s final report on its inquiry into Electricity Supply and Prices went a lot further than expected? Its recommendation to prohibit acquisitions or other arrangements (other than investment in new capacity) that would limit market shares to 20% per cent in any region or across the national energy market as a whole to prevent further “harmful concentration” will be known as the “AGL clause”. AGL’s national market share at 21% (29% in NSW, 30% in VIC and 39% in SA) means that it will be locked out of any acquisition opportunities.

Vessey’s strategy that the company needs to move to lower emissions generation technology and that there is no future in coal fired power generation might well prove to be right. However, he has overplayed his hand and shareholders are paying the cost. AGL needs to get in sync with the community and bury the hatchet with the Government. This will be easier if Vessey goes.

Do the brokers see any value in AGL?

The major brokers who have assessed AGL following the release of the ACCC report have a marginally positive view on its outlook. According to FN Arena, there is 1 buy recommendation and 4 neutral recommendations (no sell recommendations).

The consensus target price is $22.90, a 6.2% premium to yesterday’s closing price of $21.56. While acknowledging that AGL is relatively cheap trading on a PE (price earnings) ratio of 14.0 x forecast FY18 earnings and 13.1 x forecast FY19 earnings, the brokers note the heightened regulatory environment and the risk this poses. They expect to see further downward pressure on wholesale energy prices and compression in the retail distribution margin. Individual recommendations and price targets are shown in the table below.

Bottom Line

I would be much more comfortable buying AGL if it was smoking a peace pipe with the Government. It is not, and probably won’t, until Vessey goes.

Further actions by Government, the regulators or as a result of public/media pressure can’t be ruled put. Energy is a “red hot issue”, particularly in the lead up to a federal election. The public want lower energy prices and are not going to shed any tears if AGL gets hurt (many would say gets what is due to it).,

In the absence of any change in Management or strategy, avoid in the short term.


BHP’s capital challenge

Thursday, July 12, 2018

A Reuters report that oil giant BP is set to pay more than US$10 billion for BHP’s US onshore oil and gas assets has led market analysts to start pondering what BHP might do with this somewhat unexpected “pot of gold”.

The onshore shale assets in the Eagle Ford, Permian, Haynesville and Fayetteville basins were acquired by BHP at the height of the oil boom in 2011. Largely written off in 2016, they are now being sold primarily in response to pressure from activist shareholder Elliott & Associates. In plans tagged “Value Unlock Plan for BHP” and “Fixing BHP,” Elliott argued that out of a total investment of US$29.2bn, US$19.9bn in acquisition costs and US$9.4bn of negative cash flow, BHP had “destroyed” US$22.7bn of shareholder wealth.

According to Elliott, BHP was not the right custodian of the US onshore assets, as there were no real operational synergies or risk diversification, and BHP didn’t have the cultural mindset or nimbleness to operate in shale oil where rigs are quickly commissioned and often drill for less than two years.

BHP hasn’t confirmed the sale to BP. Its last update to the market said that the process was tracking to plan, with bids due by the end of June and the “potential” for a deal announced by the end of calendar 2018. It also hadn’t ruled out a demerger or IPO of the business.

In the resources business, timing is everything, and BHP seems set to benefit from some “luck” in the sale process. A steady rise in the oil price to US$74 a barrel, President Trump’s corporate tax cut and some successful well trials are helping to lift interest in the sale and raise expectations about the proceeds. So, with BHP set to receive a small windfall, what will it do with the funds?

Capital options

BHP has three broad options for the funds - capital expenditure on new projects or buying assets, to pay down debt, or return the funds to the shareholders.

Under Andrew Mackenzie’s reign as CEO, BHP has been very disciplined with capital expenditure, particularly when it comes to new projects. It currently has four major projects underway with a combined capital expenditure of US$7.5bn over the life of the projects. There are two petroleum/LNG projects (Mad Dog Phase 2 in the Gulf of Mexico and North West Shelf Greater Western Flank-B in WA), the Spence Growth Option in Chile to expand copper production and the excavation, lining and building of infrastructure for the Jansen potash project in Canada. BHP recently announced a fifth project, the US$2.9bn South Flank iron ore project in the Pilbara.

Future growth options include offshore oil in the Gulf of Mexico with Atlantis, copper at Olympic Dam in SA, metallurgical coal at Wards Well in the Bowen Basin in Queensland, copper at Resolution in Arizona and after almost a decade, possibly the production of potash at Jansen. BHP says that “any investment decisions will be made in accordance with our capital allocation framework and fully consider the broader market impact”.

According to Mackenzie, BHP’s return on capital employed (ROCE) which was just 10% in FY17, is forecast to rise to around 14% in FY18 and the company is targeting 20% by FY22. 

BHP has also been working hard to drive cost efficiencies, for example, lowering the production cost of iron ore to US$13 per tonne, and is targeting further productivity gains of US$2bn by end FY19. Debt has been reduced, down to US$15.4bn as at 31 December, with BHP now targeting ongoing net debt in a range of US$10– $15bn. It has guided to capital and exploration spending of US$8bn pa to FY20.

The BHP story is “capital discipline, debt reduction and shareholder returns.”

Unless BHP has a major change in strategy, this means that a fair chunk of the proceeds from selling the US onshore oil assets will be earmarked for shareholder returns. This will most likely translate into an on-market buyback of shares in the UK listed entity (to reduce the discount with the Australian listed entity), and an off-market buyback (at a discount) of shares in the Australian listed entity.

The latter will allow BHP to distribute excess franking credits to Australian shareholders and will prove to be very popular with shareholders, assuming that they can get it done before a Bill Shorten ALP Government changes the rules.  

Do the brokers see any value in BHP?

In a commodity up cycle, the major brokers are supportive of BHP with 7 buy recommendations and 1 neutral recommendation (no sell recommendations). That said, they don’t see a lot of upside with a consensus target price $34.48, just 2.1% higher than last night’s closing price.

Individual broker recommendations and target prices (source: FN Arena) are set out below. Because resource company profits are highly dependent on commodity prices, broker forecasts should be treated with an extra degree of caution because a key input is the broker’s forecast for commodity prices.

In a commodity up cycle, the major brokers are supportive of BHP with 7 buy recommendations and 1 neutral recommendation (no sell recommendations). That said, they don’t see a lot of upside with a consensus target price $34.48, just 2.1% higher than last night’s closing price.

Individual broker recommendations and target prices (source: FN Arena) are set out below. Because resource company profits are highly dependent on commodity prices, broker forecasts should be treated with an extra degree of caution because a key input is the broker’s forecast for commodity prices.

                                                Broker Recommendations

Bottom line

Commodity prices are still in uptrend and if you are long BHP, I think you stick around for the ride. With BHP maintaining a high degree of discipline over its capital expenditure and balance sheet, shareholders will be rewarded with higher dividends and capital returns.

Can share investors seeking exposure to resources find better value elsewhere? Probably. If you place faith in the broker forecasts, the same analysts see 11.4% upside potential with Rio and 24.4% upside potential for Fortescue. The latter is much higher risk, given that it is virtually a pure play iron ore miner.

But the sale of the US onshore oil assets should allow BHP to further reward investors, and while it is probably too late to buy, there is no reason to bail out yet. Hold.




Super changes for the new year

Thursday, July 05, 2018

The start of a new financial year invariably means changes to the super system. This year, the changes are all positive and will potentially assist people at opposite ends of the age spectrum, as well as those that might be temporarily out of the workforce. Here is the rundown.

1. Downsizers can contribute to super 

If you are 65 years or older, you can choose to make a downsizer contribution into your super of up to $300,000 from the proceeds of selling your home. A couple could effectively get up to $600,000 into super.

The main qualification is that your home, which was your primary residence, was owned by you or your spouse 10 years or more prior to the sale. Contracts must have been exchanged on or after 1 July, the home can’t be a caravan, houseboat or other mobile home, and you must make the downsizer contribution within 90 days of settlement. You can’t access the scheme more than once. 

Technically speaking, you don’t actually need to buy another home!

It is very unlikely that this scheme will drive the decision to downsize, but if for lifestyle or other reasons you are thinking about downsizing, it could be an added incentive. Super is of course a very tax effective way to invest, with a maximum tax rate of 15% and the magical tax rate of 0% available to retirees who are eligible to access their super through an account based pension. 

The main disadvantage is that if you receive a government pension, funds in super will count against the assets test limit. This happens because you sell an asset that is exempt from the assets tests, so it’s not a drawback of the scheme per se but rather a financial disincentive from the act of downsizing.

The downsizer contribution won’t count against your non-concessional contribution cap and can be made even if your total super balance is more than $1.6 million. It will then be included when this is next re-calculated at the end of the financial year.

2. A no-brainer for first home buyers

The First Home Owner Super Saver scheme is up and running and is a “no brainer” for first home owners. It is essentially an accelerated savings scheme where you make additional voluntary contributions into super and take out later for your deposit or down payment on that first home.

In this scheme, you will save about 30% more than if you save by putting the money in a bank account or term deposit. This could be worth up to $6,000.

The only reason a young adult who has never owned a property wouldn’t access it is because if they never end up buying that first home, the funds will be stuck in the super system until age 60.

The scheme is, of course, subject to caps and rules. The main one is that you can only deposit $30,000 in total and a maximum of $15,000 in any one year. While the contribution can be a non-concessional contribution from your own monies, most participants will choose to make a concessional contribution out of pre-tax monies via the salary sacrifice system. 

In both cases, the contributions will count against the respective caps.

In terms of eligibility, you can’t access the scheme if you have owned property before. This includes an investment property. A couple could potentially deposit $60,000 and as it is assessed on an individual basis, if one partner has owned property and the other hasn’t, the latter can still deposit up to $30,000. There is no age limit.

When you take the funds out, you must sign a contract to purchase or build a home within twelve months. While the funds can’t be used to purchase vacant land, they can be used to construct a home on vacant land.

3. Catch up concessional contributions 

Announced back in the 2017 Federal Budget, the ability to carry forward unused concessional contributions commenced from 1 July. This may suit someone with a low superannuation balance who leaves the workforce for a period of time (such as maternity leave), or who for other reasons is unable to utilise their full concessional cap. 

The unused portion of the concessional cap of $25,000 per annum can now be carried forward for up to 5 years. This means that if you didn’t make any concessional contributions for four years, you could potentially make a concessional contribution of up to $125,000 in the fifth year. Or if you made a concessional contribution of $5,000 in the first year, you could make a concessional contribution of $45,000 in the second year.  

To be eligible, your total superannuation balance must be under $500,000 as at 30 June of the previous year.

Contributions are measured over a rolling five- year period and unused portions expire if not used. As the scheme only started this year, the first year that you can access it to make a higher concessional contribution is next financial year (2019/2020) and the carry forward will only relate to 2018/19. The following example from the ATO shows how this works.  




5 last minute super actions to take before the end of the financial year

Thursday, June 28, 2018

With only a couple more sleeps to go until the end of the financial year, here are five last minute super actions to take. But you will need to act straight away because contributions must be receipted and banked by your super fund or your SMSF before the close of business on Friday.

1.    Can you claim a tax deduction by making additional contributions to super?

There are two caps that limit how much money you can contribute into super. A cap on concessional (or pre-tax) contributions of $25,000, and a cap on non-concessional (or post tax) contributions of $100,000.

Concessional contributions include your employer’s compulsory super guarantee contribution of 9.5% and any salary sacrifice contributions you elect to make. They are called “concessional” contributions because they are a tax deductible expense for your employer.

There is also a third form of concessional contribution which is a personal contribution you make and claim a tax deduction for. Until this financial year, the ‘10% rule’ meant that only self-employed persons who received less than 10% of their income in wages or salary could claim this deduction. This rule has now been scrapped so that anyone can claim this tax deduction.

There are two important caveats. Firstly, you must be eligible to make a super contribution. If you are under 65, or aged between 65 and 74 and pass the work test, you will qualify (there are some particular rules for the under 18s). Secondly, you aren’t allowed to exceed the $25,000 cap on concessional contributions.

Let’s take an example. Tom is 45 and earning a gross salary of $100,000. His employer contributes $9,500 to his super, and he has elected to salary sacrifice a further $5,000. Potentially, prior to 30 June, Tom can contribute a further $10,500 to super and claim this amount as a tax deduction. He will do this when he completes his 17/18 tax return.

Tom will need to notify his super fund that this is a contribution he is claiming a tax deduction for. He does this by using a standard ATO form or online with his super fund. Technically, he will have until the earlier of when he lodges his tax return or 30 June 2019 to do this.

2.    Can you make additional post-tax contributions to super?

Non-concessional contributions are personal super contributions made from your own after-tax monies. You don’t claim a tax deduction for these contributions and they are capped at $100,000 each year. You must be under 65, or if aged between 65 and 74, meet the work test to qualify. And your total super balance (as at 1 July 2017) must also be less than $1,600,000.

If you are under age 65 (technically aged 64 or less at 1 July 2017), then you can access the “bring-forward rule” which allows you to make up to three-years’ worth of contributions, or $300,000, in one go. A couple could potentially get $600,000 into super. Ability to access this is further limited by your total super balance (under $1.4 million full amount; $1.4 million to $1.5 million $200,000; $1.5 million to $1.6 million $100,000).

3.    Can you or a family member access the Government Co-Contribution?

There aren’t too many free handouts from Government. The government super co-contribution remains one of the few that is available – so it seems silly not to try to access it. If eligible, the Government will contribute up to $500 if a personal (non-concessional) super contribution of $1,000 is made.

The Government matches a personal contribution on a 50% basis. This means that for each dollar of personal contribution made, the Government makes a co-contribution of $0.50, up to an overall maximum contribution by the Government of $500.

To be eligible, there are three tests. The person’s taxable income must be under $36,813 (it starts to phase out from this level, cutting out completely at $51,813), they must be under 71 at the end of the year, and critically, at least 10% of this income must be earned from an employment source. Also, they can’t have exceeded the non-concessional cap or have a total super balance over $1.6 million.

While you may not qualify for the co-contribution, this can be a great way to boost a spouse’s super, or even an adult child. For example, if your kids are university students and doing some part time work, you could potentially make a personal contribution of $1,000 on their behalf – and the Government will chip in $500!

4.    Can you claim a tax offset for super contributions on behalf of your spouse?

While this tax offset (rebate) has been around for years, the Government decided in last year’s budget to make it a whole lot more accessible by raising the income test threshold to $37,000 (it was previously $10,800). So, if you have a spouse who earns less than $37,000 and you make a spouse super contribution of $3,000, you can claim a personal tax offset of 18% of the contribution, up to a maximum of $540.

The tax offset phases out when your spouse earns $40,000 or more. Effectively, your maximum rebatable contribution of $3,000 is reduced on a dollar for dollar basis for each dollar of income that your spouse earns over $37,000. The offset is then 18% of the lesser of the actual super contribution or the reduced maximum rebatable contribution.

Your spouse’s income includes their assessable income, reportable fringe benefits and any reportable employer super contributions such as salary sacrifice. Similar to the rules for the co-contribution, you cannot claim the offset if your spouse exceeded their non-concessional cap or their total super balance was more than $1.6 million. 

5.    Pensions – have you paid enough?

If you are taking an account based pension, then you must take at least the minimum payment. If you don’t, then your fund will potentially be taxed at 15% on its investment earnings, rather than the special rate of 0% that applies to assets that are supporting the payment of a super pension.

The minimum payment is based on your age and calculated on the balance of your super assets at the start of the financial year (1 July). The age based factors are shown below.

Minimum Pension Factors

For example, if you were aged 66 on 1 July 2017 and had a balance of $500,000, your minimum payment is 5% of $500,000 or $25,000. You can take your pension at any time or in any amount(s), but your aggregate drawdown must exceed the minimum amount and be taken by 30 June 2018.

If you commenced a pension mid-year, the minimum amount is pro-rated according to the number of days remaining until the end of the financial year, and calculated on your balance when you commenced the pension.


Telstra’s profit downgrade overshadows attempts to create "new Telstra"

Thursday, June 21, 2018


Telstra CEO Andy Penn’s attempt yesterday to drum up support for the company at its Strategy Day fell on deaf ears. Penn’s strategy, somewhat unimaginatively titled ‘Telstra2022’, was overshadowed by a larger than anticipated profit downgrade for FY19 and a refusal to provide guidance on the FY19 dividend.

As might be expected, some broker analysts cut their dividend forecast for Telstra from 22c in FY18 down to a range of 15c to 19c in FY19.

Telstra shares fell 4.8% on the day. After trading as low as $2.69, they finished at $2.77, down 14c. In part, this was a retracement of the run up in the share price ahead of the Strategy Day, but also reflected underlying disappointment about Management’s ability to right “the Telstra ship”.

The market is desperate for an excuse to buy Telstra but is not convinced that Penn and his team are the right people to lead it. Yesterday’s downgrade, coming just 5 weeks after the last downgrade, shook confidence again.

Telstra has guided for FY19 EBITDA of $8.7bn to $9.4bn. Using the midpoint of $9.05bn, earnings have been slashed by more than $1.0bn compared to the revised (lower) FY18 forecast provided on May 14. And this excludes restructuring costs of $0.6bn.

Telstra has been hit by intense competition in the mobiles market. It expects overall FY19 market mobile and fixed revenue to be down by 2-3% on FY18, and mobile EBITDA to decline given trends in revenue per user and the impact of new entrant TPG on the market. Excess data fees are expected to decline as consumers switch to unlimited data plans, while headwinds from the NBN rollout will continue to impact the fixed line business.

Partially offsetting this is Telstra’s cost productivity target of $1.5bn, which is now expected to be met by the end of FY20.

But this downgrade was worse than expected, and with a dividend cut in FY19 more than a possibility, the market was in no mood to be too forgiving. And what of ‘Telstra2022’, Telstra’s new strategic plan?

‘Telstra2022’ has four strategic pillars:

  • Radically simplifying product offerings, eliminating customer paint points and creating all digital experiences;
  • Establishing a standalone infrastructure business;
  • Simplified structure and agile work environment; and
  • Cost reduction and portfolio management.

The first pillar will see, amongst other things, Telstra reduce the number of customer plans from 1800 to just 20 by June 2021, the end of excess data charges, and a much improved digital experience. Telstra expects that $500m of “historic” revenue will be eliminated from the business over the next 3 years as products and plans are simplified.

The second pillar involves establishing a wholly owned standalone infrastructure business unit. It will comprise Telstra’s fixed network infrastructure assets including data centres, domestic fibre, international subsea cables, exchanges, poles, ducts and pipes. It will provide access to these assets to other Telstra business units on commercial terms, as well as services to nbnco . It is expected to have an initial workforce of 3,000, assets with a book value of $11bn, revenues of approximately $5.5bn and EBITDA of $3.0bn.

The infrastructure business will not include mobile assets including spectrum, radio access equipment, towers and some elements of backhaul fibre. Telstra sees these as being crucial to its 5G strategy and allowing it to maintain a competitive differentiation around the capability of its mobile network.

It is expected to be fully segregated by 30 June 2019. When the nbn rollout is complete, Telstra could potentially sell or spin out the infrastructure business.  

In regards to organisation, Telstra plans to create an agile work environment and simplify its structure by flattening the organisation and reducing 2 to 4 layers of management. It will create a Telstra Global Business Services division for its large “back of house” processes (shared services division) and eliminate a net 8,000 jobs over the next 3 years. Overall, Telstra is targeting a reduction in labour costs of 30%.

Telstra is upping by $1bn the target for its previously announced productivity programme from $1.5bn to $2.5bn by FY22. It is targeting total costs to be flat or decline each year. It also plans to monetise $2bn of assets by the end of FY20 with the proceeds used to strengthen the balance sheet.

Bottom Line

Telstra needed to deliver a strategy aimed at slashing costs, and in this regard, it has. Reducing headcount by a net 8,000 positions to cut payroll costs by 30% and hold overall costs for the next four years at or below FY18 levels will be no mean feat, particularly in an environment where it needs to improve the customer experience to compete. These are ambitious, but commendable targets.

The questions the market has are twofold. Firstly, can Telstra actually do it, and secondly, why has it taken so long for Management to come up with the plan? Telstra fessed up to the NBN earnings hole of more than $3.0bn over 12 months ago and intense competition in the mobiles market is not new news.

At the moment, the jury is out on whether Andy Penn and Co are the right team to lead Telstra. A market re-rating is still some way off.




Takeover bid for APA fuels infrastructure stocks

Thursday, June 14, 2018


Yesterday’s $13bn bid for energy infrastructure provider APA by Hong Kong based CK Infrastructure (CKI) saw gains across the board for infrastructure stocks. In an otherwise down day on the ASX, Spark Infrastructure added 2.8%, Ausnet Services 1.0%, AGL 2.5% and toll road operator and owner Transurban 1.4%.

APA’s securities finished trading at $10.00, up 20.9% on Tuesday’s closing price of $8.27, but still a full dollar short of the indicative bid price of $11.00. The wide discount reflects the market saying that this bid is by no means a “done deal”.

And it is not just that the bid is indicative and conditional. It has the usual conditions around being subject to satisfactory due diligence, implementation through a scheme of arrangement and APA Directors indicating that they will support the offer and vote in favour.

The big condition relates to regulatory approvals from the Foreign Investment Review Board (FIRB) and the Australian Competition and Consumer Commission (ACCC).  

APA is one pf Australia’s leading energy businesses, owning and/or operating in excess of $20 billion of energy infrastructure assets. Its 15,148km gas transmission pipelines span every state and territory on mainland Australia, delivering approximately half of the nation’s gas usage. It also distributes gas to 1.4m consumers through 28,600km of gas mains and pipelines, owns wind and solar farms producing 585MW of power, gas processing plants and 244km of high voltage electricity transmission.

CKI and its associated consortium partner Power Assets own a majority stake in SA Power Networks, the primary electricity distribution network in South Australia; Citipower, which supplies electricity to 310,000 customers in Melbourne's CBD and inner suburbs; and Powercor, Victoria's largest electricity distributor which supplies electricity to 700,000 regional, rural and outer Melbourne customers. It also owns Australian Gas Infrastructure Assets. The latter supplies gas to 2 million customers through 34,000km of mains and pipelines, and owns 3,500km of gas transmission pipelines.

The CKI consortium revealed that it had already had discussions with and provided information to both FIRB and the ACCC. In respect of the ACCC, it has proposed a divestment package which would include APA’s interests in the Goldfields Gas Pipeline, Parmelia Gas Pipeline, Mondarra Gas Storage Facility and a standalone management team.

Whether these divestments will be sufficient for the ACCC is hard to say, but clearly the market thinks that competition concerns are going to come to the fore. FIRB’s position is unclear, but with more and more energy infrastructure assets coming under foreign control, a recommendation to the Treasurer to block the takeover can’t be ruled out.

One aspect that can be ruled out is a competing offer. The bid price of $11.00 is full, representing a 33% premium to APA’s last traded price and a 26% premium to the broker consensus target price of $8.73. Further, this is a company that is sitting on $9.3bn of net debt in an environment of rising bond yields, geared at 67%, with limited revenue or earnings growth. The company has guided to EBITDA of $1,475m to $1,510m in FY18 compared to $1,470m in FY17. Best case, 2.7% growth.

A forecast distribution of 45c in FY18, largely unfranked, puts it on a yield of 4.1% based on an offer price of $11.00. Broker consensus, according to FN Arena, has the distribution rising by 3.5% to 46.6c in FY19, a prospective distribution yield of 4.2%.

Shareholders, particularly those who took part in a $500m capital raising just a few months’ ago at $7.70 per security, will be hoping that FIRB and the ACCC let the bid through. Those worried about the “national interest” might have a different view.


Bank cartel charges could take years to play out

Thursday, June 07, 2018


My Switzer Daily colleague, Andrew Main, was spot on yesterday when he warned that a successful prosecution of the bank executives in the ANZ cartel case would have a material impact on Australia’s capital markets and the ability of companies to raise capital quickly. Further, it could also have a huge impact on the reputations of two of the world’s leading investment banks - Deutsche and Citi.  

With so much at stake, in such untested waters, I think this case, with appeals, could drag on for years. And that’s assuming that the Commonwealth Director of Prosecutions (acting on behalf of the ACCC) can get it to trial in the first place, which could still be a very big if.

If you haven’t caught up with the cartel allegations, here is the background to the criminal charges that have been laid against the three banks (ANZ, Citi and Deutsche) and six current or former bank executives.

In late 2014, David Murray handed his Financial System Inquiry report to then Treasurer Joe Hockey. One of the key recommendations was that Australia’s major banks needed to be “unquestionably strong” in terms of capital and balance sheet strength. With input from the regulator APRA, in particular around risk weights for mortgages, this played out in 2015 with each of the major banks raising capital through an issue of ordinary shares.

NAB was the first to go in late May raising $5.5bn. ANZ and CBA followed in August 2015, with Westpac completing the quadrella by raising $3.5bn in October 15.

The criminal charges relate to ANZ’s raising of $3.0bn in August 2015. On the morning of Thursday 6 August, ANZ shares were placed into a trading halt. ANZ announced to the market an institutional placement of $2.5bn and a share purchase plan for retail shareholders to raise $0.5bn for a total raising of $3.0bn.

The institutional placement of $2.5bn was fully underwritten by Citi, Deutsche and J.P. Morgan. It was pitched as an “accelerated book-build” with the final price to be determined by institutional bidders but not lower than the underwritten floor price of $30.95.

ANZ shares had closed trading the day before (Wed 5 August) at $32.58, meaning that the shares were being offered to institutions at a maximum discount of 5.0%.

On the Friday (7th August), ANZ announced to the market that it had successfully completed the $2.5bn institutional placement by issuing 80.8m ANZ shares at $30.95, the underwritten floor price. ANZ shares resumed trading, opening at $29.99 (almost a $1.00 below the raising price), before trading between a low of $29.80 and a high of $30.64 to close the week at $30.14.

ANZ made no mention in its statement that institutions had only successfully bid for 55.3m shares and that the underwriters were left holding 25.5m shares (worth around $790m). Not directly related to the cartel charges, ASIC is currently investigating whether ANZ should have disclosed this to the market.

With an exposure of almost $800m to ANZ, the underwriters acted to reduce this by selling the shares on market over the next few days. This is where the accusations of cartel behaviour come into play, in that the underwriters joined forces to sell the shares and colluded or co-operated in breach of the law. While we won’t know the full details of their alleged cartel behaviour until the case makes it way to the courts, we can be pretty sure about the motive. The underwriters wanted to minimise their losses, as they were on the hook to buy these ANZ shares at $30.95 and wanted to sell them at the best possible price.

Was anyone hurt by the underwriters alleged actions? Possibly, because they may have paid more for ANZ shares on market than they would have had the behaviour not happened. But possibly not, because the shares were already trading below the institutional issue price.

As Andrew Main pointed out yesterday, the market already knew that the placement was a “failure” (meaning weak demand and a possible shortfall for the underwriter) because the shares hadn’t been placed a price higher than the floor. That’s why ANZ commenced trading at $29.99 the next day and I can say surmise that possibly, no one was hurt by the cartel behaviour.

While the ACCC isn’t required to prove that a “loss” occurred in order to prove its case, to help maintain perspective on this matter, if the net result of the cartel’s alleged actions was to improve the price by $1.00 a share, we are talking about a potential loss to other investors of $25.5m. Big, but not huge.

The huge loss will be to the reputation of the investment banks and if criminal charges stick, the bankers caught out. It will also impact how companies raise capital and the whole underwriting process, where investment banks join forces to share the spoils and the risks.

With this in mind, I think that this case is going to be hard fought and could potentially drag on for years. My two bob’s worth is that it is more likely to end in tears for the ACCC.



Super shake-up is long overdue

Thursday, May 31, 2018


The good news is that the Productivity Commission (PC) has got it largely right with its recommendations for sweeping changes to the super industry. This is an incredibly fat and complacent industry that can do a lot more for the members it seeks to serve. Making it more efficient and competitive will boost retirement savings for millions of Australians.

But because it is such a gravy train – with a fee pool of circa $30 billion per annum to be shared out between the super funds, advisers and consultants – there is going to be an almighty pushback by industry participants. Get ready for the “super culture wars” as vested interests line up to shoot down the PC’s findings and articulate why their way of doing things is in “the members’” interests.

The PC has issued 20 draft recommendations covering matters such as cleaning up lost accounts, default superannuation accounts, super fund governance, encouraging fund mergers, member friendly dashboards and insurance in super.

Many of these recommendations are no brainers. For example, the PC says that one third of all super funds are ‘unintended multiples’ (created when a member changes job or industry and does not close their old account or rollover their existing balance). This costs those members $690m in excess administration fees and $1.9bn in excess insurance fees each year. It recommends that the Government legislate to ensure that accounts are sent to the ATO once they are ‘lost’, empower the ATO to “auto-consolidate” lost accounts into a member’s active account and reduce the ‘lost inactive’ threshold from five years to two years.

But the real bunfight will be over the recommendation for the ‘default account’ and the PC’s idea to have an expert panel determine a “best in show” shortlist of super funds.

A default account is the super account that is opened for a person who starts a job and hasn’t provided their own fund choice. Most employees don’t choose a super fund (because they don’t have a basis to make a choice), and in some cases, the fund is mandated by the industrial award. As a result, people working in the building industry generally end up with their super in CBUS, while retail employees have their super directed to REST. The default arrangements become absolutely critical to the long-term growth aspirations of the super funds.  Catch the employee at the start of their career and you should keep them as a member at least until they retire.

The big bank and privately owned super funds have been lobbying the Government hard to open up the super default arrangements because they largely favour the union backed industry funds. This was one of the major reasons that the Government asked the PC to enquire into the efficiency and competitiveness of the super system.

Rather than suggesting that super funds should compete and “tender” for industry/company default arrangements, the PC has recommended that a single shortlist of up to 10 superannuation products should be presented to all members who are new to the workforce or do not have a superannuation account, from which they can choose a product. Clear and comparable information on the key features of each short-listed product would also be provided. Any member who failed to make a choice within 60 days (from this list or any other fund, including an SMSF) would be defaulted into one of these 10 products via sequential allocation. 

The 10 shortlisted products would be chosen by a Government appointed independent expert panel. The panel would run a competitive process for selecting the products based on a clear set of criteria and which are judged to deliver the best outcomes for members, with a high weighting placed on investment strategy and performance.

The PC envisages that a “Reserve Bank Board” style panel, non-partisan and credible, would be appointed by Government. Members would serve for a fixed term, with only one third of the panel carrying over from one selection period to the next. Panel positions would be advertised, with short listed candidates presented to the relevant Minister, and then appointed by Cabinet.

The PC rejected the idea that the regulator (APRA) should take on this role. It also considered that the Fair Work Commission was ill suited for the role as it doesn’t have expertise in superannuation.

It also rejected the idea that a Government owned entity, perhaps the Future Fund, take on the role of being the default fund provider. It believes that in the event of “poor performance”, there may be significant political pressure for taxpayers to “top up” returns. It also sees risks from political interference in the investment process, potential pressure for a more conservative investment style to minimise the risk of losses and a lessening of industry competition.

Perhaps unsurprisingly, few industry players are happy. The union backed industry super funds have the most to lose over the medium term under the proposed model and will argue that the Fair Work Commissioner should play a role. The bank owned retail super funds would have preferred a tender model, because they could propose a “low fee” fund for new members without impacting on their existing “higher fee” funds. They don’t enjoy the same performance results as the industry funds, so few, if any, will make the first cut of the “top 10”. And for the smaller super funds – the writing is on the wall because once there is a “top 10”, it will be really hard for the plethora of funds who miss out to thrive.

What did the PC miss in its review

The PC didn’t get everything right. It made a start on the great insurance racket, which sees most members being “compulsorily” signed up for the product. It says that for members under 25, this should be on a deliberate “opt-in” basis, that the Government should legislate to cease insurance cover on all accounts where no contributions have been obtained for the past 13 months and that the industry should adopt an insurance code of practice.

But this doesn’t go far enough. Taking insurance through super usually makes sense for people who have dependents, a mortgage or lack secure employment, but if you are young or care free, or perhaps even approaching retirement, it can often make little sense. The “opt in” should be extended to at least age 30, and all members should be advised annually that they can “opt out” at any time.

Another area that the PC didn’t address is how funds should assist members to select the most appropriate investment option. Arguably, selecting the investment option within your fund is much more important than selecting the right super fund.

How will this play out

The PC’s report is draft report, which means that public submissions are being sought (can be lodged up until 13 July) and that they are also going to hold further public hearings. A final report may get to the Government in late 2018.

This places it almost bang in the middle of the electoral cycle. Super is highly politicised, so it is likely that the Government will seek to push ahead with changes that impact the union affiliated industry funds, while the ALP seeks to stall and delay. Bottom line is it might go nowhere quickly.

This all said, I can’t see the “top 10” recommendation surviving as currently proposed. I don’t think the PC has thoroughly thought through the impact on the 198 super funds that don’t make the initial cut. Sure, we need fewer funds and bigger funds for economies of scale, but we don’t want too much lessening of competition. Ten won’t be enough.



Let the shareholders decide

Thursday, May 24, 2018

On Tuesday, the Boards of two major companies rejected takeover proposals. Oil major Santos rejected a proposal from Harbour Energy and “terminated discussions”, while hospital operator Healthscope killed off two bids by deciding not to provide “due diligence access”.

Following closely on the heels of the AMP Board debacle, these actions represent further examples of Boards failing to understand what their real role is. The Board is there to govern on behalf of shareholders, not on behalf of the management team or themselves, and if this means working with a bidder to develop an appropriate offer, then that’s their job. It is then up to shareholders to decide whether to accept or reject the offer.

More so as both companies have been chronic underperformers. Not surprisingly, Santos shares fell by 8.4% yesterday to $5.90, while Healthscope retreated by a more modest 2.1% to $2.35.

Where does that leave shareholders in Santos and Healthscope? Let me answer this by looking at each bid and the reasons cited by the Board for the rejection of the offer.


Harbour Energy’s bid was to acquire 100% of Santos by way of a scheme of arrangement at a cash price of US$5.21 per share or approximately AU$6.86. They had also offered to increase this to US$5.25 per share ($AU$6.91) if Santos extended certain oil price hedging arrangements.

The Santos Board (the independent directors, including Chairman Keith Spence, and CEO Kevin Gallagher) resolved to reject the offer and terminate all discussions with Harbour Energy. It cited   three reasons:

  • Superior shareholder value could be realised by executing the existing strategy;
  • Offer price too low; control premium inadequate; and
  • Private equity transaction structure complex, high risk, uncertain and unequal treatment of shareholders.

The first two reasons are usually cited by companies under takeover offer and can be dismissed. It is not to say that they aren’t without merit, but the market (and shareholders) will ultimately form an opinion about these matters. Judging by the market’s reaction yesterday with the share price some 14.6% below the offer price, it is not rushing to back the Board’s view.

The third reason is more interesting in that the Board decided that the transaction had a high degree of uncertainty and therefore risk. Firstly, a protracted execution timetable due to the need to secure approvals from the Foreign Investment Review Board and the SA Government, and secondly, the offer was being made by a debt funded, private equity bidder with no Australian presence or synergies. In regard to the debt funding, this required support from Santos to facilitate, including significant oil price hedging. There was also an issue about “unequal” treatment of shareholders, with Harbour Energy having joined forces with major shareholders ENN and Hony who would be offered shares in the new vehicle.

ENN and Hony collectively own 15.11% of Santos and had agreed to work with Harbour on the proposal. Now that it has been rejected and the door shut, it is not clear what they will do with their holdings.

Harbour Energy had previously made three unsolicited bids to buy Santos prior to this offer (the first going back to 14 August 2017), and must be feeling quite miffed that shareholders haven’t been given the chance to decide. Will they back up their kitbag and go home? Only time will tell, but according to UBS, Harbour cannot make another bid for at least six months.

This means that Santos shares are likely to settle lower and trade according to movements in the oil price and Management’s success or otherwise in executing the strategic plan. Broker sentiment is marginally negative, with Citi downgrading to ‘sell’ from ‘neutral’. Of the major brokers, FN Arena says that there is 1 ‘buy’ recommendation, 2 ‘neutral’ recommendations and 2 ‘sell’ recommendations (also 2 ‘no ratings’). The consensus target price is now $5.78.


Healthscope Chairman Paula Dwyer led with her chin when announcing that the company would not be granting due diligence access to the two bidders on the same day as CEO Gordon Ballantyne detailed another profit downgrade. He warned that FY18 EBITDA would be in the range of $340m to $345m, down from last year’s $359.4m due to “softer than planned market conditions” and site specific issues with three Victorian hospitals.

The Healthscope Board had been considering a cash bid from a consortium involving BGH Capital and Australian Super at $2.36 per share, and a subsequent bid at $2.50 per share from global alternative asset manager Brookfield Asset Management Inc. Both bids were indicative, non-binding, and subject to a number of conditions including due diligence and arranging debt financing.

Dwyer read from the standard textbook when dismissing the bids:

“The Directors have carefully considered each proposal and concluded that neither proposal adequately reflects the long term value of Healthscope, nor its underlying assets nor future potential”.

To be fair to Dwyer and her Board, there were some issues in regard to the due diligence access sought by the bidders, with both parties trying to lock out the other party. This is complicated by Australian Super, Healthscope’s largest shareholder with about 14.0% of the shares, which has joined forces with BGH Capital and won’t support the bid by Brookfield.

But surely there is a way to allow due diligence to proceed on some form of amended terms, and if a binding bid emerges, that to be put to shareholders? We don’t need Boards acting as the arbiters of “value”.

Neither of the bidding parties looks ready to back-off and shareholder pressure will inevitably force the Healthscope Board to work with one or more of the bidders to extract an offer for shareholders. That’s why the share price only retreated marginally yesterday to close at $2.35.

As for the major brokers, they are mostly neutral on the stock with 1 buy recommendation, 6 neutral recommendations, 0 sell recommendations and 1 ‘no rating’. The consensus target price is $2.33.

The takeover battle for Healthscope is not over yet. When the next offer emerges, let the shareholders decide.



5 Budget changes for investors, retirees and SMSFs

Thursday, May 17, 2018


Now that the dust is starting to settle on last week’s Federal Budget, here is a summary of the five immediate financial changes that will impact retirees, investors and SMSF members. All changes will take effect from 1 July 2019. 

1.      Pensioners will be able to earn more before it hurts their pension

If you are one of the 88,000 aged pensioners who works part time, or perhaps a pensioner who wants to work part time, you will be able to earn more before this starts to affect your government pension. The Pension Work Bonus will be increased from $250 per fortnight to $300 per fortnight. When this is added to the $168 income free area, a single pensioner could potentially earn $468 per fortnight ($12,168 pa) and still receive the maximum government aged pension.

Eligibility is also being extended to earnings from self-employment, although a ‘personal exertion’ test will apply. Unused amounts of the work bonus can be carried forward up to a maximum of $7,800.

Because the pensioner income test reduces the fortnightly pension by $0.50 for every $1.00 of income over the income free area (plus work bonus), some pensioners will receive a higher part-rate pension. For example, if Tom earns $600 a fortnight, his part pension will increase by $25 per fortnight.

2.      Government Reverse Mortgage (Pension Loans Scheme available to all retirees)

All Australians of age pension age (67 years or older if born after 1 January 1957) will be able to access the Pension Loans Scheme to boost their retirement income. This is effectively a Government run reverse mortgage scheme. Eligibility is being extended to include self-funded retirees and the payments available are being increased.  

The maximum amount that can be “borrowed” (received as a regular payment from the Government) is for a single person $11,799 pa ($453.81 per fortnight). For a couple, it is $17,787 pa ($684.11 per fortnight). The actual loan size (payment) will depend on the age of the recipient(s) and the value of their home.

As a reverse mortgage, the loan will be secured by a charge over the retiree’s/pensioner’s residential property. Upon death, the home will be sold and the proceeds used to re-pay the outstanding loan balance. Interest is charged on the outstanding loan balance at a rate of 5.25% pa and is capitalised.

Payments are made each fortnight, usually accompanying the regular pension payment. Lump sum withdrawals (loan amounts) are not permitted. On the other side of the ledger, recipients can repay their loan in part or full at any time without penalty.

From a cost point of view, it is relatively attractive with the interest rate about 1% lower than commercial reverse mortgage schemes. There are also no monthly account fees.

Let’s take an example to demonstrate how the Pension Loans Scheme works.

Bob and Sue are a 70 year old maximum rate pensioner couple, with a house valued at $850,000. Their combined Age Pension income is currently $1,368.20 per fortnight ($35,573 per year).

They decide to boost their income and access the Pension Loans Scheme. They choose to receive the maximum amount available of $684.11 which takes their total fortnightly payment (pension plus loan scheme amount) to $2,052 per fortnight ($53,360 per year). This income stream increases over time in line with inflation.

Over the next 20 years, Bob and Sue receive around $500,000 in additional income to support their standard of living in retirement.

After 20 years, Bob and Jane sell their house for $1.6 million. The value of the outstanding loan, which has accrued interest at a rate of 5.25% pa, has grown to around $900,000. Bob and Sue pay out this balance from the sale proceeds and retain $700,000.

3.      An extra year to contribute to super

Currently, if you are over 65 years and under 75 years, you need to pass the ‘work test’ in order to make contributions to super. The test is defined as working a minimum of 40 hours in any 30 day consecutive period in the financial year – so it is like working full time for a week or one day a week for a month. Not that hard, but still a test to pass.

Of course, if you are under age 65 you can make super contributions whether working or not, and if you are 75 or older, you are restricted to just your employer’s mandated 9.5%.

From 1 July 19, people aged 65 to 74 with a total superannuation balance below $300,000 will be able to make voluntary contributions for 12 months from the end of the financial year in which they last met the work test. They will potentially be able to access their non-concessional cap of $100,000 for personal contributions, and their concessional cap of $25,000 for contributions they could claim a tax deduction for. They will also be able to access any unused concessional cap space under the new 5 year ‘carry forward’ rules.

4.      SMFS’s will only need to be audited every three years

The Government will change the annual audit requirement to a three-yearly requirement for self-managed superannuation funds (SMSFs) with a history of good record-keeping and compliance. This measure will reduce red tape for SMSF trustees that have a history of three consecutive years of clear audit reports and that have lodged the fund’s annual returns in a timely manner.

Another positive, particularly for larger families, is that the maximum number of allowable members in new and existing self-managed superannuation funds and small APRA funds will be increased from four to six members from 1 July 19.

5.      No tax deductions on vacant land

And perhaps the only negative is the axing of tax deductions for holding vacant land. From 1 July 19, the Government will deny deductions for expenses associated with holding vacant land such as interest costs or council rates.

Deductions will still be available if the expense has been incurred after a property has been constructed on the land, it has received approval to be occupied and is available for rent or if the land is being used by the owner to carry on a business, including a business of primary production.

The measure is expected to save the Government $25m pa.




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