Takeover interest on an under-valued NZX

Monday July 22nd was a busy day on our local market. First came the announcement that the directors of Arvida Limited (NZX: ARV) were recommending an offer for a takeover via a Scheme of Arrangement at $1.70 per share – well up on a share price that had become range-bound between $0.90 – $1.00 over the last 6 months. This was followed shortly afterwards by the confirmation of speculation that had emerged in Australian media during the weekend that The Warehouse founder, Sir Stephen Tindall, was teaming up with Australian investment house Adamantum Capital in proposing a non-binding indicative offer for the Warehouse Group (NZX: WHS) at between $1.50 – $1.70 per share.

Both offers come/ in a context of a tough time for both New Zealand as a whole – and, more specifically, the NZX. For the Warehouse in particular, this is compounded by market sentiment as the company is still in the throes of re-focussing its business as it recovers from past decisions.

Takeover is the ultimate form of shareholder activism. It’s a mechanism that allows value unrecognised by the market to become realised. And for the NZX right now, that is a peculiarly unique problem. From a period of frothiness driven by Covid-induced fiscal stimulus and low interest rates, to the inevitable economic hangover, for many listed companies the NZX now resembles something more akin to the Briscoes slogan (“You’ll never buy better“).

In that context, it isn’t surprising that overseas-based funds have taken an interest in our little corner of the world.

In theory of course, the market should not undervalue listed companies. The theory of ‘perfect markets’ is based on a free flow of information and capital on a global basis, allowing cash to flow towards issuers that are ‘undervalued’ and away from those where the value has become too rich. But it is fairly clear that NZ issuers, particularly small to mid-caps and those exposed to technology, often trade on lower valuations than similar companies on overseas exchanges. So why the disconnect? Certainly, it is unlikely to relate to the free flow of information – the NZX continuous disclosure regime has done much to address the sins of the past. Organisations like NZSA (amongst others) have emerged as credible, constructive critics to ensure that disclosure standards in public markets maintain the right balance between the needs of those seeking capital and protection for those willing to invest.

Market access

What is more clear is that for retail investors at least, the NZX has become disconnected from the global flow of capital.

It might seem a little ironic to say that, in a week where deep-pocketed foreign investors have expressed a desire for two (out of 128) NZX-listed companies. However, it is likely that a key reason for the interest in both cases is the significant dislocation between the share prices on the NZX and the underlying value of the companies. That has created a ‘scale’ factor that attracts the interest of said deep-pocketed, foreign investors. What has arguably been missing is the significant collective liquidity provided by many thousands of small investors (both New Zealand-based and foreign) seeking ongoing “price discovery”.

For an investor from Australia, our closest neighbour and partner through the CER agreement, it is relatively difficult to buy shares in NZX-listed companies. While previously possible via share trading platform Commsec, this is no longer the case. Foreign retail investors cannot buy NZX shares via Interactive Brokers, a large global platform. For many major NZX issuers, that creates pressure from Australian institutions for companies to create a secondary listing on the ASX to allow access for Australian investors. That doesn’t necessarily help liquidity on either side of the Tasman, as the volume is split across two listings. Arguably, it creates a significant cost for NZ-based companies to operate an additional ASX listing. Nonetheless, it remains a short-term pragmatic option for issuers, even if it doesn’t solve the underlying issue of Australians being able to easily access the NZ market.

Ironically enough, the cost for an overseas-listed company to operate a “secondary listing” on the NZX is relatively inexpensive. That seems a logical strategy for NZX to pursue – a means of broadening market access for New Zealand domestic investors. However, it hasn’t resulted in a stampede of secondary listings by Australian (or other) companies, although its good to see the listing of Santana Minerals (NZX: SMI) this week.

Of broader concern, the NZX is also impacted by a flood of regulatory settings that make it appealing for New Zealand companies to consider ‘private’ forms of raising capital rather than focusing on our local listed market. NZSA has been vocal in advocating for a form of “proportionate regulation” in our Companies Act and related legislation, to lessen the “regulatory arbitrage” on offer for companies and offer better protection for investors in unlisted companies. An accelerated pace of de-listings from NZX this year highlights the increasing need for structural reform of the settings that govern the relationship between public and private markets.

Arvida

Let’s get back to the offers announced this week. Arvida was the first – at 8:55 on Monday morning (July 22nd), the Board advised to the market that they had entered into an agreement with Stonepeak BidCo for the sale of 100% of Arvida shares at a price of NZ$1.70 per share in cash by means of a scheme of arrangement (“Scheme”).

This is, of course, subject to shareholder approval – as well as approval by the Overseas Investment Office. Tellingly, the Board has given itself the right to receive “a superior proposal“. The proposal by Stonepeak is at the same price level they first expressed in a non-binding indicative offer in late 2023; it’s clear that shareholders expressed some frustration to the Arvida Board that the initial interest was not taken further at the time. NZSA noted at the time that the company’s Board had taken the initial approach seriously, with an independent valuation of the company indicating that $1.70 did not reflect the underlying intrinsic value of the company. Certainly, the offer is less than the $2.04 per share implied by the company’s net asset value (NAV) – a value arguably validated (at least partially) by the recent sale of Timaru assets at a value only 2% less than NAV.

For shareholders, the choice will be one of accepting a certain $1.70 now or waiting for the market to reflect an (uncertain) net asset value. Shareholders also have an ability re-invest proceeds elsewhere in the sector in New Zealand – with Arvida’s sector peers also trading at significant discounts to net asset value.

Given that, the market reaction to the offer was unsurprising, with the “Arvida effect” seeing an increase in share prices across the sector over the last few days. This reflects a form of arbitrage by investors, with many taking advantage of the share price increase in Arvida (to $1.62) to sell and re-invest proceeds into another sector participant.

The increase in sector share prices is also driven by a re-examination of the sector by analysts in the wake of the Arvida offer. It is verging on shameful that it takes a takeover offer for one company for NZ-based institutional investors to re-rate their analysis for the entire sector – and again, reflects the potential lack of access to the NZX by overseas-based investors. Most investors should have been well aware of the tailwind to be provided by falling interest rates and the potential for recovery in residential property.

Certainly, the timing of Stonepeak’s offer indicates a clear turning point.

It’s also clear that Stonepeak (as a US-based bidder) will benefit from the fall in the NZ$ – it means they are paying around 5% less for Arvida than they would have a year ago, while still offering the same value for NZ investors.

The Warehouse

Less than an hour after the Arvida announcement, came a “Don’t Sell” notice from the Warehouse Group, a headline on a market announcement that I have not seen for a while. The reasoning, however, was clear – there had been speculation in Australian media over the weekend, that had translated into an approach by Sir Stephen Tindall and shareholders should await more advice from Directors. That advice came the following day, with the Warehouse indicating it had received (on Tuesday morning) a non-binding indicative offer (NBIO) from Sir Stephen and Adamantum Capital, at a range of between $1.50 – $1.70 per share.

Pleasingly, from NZSA’s perspective, the company had already created a Takeover Committee comprising independent directors following receipt of the proposal.

An NBIO reflects a proposal that is far less advanced than the situation at Arvida. Much water needs to flow under the bridge – a key role of the Takeover Committee is to determine its own view as to what constitutes fair value for the Warehouse Group and the conditions under which the Offeror can undertake due diligence (if at all). The range offered by Adamantum indicates similar uncertainty.

Yet by most measures, this looks like a well-timed attempt by Adamantum to gain a significant asset at a favourable price. Market sentiment towards the Warehouse has never been worse, with both external and internal issues weighing heavily on investors minds. From an external perspective, disruptive competition and a difficult macro-economic environment are hurting the Warehouse, while the company has now at least set a platform for recovery from a number of internal mis-steps that have seriously dented the performance of the company. The state of the Warehouse’s financial performance in 2024 is a far cry from only three years ago when it achieved a net profit of $107m.

The Warehouse has form when it comes to recovering from tough situations – does anyone else remember the ill-fated foray into Australian retail? Silly Solly’s lived up to its name for Warehouse shareholders at the time, and Clint’s Crazy Bargains turned out to be anything but a bargain. Nonetheless, the company did recover. Noel Leemings has proved a strong purchase, and the combination of red sheds, blue sheds and Noel Leemings account for around 3% of New Zealand’s retail sales.

During 2024, the sale of Torpedo 7 the closure themarket.com and the “resignation” of Nick Grayston as CEO, with subsequent changes to the leadership team, are all indicators that the Board has now developed a strong muscle when it comes to re-focusing the Warehouse on its core brands, its core operations and (even better) its core capabilities. That word ‘focus‘ is a critical one when it comes to retail, with a revamped culture likely to result in a better shopping experience for customers and streamlined cost base and margin focus benefitting shareholders.

The “interesting” question for shareholders is simply, how long will it take for any transformation to bear fruit? Or perhaps more fundamentally, does the Warehouse even have the ability to transform at all, in the context of a 2024 retail environment? Or, should the Adamantum / Sir Stephen bid amount to a concrete proposal, is it just easier to sell out to an Offeror with a different view of the future ‘Warehouse’ business model?

For most shareholders, $1.70 per share is unlikely to reflect the initial entry price for their shares. That in itself is not relevant; the question should be whether any resulting offer forms better value than the alternative. But it perhaps forms a level of psychological resistance to the Adamantum bid that will reduce support.

It is also telling that Warehouse shares were trading at $1.70 as recently as December – and that was prior to the slew of business transformation/improvement actions taken in 2024.

An alternative

Tellingly, the influential Norman family, who own just under 20% of the Warehouse Group and a swag of other New Zealand retail chains (including Farmers), have not indicated their support for the Adamantum bid. Now that the Warehouse is “in play”, wouldn’t it be interesting if the Warehouse Group was to become a form of ‘reverse listing’ for the Norman’s other retail assets? Existing Warehouse shareholders would be more likely to support an offer that saw them retain a (likely minority) stake in a larger, more diversified business – at a value that better reflected the strengths within the Warehouse’s existing business. Such a solution might also form an interesting, longer-term exit strategy for the Norman’s.

All speculation of course – but I cannot help but be curious.

They say that “time in the market matters” rather than trying to “time the market”. But that rule does not carry sway when it comes to a one-off takeover offer. As noted above, a takeover is a form of shareholder activism that reacts to under-valuation or poor corporate performance. When it comes to the Warehouse, there’s likely to be a good dose of both these factors.

Oliver Mander

Readers should note that the author has direct shareholdings in both Arvida and The Warehouse Group, with Arvida now forming a material position (>5%) in the context of his wider portfolio.