Brian Gaynor

Michael Hill’s relatively subdued mood at today’s annual meeting was a realistic reflection of the state of the retail sector. Sales are depressed and most companies are hoping for, rather than forecasting, a good Christmas period.

Hill told shareholders - rather tongue in cheek - that he is optimistic about the next few months because he expected individuals to stop buying yachts and purchase jewellery instead.

Figures in the following table show that the listed retail sector is depressed, particularly as far as the New Zealand operations of NZX listed companies are concerned.

On Monday Briscoe reported that group sales for the quarter ended 26 October were down 11.2% compared with the same period in the previous year, with Homeware sales off 10.2% and Rebel Sports 13.3%. Managing Director Rod Duke said August and September were poor but October was a bit better.

On the same day Hallenstein reported an 8% fall in NZ sales for the 2 August to 31 October period and noted that “trading conditions in New Zealand have been more difficult than Australia”. Finally, The Warehouse told the NZX this morning that group sales for the quarter ended 26 October were down 2.1% with Red Sheds’ sales off 1.6% and Warehouse Stationery 5.6% lower. The company reaffirmed that it expected consumer spending and trading conditions to remain subdued for some time.

These year-on-year sales figures compare with the country’s 5% annual inflation rate. Retail sales are usually subdued during a general election campaign but this election has been exacerbated by wall-to-wall media coverage of the international credit crisis.

Most retailers are highly dependent on the Christmas period and this year will be particularly important because of the depressed trading throughout most of 2008. The retail sector, particularly small mom and pop outlets, will face serious financial difficulties next year unless consumers open their wallets between now and 25 December.

Conflict of interest is a serious issue in the business sector. This is clearly demonstrated by Justice Raynor Asher's decision to overturn an Auckland District Health Board contract with Labtests because of Tony Bierre's conflict of interest.

The conflict of interest issue also arises with listed companies, particularly Guinness Peat Group (GPG). 

GPG's four executive directors, who dominate the company's board and remuneration committee, have received combined salaries, bonuses and gains on options of $74 million over the past five years.  They also had unexercised options worth another $48.1 million as at December 31.  This is an average of $30.5 million for each executive director.

These generous remuneration and options schemes create a potential conflict of interest even though the company believes "Sir Ron Brierley has qualities which are sufficient to ensure the integrity and independence of the remuneration committee in fulfilling its duties".

The huge increase in GPG's executive remuneration has occurred during an era when a UK corporate governance code has been introduced to reduce potential conflicts of interest at the board table. This Combined Code on Corporate Governance, is relevant to GPG because it is a British-registered company.

UK listed companies are expected to comply with the code, although it is recognised that departure from the provisions of the code may be justified in particular circumstances.

Several code provisions are relevant to GPG's executive remuneration. They include:

* The board should establish a remuneration committee of at least three members who should all be independent non-executive directors.
* No director should be involved in deciding his or her remuneration.
* Upper limits should be set on annual bonuses, and should be disclosed.
* The chairman should ensure that the company maintains contact as required with its principal shareholders about remuneration.
* Shareholders should be invited to approve all new long-term incentive schemes and significant changes to existing schemes.

The New York Stock Exchange also requires that all remuneration committee members should be non-executive directors.

But GPG's board is dominated by executive directors. The current board consists of Sir Ron Brierley (chairman), Graeme Cureton, Tony Gibbs, Blake Nixon and Gary Weiss.  Brierley has been classified as a non-executive director since 2000 - even though the Australian media still credits him with most of the company's successful deals.

The other four directors are executives.  Last year's annual report says the remuneration committee is Brierley, Nixon and Weiss. Thus, two of three committee members are executives.

GPG's board and committee structure creates a potential conflict of interest even though the company insists that no director is involved in deciding his own remuneration.

Most corporate governance codes recommend no executives be on the remuneration committee because they could put the interests of their fellow executives ahead of those of shareholders.

As well, Brierley has worked with Cureton, Gibbs, Nixon and Weiss for many years and has demonstrated in earlier situations, particularly at Brierley Investments, that he is not particularly forceful when dealing with strong personalities.

GPG's executive directors receive a combination of a base salary, cash bonuses, accrued leave entitlements and share options.  Base salaries paid to Cureton, Gibbs, Nixon and Weiss have risen by between 42 per cent and 108 per cent since 2002.

In 2001, GPG introduced a staff bonus scheme, with the proviso that "no bonus will be payable in respect of any year where net profits attributable to GPG shareholders do not achieve a 12.5 per cent return on opening shareholders' funds".

No limits have been put on these bonuses, contrary to the recommendations of the combined code, and these payments have accounted for the huge increase in executive directors' remuneration in recent years.

GPG's generous option scheme, which expires in 2012, was approved by Brunel shareholders before the 2002 Brunel/GPG merger.  Details of the scheme were included in a highly technical 226-page merger document.  This says that "when granting options, the board should specify objective conditions by way of performance targets, to be satisfied before options may be exercised".

The exercise price is determined by the board but may not be less than the higher of the nominal value of the shares (5 pence) and the middle market price per share on the last dealing date before the options are granted.

There is no evidence of any public statements regarding the targets executives have to achieve to be granted these options. The directors appear to have issued all options at the lowest exercise price allowed under the scheme.

How can GPG shareholders be sure the performance targets are realistic and the exercise price of the options is fair and reasonable when all of the directors, including Brierley, participate in the scheme?

The 2005 financial year was a bonanza period for GPG's executive directors because the company achieved a return of 22.3 per cent, well above the benchmark target of 12.5 per cent. The combined payment for the four executive directors was $22 million made up of: salaries, $4.5 million; cash bonuses, $12.7 million; accrued leave, $1 million; gains on the exercise of options, $3.8 million.

The 12.5 per cent measurement is highly questionable as far as an investment company is concerned, because gains can be unusually high in a bull market, particularly when opening shareholders' funds include subsidiaries and associate companies valued at cost.

Last year, GPG's return was only 4.1 per cent and no bonuses were paid. Total executive director payments of of $11.6 million comprised: salaries, $4.9 million; accrued leave, $100,000; gains on options exercised, $6.6 million.

As well as these generous remuneration schemes the four executive directors had 27.5 million ordinary shares as at December 31, now worth $63.3 million, and can receive 18 months pay if dismissed and two years' pay if GPG is taken over.

This issue is not about the total payments received by executive directors; it is about the way decisions are made on payments and options issued to them.  The decision-making process raises the possibility of a conflict of interest as far as GPG's executive directors are concerned.

Shareholders should be concerned because GPG's share price performance, relative to the ASX, NZX and London Stock Exchange benchmark indices, has declined in recent years as the payments to executive directors have increased.

The remuneration committee will probably be in a position to approve further huge bonuses this year, because the sale of the 19.4 per cent Australian Wealth Management stake on Thursday should enable the group to exceed the 12.5 per cent target for extra executive compensation.

Shareholders should also be concerned because the demise of Brierley Investments, the effective predecessor to GPG, was mainly due to an employee-dominated board that wasn't scrutinised by strong independent directors or shareholders.

Sir Ron Brierley is the darling of many New Zealand retail investors but no one, including Brierley and his highly successful GPG executive team, should be immune from shareholder scrutiny.

Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management and a Guinness Peat Group shareholder.  bgaynor@Milfordasset.com

COMMENT: When it comes to going forward, a good plan is better than a good quarter

P UMPKIN Patch executive chairman Greg Muir's refusal to give a profit update or guidance didn't raise a whimper at this week's annual meeting.

Shareholders were smart enough to realise that the company's growth strategy, rather than the important November- December trading period, will determine its sharemarket performance.

Pumpkin Patch's approach is far more aggressive than any other New Zealand retailer, and it will become one of the great New Zealand-owned companies if the strategy is successful.

In simple terms, there are two types of retailer, the big multi-purpose store operator and the specialty retailer. The Warehouse, which has turnover of nearly $18 million a year for each of its stores, is a big multi- purpose retailer whereas the three main listed specialty retailers with overseas ambitions, Hallenstein Glasson, Michael Hill and Pumpkin Patch, have annual sales of less than $2 million a store.

The multi-purpose operator grows by building bigger and bigger stores offering a wider range of products, whereas the growth orientated specialty retailers have to keep opening more stores in different places.

Pumpkin Patch has grown from 27 stores in July 1999 to 168 in July. This equates to 20 new stores each year or one every 18 days.

Michael Hill has taken a more subdued approach - its store numbers have risen from 102 to 177 over the same seven-year period, a new opening every 33 days.

In the past 12 months Pumpkin Patch opened 31 new stores, Michael Hill a net 21 and Hallenstein Glasson eight.

The Warehouse's Red Sheds in New Zealand remained static at 85. But their retail space increased by 4.2 per cent as existing stores were replaced and others extended.

Pumpkin Patch plans to raise the tempo and open at least 35 new stores by next July - equivalent to a new opening every 10 days.

Fitting out each new store will cost up to $1 million.

There will be a particularly strong emphasis on the United States and Great Britain although the company continues to expand in New Zealand and Australia.

This rate of growth is unprecedented for a New Zealand retailer or any other NZX company.

Listed specialty retailers have to expand overseas because New Zealand's small size and low population density restrict their growth prospects.

In the year to July, Pumpkin Patch achieved average sales per New Zealand store of $1.27 million compared with NZ$1.99 million per Australian store.

Ebit (earnings before interest and tax) per store in New Zealand was $252,000 compared with NZ$396,000 in Australia.

The group will be highly profitable if it can emulate or exceed its Australian returns in the Northern Hemisphere.

But Pumpkin Patch is far more than a specialty retailer. It designs its own clothes, contract manufactures in China, ships the end products back to New Zealand, sorts and then dispatches them to its worldwide stores. It also has wholesale and direct selling - internet and mail order - operations.

The organisational demands on the group are huge.

Greg Muir and managing director Maurice Prendergast have to ensure that the company maintains the highest standards in a number of areas including;

The design team has to remain at the cutting edge of the fashion world.

The company has to ensure that its contract manufacturing continues to produce high quality and consistent merchandise.

Transport and logistics will become increasingly important the more it expands overseas.

Store site selection will continue to be important as will the fit out of these new outlets.

The company must continue to adopt appropriate pricing and marketing policies for its different markets.

If - and it is a big if - Pumpkin Patch continues to maintain its current level of excellence and growth for a further 10 to 15 years then it will become one of the great New Zealand-owned companies.

Michael Hill has developed and sustained a successful business strategy over a long time.

Hill opened his first jewellery store in Whangarei in 1979 and moved to Brisbane in mid-1987.

Michael Hill International has had a more subdued growth rate. It opened its first store 27 years ago and plans to have 197 outlets by mid-next year after adding 20 this financial year.

Pumpkin Patch opened its first store in 1992 and plans to have at least 203 retail outlets by mid-next year.

Pumpkin Patch designs and contract manufactures all of its product whereas Michael Hill designs and contract manufactures only a small proportion of its final sales.

Another big difference between the two companies is that Michael Hill took complete ownership of his company's expansion into Australia, selling his Whangarei home and moving his family across the Tasman. His daughter Emma now takes full responsibility for the company's expansion into Canada.

By comparison, no senior executive seems to be taking clear responsibility for Pumpkin Patch's Northern Hemisphere expansion.

The group gives confusing signals as Greg Muir was awarded the Deloitte/Management magazine Executive of the Year award this week for driving the company's overseas expansion whereas most investors believe that Maurice Prendergast is responsible for this.

The company also misses the opportunity to give shareholders an in-depth analysis of the American or British markets, particularly at this week's annual meeting.

Maybe this was the reason no questions were asked and the meeting was over in 35 minutes.

Hallenstein Glasson is the other specialty retailer trying to make it across the Tasman. As the accompanying table shows, it generates more revenue and ebit per store than Michael Hill or Pumpkin Patch but it has been unable to achieve an adequate return in Australia.

Hallenstein Glasson is struggling to make headway in Australia because it doesn't have anything unique to offer compared with Michael Hill or Pumpkin Patch, which design and contract manufacture a proportion of or all of their retail merchandise.

Finally the takeover offer for Australian jewellery retailer Angus & Coote by the highly ambitious Auckland couple David and Anne Norman illustrates there is only the quick or the dead as far as specialty retailing is concerned.

Angus & Coote was founded 111 years ago and listed on the Australian Stock Exchange in 1952 yet its market capitalisation was only A$56 million before the Normans made their A$6.40 a share takeover offer last Friday.

The ASX listed company reported a A$3.8 million loss for the year to July because of weak demand, high gold prices and a 27 per cent increase in the number of retail jewellery outlets in Australian shopping centres between 2003 and last year.

After the takeover, which has been recommended by the target company's directors, the Normans will own more than 500 jewellery stores in Australasia under the Angus & Coote, Prouds, Pascoes and Stewart Dawson brands. They also own the 55-store Farmers chain in New Zealand.

The Angus & Coote acquisition should help rationalise the Australian market, but the Normans will be tougher competitors for Michael Hill International.

Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management.

Graeme Hart and Eric Watson have little in common except that they are both extremely rich and have made recent takeover offers for their listed vehicles.

As the accompanying table shows, the 21st century has been particularly prosperous for both individuals with Hart's net worth leaping from $200 million to $2.75 billion, while Watson has jumped from $110 million to $500 million (the latter figure has recently been revised up from $350 million).

But the two businessmen have travelled different paths to achieve their wealth. Hart has been hands-on, focused and has built a team of extremely competent associates while Watson has been a relatively passive investor with little focus and has failed to build a competent support team.

In addition, Hart has created wealth for minority shareholders in his listed companies whereas a large percentage of individuals who invested in Watson's numerous stock exchange vehicles have lost money.

This is the reason why investors will be hoping that Hart returns to the sharemarket if his bid for Burns Philp is successful. It is highly unlikely, though, that the NZX will see Watson again after he completes the PRG Group acquisition.

There was only the faintest sign of Hart's impending success at the Whitcoulls annual meeting in the Kupe Room, Aotea Centre, on October 25, 1995. No more than 20 or 30 shareholders attended, the meeting was over in a flash and the highlight was Hart's young son making happy noises at the back of the room.

Whitcoulls had just reported a 16 per cent reduction in net earnings to $20.2 million, mainly due to the disappointing performance of the Australian acquisition Angus & Robertson. Hart's 64.5 per cent Whitcoulls stake had a sharemarket value of $170 million at the time (the listed entity was called Rank Group until Whitcoulls was acquired from Brierley Investments in 1991).

The next year, Hart made a successful bid for Whitcoulls, valuing it at $282 million and, shortly afterwards, onsold it to Blue Star for $320 million. Eric Watson was running Blue Star and Maurice Kidd, his long-time business associate, was its financial controller.

In mid-1997, Hart purchased 19.9 per cent of Australian food conglomerate Burns Philp for A$260 million or A$2.50 a share. Three months later, Burns Philp's share price had fallen below A$1 after a poor result and Hart's investment was worth less than A$50 million.

The National Business Review's Rich List estimated that Hart's net wealth had plunged from $200 million in 1997 to a mere $25 million in 1998.

But Hart's true qualities came to the fore during this difficult period. He played a major role in Burns Philp's turnaround, which included the acquisition and subsequent 80 per cent sale of Goodman Fielder.

The country's richest individual has gone from strength to strength and, this year, completed the takeover of Carter Holt Harvey for $3.3 billion. His offer for the remaining 42.6 per cent of Burns Philp, which values the company at A$3.1 billion ($3.7 billion), will cost Hart A$1.3 billion.

As Hart's shareholding in Burns Philp is worth more than A$1.7 billion, the Sydney-based company represents a large proportion of his wealth. If the Burns Philp offer is successful, Hart will obtain full control of nearly A$2.5 billion of cash, a 20 per cent Goodman Fielder stake worth in excess of A$500 million and NZ Snacks, which has an estimated value of nearly A$200 million.

The deal makes sense for Hart and his bankers as he will get full access to almost A$2.5 billion of cash for an outlay of only A$1.3 billion. Hart may also believe the huge amount of private equity money has inflated asset prices and there are limited attractive opportunities for Burns Philp to utilise its cash.

This contrarian approach is an important part of Hart's success, as is his ability to execute deals, make these acquisitions work and attract and keep top-quality executives.

By contrast, Watson is a deal-maker with limited operational abilities and, most importantly, an inability to attract and retain top-quality executives. A notable exception is Stefan Preston, who runs Bendon for PRG.

Watson first became involved in PRG (then called Pacific Retail Group) in 1998 when he made a takeover offer at $1.30 a share. This valued the target company at $59 million. Watson ended up with 73.7 per cent after the two major shareholders, Murray International (58 per cent) and Roger Bhatnagar/Greg Lancaster (12 per cent), sold to him.

Watson made another unsuccessful offer in 2001 at $1.76 a share. This valued the target company at $89 million.

The next year, he made a third bid at $2.25 a share. This valued PRG at $116 million, but Grant Samuel produced a strong negative response after assessing the company was worth between $223 million and $248 million ($4.31 to $4.80 a share).

Watson then turned PRG into an investment company and one of his first investments was a stake in Burns Philp.

Meanwhile, he became involved in several listed companies including RMG (in receivership), Strathmore (now Media Technology), Eldercare (Abano), Advantage (Provenco), Metlifecare and AQL (Certified Organic).

PRG made the ill-conceived PowerHouse acquisition in 2003 and as a result has had to sell Noel Leeming, Bond & Bond and PRG Finance Group. PowerHouse has been a disaster for PRG and the company hasn't paid a dividend under Watson's stewardship.

Watson's fourth offer for PRG at $1.22 a share values the company at only $76 million compared with Grant Samuel's mid-point valuation of $235 million four years ago.

This offer will be successful because the bidder started with 81.3 per cent, AXA has accepted in respect of its 12.3 per cent (AXA effectively stymied Watson's earlier offers) and Grant Samuel now values the company at between $66 million and $107 million ($1.06 and $1.72 a share).

It will cost Watson $14.2 million to acquire the outstanding 18.7 per cent and, in return, he will obtain full control of Bendon, Living & Giving and an unknown amount of cash.

It is difficult to ascertain PRG's true financial position because PowerHouse was placed in administration in the UK this month, the company has not released its March 2006 year annual report and is delisted from the NZX.

The huge spread in Grant Samuel's valuation range indicates that PRG is in a mess and there is much uncertainty over the true value of the company.

By contrast, Burns Philp is in great shape and is relatively easy to value.

Watson's stewardship of PRG has been a disaster yet his net wealth has risen from $275 million to $500 million since the PowerHouse acquisition. The main reason for this is his relatively passive holding in the unlisted Hanover Group. The true value of this holding can only be ascertained when he sells his stake through a trade sale, IPO or to the other Hanover shareholder.

The capitulation of AXA to the PRG offer clearly indicates that sharemarket investors have had enough of Watson. His PowerHouse acquisition was the last straw and he seems to have limited ability to extract himself from difficult situations, unlike Hart with Angus & Robertson and Burns Philp in the 1990s.