Behind the profit line: strange behaviour

By Peter V O'Brien

Friday 27th February 2004

Recent announcements confirmed the longstanding proposition that there is more to running a company and looking after shareholder interests than merely selling goods and services and earning a profit.

Most were given limited treatment among the welter of profit announcements for the December period reporting round.

TrustPower produced an intriguing comment about its previously announced proposed $85 million share buyback. The buyback is now off.

"The decision not to proceed has been made because it is apparent there is not a satisfactory level of shareholder support for the arrangement."

That was surprising, because buybacks usually benefit shareholders. They receive cash for whatever shares participate. The value of the remaining holdings tends to rise when the market reassesses prices after adjusting for revised earnings a share (assuming profit is maintained or increased), the consequent return on shareholders equity, new historic and forecast price/earnings multiples and the possibility of higher cash dividends on lower share capital.

It is understood TrustPower's decision was made because a buyback may have caused complications for some shareholders.

The words "not a satisfactory level of shareholder support" would be a careful way of covering the point.

TrustPower's directors "therefore consider it appropriate" to pay a special dividend of 10c a share (fully imputed) on April 2 and make a 2:1 share split on the same date after the dividend payment.

Apart from the extra dividend, shareholders should benefit from the share split.

There is some irrationality about share prices improving after a share split. Theory says nothing has changed.

The number of shares doubled after a 2:1, historic and (probably) prospective earnings a share halved, as did the results of an unchanged policy.

Yet the share price has an immediate, if marginal, price increase. Increased liquidity could be part of the reason, with some shareholders deciding to sell while retaining an interest.

Maybe but every willing offer has to be matched with a willing buyer, irrespective of the apparent lower outlay.

The outlay is apparently "lower," because, for example, a seller and buyer of, say, 10,000 shares ex split at $5 made the same outlay as those dealing in 5000 shares at $10 each pre-split.

Investor perceptions are probably different when dealing in relatively small parcels but the principle is the same.

We will see what happens with Trustpower. The price went up immediately after the announcement and then fell in the week ended February 20, although on comparatively low turnover in both cases.

Theme park operator New Zealand Experience was an example of why investors should discount stocks that had tax holidays. The company reported profit of $519,000 for the six ended December, down 33.6% on the $782,000 for the corresponding period of the previous year.

Its results had no effect on the share price, because the company signalled in its report for the year ended June "it is noted that a full tax charge will be recognised in the financial statements against ongoing operating profits."

Profit before tax was $774,000 in the latest half-year, down 1% on the before-tax and net profit result for the six months ended December, 2002.

Informed investors and their equally informed advisers knew what was coming and priced the shares accordingly, making nonsense of a critical media assessment of the result.

Evergreen Forests' apparently horrendous net loss of $13.15 million for the six months ended December (4.27 million profit in the corresponding period) included a forest value writedown of $13.16 million after tax, yet the company had a $6.48 million tax liability, compared with nil in the 2003 half-year.

The company changed from historical cost accounting policy to valuation accounting in the period.

Discussions about accounting policies and their formulators have as many views as there are proponents of different approaches. The problem of potential substantial "profit" fluctuations arises in this context.

Assume a strong rise in the US dollar and a coincident and consequential abandonment of currency manipulation among Asian economies and their associated processors of imported raw materials priced in US currency. Forest prices would rise.

Those recent valuation writedowns would become writeups.

Words such as "profit" then have Humpty-Dumpty definitions: "a word means exactly what I want it to mean; no more and no less."

These matters have nothing to do with the competence of directors and executives to run companies' "normal" activities but concern investors. The latter would be interested in how New Zealand authorities might intervene in the foreign exchange markets, following Finance Minister Michael Cullen's hints.

Intervention could occur, probably for a few weeks at best, before speculators swamped the Reserve Bank and Treasury with currency and derivative deals beyond their intervention capacity.

Remember speculator George Soros in that context. He has counterparts in other places.

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