Correspondence
Back to Correspondence[copy of letter sent to Vector Limited]
21st May 2009
Vector Limited
PO Box 99882
Newmarket
Auckland 1149
Attention: The Chairman, Michael Stiassny
Dear Michael
I recently completed an analysis of the published financial statements for 47 public companies for the June 2008 or equivalent year end from a banking perspective. Obviously with the public default of Nuplex and the disclosure by them of critical banking covenants, debt has become an issue that the market should be concerned about.
Of those 47 companies 20 were, based on the knowledge that we now have of banking covenants, potentially in debt difficulties. Your company was one of those companies.
Rather than publishing this research which would have been irresponsible, I have instead elected to pass it to the New Zealand Shareholders Association to deal with in its usual manner.
I thus now write to you in my capacity as NZSA Chairman.
Based on your last full year published result, the key bank covenant ratios for your company are as follows:
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Covenant
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Likely level of bank discomfort
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Your result
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Debt to Ebitda
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Above 7 likely default, above 5 discomfort
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$5.77
Debt $3,163,573k
EBITDA $547,922k
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Interest bearing debt to book equity
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Above 2 discomfort above 3 likely default
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$1.66
Book Equity $1,901,324k
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Interest bearing debt to net tangible assets plus interest bearing debt
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Above 90% default, above 80% discomfort
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91%
NTAs plus interest bearing debt $3,471,331k
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Earnings before interest and tax to interest paid
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Less than $2.50 discomfort, less than $2.00 default.
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$1.92c
Interest Paid $212,240
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To provide some clarity regarding the basis on which this analysis is prepared, I refer you to my personal Blog onStuff (Stirring the Pot.) The final in that series is attached as it explains how these numbers were compiled and will assist you in reconciling your reply.
The key issues appear to be Debt to NTA’s and book equity and EBITA cover to interest. Thus the sensitivity in your financial stability is the relative blow out of Debt to equity. Assuming you are not increasing your borrowings, although we note that you are completing a senior bond issue, a key problem is exchange rate volatility.
This said you may have fully hedged your position both on capital and interest servicing, but your financial statements are almost incomprehensible in sorting this out.
For example at your last balance date you had NZD$365,994k due in USD, on which you will have taken a sizable currency hit, NZD$ 296,142k in GBP, on which you would likely be no worse off, and a further NZD$254,750k in AUD on which you will also have taken a currency loss.
You had capital notes outstanding amounting to $196,857k. Even if the banks treated this debt instrument as equity, in our view you are still undercapitalised.
Clearly you operate in a monopoly environment, and you in particular have been very successful in managing the aspiration of regulators on your pricing. As a customer of Vector I am aware of your recent price increases and I and other customers could be forgiven for thinking that these increases are more in response to your debt issues than in response to genuine increased costs. You cannot expect to continue extracting monopoly pricing from the market without attracting regulator interest, and thus your strategy of high debt and high pricing is not in our view a sustainable business model.
However the greater risk is your inability to raise equity. The ownership structure of Vector is that 75% is owned by the Auckland Energy Consumer trust, which has no resource available to it other than its ownership of Vector and lack any reasonable capacity to borrow to support a capital raising, thus if further equity is required they would be forced into a dilution while currently having the ability to block any such issue. Politically they likely would do this as they are on record as saying they are not a seller of Vector.
So as we see it in terms of managing your way through this debt issue, you are relatively between a rock and a hard place and may only have the option of asset sales if pushed by your bankers or the trustees for your capital note holders.
We also note that you are conducting an on market share buyback which will clearly erode your book equity and net tangible assets further and hardly seems sensible or prudent given the levels of bank debt that you are carrying.
You do not disclose your bank covenants.
In the circumstances we ask that you comment on our analysis and the issues raised in such manner as you see fit, and further ask that you disclose your bank and capital note covenants in detail and the relevant ratios to show that you were in compliance at your last balance date and remain compliant at the date of your letter.
Also as you have no obvious natural hedge for your foreign currency borrowing please fully explain your rationale for taking such a risk, the all up cost of the funds of each currency loan and what if any specific hedging arrangement you have made to lock in your cost of funds and protect your balance sheet.
The Association usually publishes its correspondence within 7 days of the letter being issued: however the issues we raise are in our view so fundamental to the wellbeing of both the company and its owners that we will delay publication until we receive your reply.
However please note that if you fail to reply within 30 days we will forward a copy of this letter to NZX with a requestto them to make inquiry of you under the continuous disclosure regime. We will subsequently publish this letter regardless of NZX’s action in response.
Yours faithfully
NEW ZEALAND SHAREHOLDERS ASSOCIATION
Bruce Sheppard
Chairman