Australia’s new Liberal-National coalition government and the IMF share a common belief. Along with four other APEC countries with current account deficits exceeding 3.25% of GDP, Australia can no longer avoid tightening her fiscal and monetary policies.
At US$21 billion, Australia’s current account deficit is now running at 4.5% of GDP. And a huge budget deficit is on the horizon. The treasury has already revised its estimates for economic growth downwards, but this has meant that, free of asset sales, the budget in 1996-97 will run at a deficit of A$4.9 billion (US$3.8 billion).
The underlying cause of these shortfalls is Australia’s large foreign debt – an encumbrance brought about by the country’s hunger for development capital and its chronic history of current account deficits. Historically, Australia has had a big appetite for capital from the US and Europe, but today Japan rivals Europe as a source of capital for quality Australian issuers.
Since the deregulation of the Australian financial system in 1984, large corporations, governments and government business enterprises have had much easier access to world markets. Deregulation has led to an acceleration in the volume of issues by Australian entities and inevitably this widening of access to global capital markets has helped to foster a more robust and competitive domestic capital market. The domestic market has been made all-the-more competitive by the determination of the major banks to resist a progressive shift away from traditional bank finance to the bond markets.
But while the domestic market has shown vigour, Australia’s appetite for foreign capital has continued to grow. Net foreign debt rose by A$5.4 billion in the final quarter of 1995 to A$184.9 billion. As a proportion of GDP, foreign debt is now 39.3%, up from 38.6% last year.
Being a nation with poor household savings levels and a history of budget deficits, Australia has had no choice but to continue looking to other countries to satisfy its needs for new capital. A relatively high interest rate regime, forced on Australia by this combination of high debt and low savings, has bolstered that approach; borrowers have been able to achieve big savings over domestic borrowing by going to the international capital markets.
Corporations, in particular, are using the capital markets instead of traditional bank financing. Traditionally, it has been companies that are household names, those with strong balance sheets and solid cashflow records, that have proved themselves most capable of tapping foreign capital. Of these issuers, one is the country’s largest company, the Broken Hill Proprietary Company Ltd (BHP). Originally just a steelmaker, BHP now makes steel and value-added steel products in three Australian cities, but also has extensive iron, coal, gold, manganese and copper mining interests around the world, including the vast Escondida copper venture in Chile. It also has a shipping line and extensive natural gas and oil fields.
The markets like BHP paper – it is supported by annual cashflow of around A$4 billion. Against this background, BHP secured a US$2 billion bridging facility from four banks – the Westpac Banking Corporation, National Australia Bank, ABN Amro, and Deutsche Bank – to finance its merger with the US-based Magma Copper in January this year.
On March 7, a syndicate of underwriters, led by US investment bank, Morgan Stanley, launched a US$750 million issue for BHP in New York. With maturities of 10, 20, and 30 years, the issue can be put back to the borrower after seven years, and each maturity seeks to raise at least US$250 million. The pricing is based on a parallel with treasury bonds with the shortest-dated paper pitched at spreads of 61-64 basis points (bp) over treasuries, the 20-year issue at 70-73bp over, and the 30-year paper 47-50bp over. Because of BHP’s enhanced standing, the rates are somewhat lower than the seven-year and 20-year issues done in October 1993.
BHP has been a frequent issuer on the US market. It made three issues in 1992 and two in 1993. But the 30-year tranche of the March 7 issue is the first time BHP has offered such a lengthy maturity. The only other Australian company ever to issue 30-year paper is CSR Ltd, a sugar and building materials conglomerate. CSR raised US$400 million last year in a Rule 144A placement.
Resource firms, such as mining and gas and oil companies, have proved the most active Australian group issuing on the US market in recent years. Other prominent issuers are banks, transport groups, including Qantas, construction and insurance companies. In the past 12 months, issuers have included TNT Transport, the trading company Burns Philp, the construction group Leighton Holdings, FAI Insurances, footwear and tyre company Pacific Dunlop, National Rail Corporation, the mining company North Ltd, St George Bank, Fosters Brewing, QCT Resources, transport group Mayne Nickless, and BHP.
The US and European markets are not only opening up to the blue chips; the lesser Australian corporates are finding a welcome. Many investors in the US and Europe, who are not represented in Australia, have joined the array of lenders willing to accept Australian paper never likely to be rated blue chip. While the US market remains generally ratings-driven, imaginatively packaged low-rating issues have been accepted by some of these lenders.
One of the more out-of-the-ordinary issues was launched by lead manager Merrill Lynch, with Chase Manhattan as co-manager, on behalf of Australis Media, a pay-television company. This A$175 million fixed-rate issue, which was rated B/CCC, was taken up by 50 US investors last year. One of the unusual features was that it was set for an eight-year maturity, but with the first five years at zero coupon, so that the interest for those five years would be capitalized. An equity warrant was also attached to the bonds. But,following the announcement of a A$97.5 million loss, Australis’ shares dropped A¢9 to A¢69 on March 18 – leaving little worth in those warrants unless the company’s fortunes improve sharply.
While avoiding this risky kind of issue, the European market is still prepared to look at Australia’s second-tier issuers, especially the household names. Australian regional banks, notably Advance Bank and St George Bank, have been active. In less than two years, Advance Bank has raised A$1 billion in three issues on the Euromarket. On February 20, Advance Bank issued US$150 million in subordinated debt on the floating-rate note market with joint lead managers CS First Boston and Morgan Stanley. The significance of this issue was that it was pitched at 20bp above Libor, in contrast to the bank’s first issue last year at 40bp above Libor. Subsequent trading in the first issue saw bondholders realize good gains. This set the background for a lower rate for the February issue and an earlier issue of US$300 million in January.
St George has also been a regular issuer on the Euromarket and ventured into the US market recently with a placement of US$200 million in subordinated debt under Rule 144A. The banks take the success of these issues as evidence that international markets have come to recognize the high security provided by Australian regional banks.
It has not been plain sailing all the way, however. The big government-owned Australian telecommunications business, Telstra, (formerly Telecom) launched a Euromarket medium-term note issue for A$327 million last November. But the issue came unstuck when Australian newspapers carried reports that Telstra’s profit and cashflow would not meet budget targets. In the end lead manager JP Morgan bought back the bonds from investors at the issue price and re-sold them at a higher yield, taking underwriting losses on the deal. The finance daily, the Australian Financial Review, described the episode as “a lead manager’s nightmare”.
But one of the biggest changes for Australian issuers has been the rapid rise of the Japanese retail market as a source of investment capital. The Japanese market demands rock-solid security, but is driven by the huge difference between Japanese interest rates and the much higher prevailing rates in Australia. With a gross margin of 5% or so, Japanese managers can easily absorb the high cost of retail distribution of their products.
With Nomura – showing considerable flair and imagination as lead manager – Japan has provided the yen equivalent of A$6.7 billion for the State Central Borrowing Authorities. According to The Capital Markets Survey, published by Ernst and Young [the international accounting firm], Nomura was by far the biggest lead manager for new medium to long-term offshore issues in 1994 (see chart above). The second-placed lead manager on value was Hambros Bank, with about half the tally of Nomura. Nomura also led with 44 issues, Hambros Bank gaining a creditable second with 33.5 issues.
In the domestic market, the budget deficit is to be tackled by the new administration via vigorous fiscal measures aimed at balancing the books. The coalition government, hampered by its election promise not levy new taxes or increase existing ones, has opted to cut spending by A$8 billion in the 1996-97 and 1997-98 budgets.
An inevitable consequence of these severe cuts in government spending will be a reduction in the rate of economic growth, currently running at just over 3%. A slower rate of growth will certainly reduce the current account deficit by reducing demand for imports. But it may also diminish Australia’s need for new capital investment, which could seriously accentuate the scarcity of quality securities.
This dearth of quality securities is also linked to the outgoing Australian government’s national compulsory superannuation scheme. The scheme has created a pool of funds forecast to reach A$295 billion this year, A$518 billion by 2000, and to exceed A$600 billion by 2001. A considerable portion is certain to flow into the domestic capital market.
With a limited number of investment securities, the Australian market is facing a potentially severe shortage, with spreads already tightening. This tightening in demand for quality is expected to accelerate as more funds flow into the market.
Apart from the growth in institutional savings under the compulsory superannuation scheme, the domestic capital market has been driven by fierce competition. One of the main outcomes has been the emergence of mortgage-backed securities, which have financed a successful invasion of mortgage providers into retail home lending – previously the domain of the banks.
In challenging the banks, the mortgage providers are beginning to penetrate the market in ways similar to those in the US. By late 1995, the non-bank share of the home-loan market had reached 9% and according to a study of Australian debt markets by SBC Warburg that share may increase “to 30% by the year 2000”.
“This transformation amounts to a structural change in Australian capital markets,” says SBC Warburg, “The demand on institutional investors to fund these securitized assets could be between A$25 billion and A$30 billion over the next five years.”
The largest mortgage-backed bond issuer is Puma Management, a subsidiary of Macquarie Bank. Puma issued more than A$2.28 billion on the domestic market in 1995. Now it has appointed JP Morgan as lead manager of its offshore issuing programme.
The cash raised by Puma goes to fund mortgage providers who will offer home loans at rates lower than the banks. The banks are fighting back, looking for appropriate vehicles through which they can offer no-frills housing loans. The National Australia Bank, (NAB), is believed to be planning to use its Bank of New Zealand subsidiary as a vehicle. Market gossip suggests NAB will make a takeover bid for St George Bank, which has a considerable home-loan portfolio.
The banks, hurt by incursions made by the home-loan newcomers, have met the challenge of the corporate bond market head-on. Aggressive lending by the banks allowed a syndicate of ABN Amro, NAB, Deutsche Bank and Sumitomo International Finance, to capture the debt underwriting for the privatization of a power station by the state government of Victoria.
The sale price of Yallourn power station is A$2.4 billion. The syndicate will assemble a A$1.6 billion non-recourse loan facility. NAB and ABN Amro were the joint arrangers with Deutsche Bank joining later. The station was bought by a consortium led by British company PowerGen. This consortium included the state Superannuation and Investment Management Corporation of New South Wales, and the AMP Society Ltd. PowerGen is taking 49.9% of the equity, AMP 26%, Itochu (connected with the Sumitomo group) 10.4%, State Super 8% and Hastings Funds Management 5.7%. AMP is also taking subordinated debt on the project.
This competitive approach indicates the importance of privatizations to the domestic capital market. Late last year, NAB and Deutsche Bank were joint arrangers and underwriters of an A$865 million working capital facility for United Energy, the first of the five power distributors being sold under the Victorian government’s electricity privatization plans. ABN Amro is acting as a lender on facilities for all five utilities.
Lead managers, medium/long-term offshore issues
The Belgian dentist makes way for Madame Sato
Money markets have traditional types of preferred investors. Europe has the Belgian dentist, and now Australia has Madame Sato from Japan. In the market folklore, these are the individuals who buy bearer bonds (with their tax-avoidance implications), and are the heart and soul of the market.
But now Madame Sato has begun to rival the Belgian dentist in terms of bond market significance, with capital raisings in Japan rivalling the levels seen in the Eurobond markets over the past 15 months.
Madame Sato is the Japanese wife who manages the household savings. She also buys bonds from salesmen whose companies send them selling door-to-door on bicycles. Finance houses in Japan have sufficient margins to be able to sell their bonds this way because of Japan’s very low relative interest rates (the official re-discount rate is 0.5%) compared to Australian rates of 5.5% to 6%.
In the first two months of this year, Australian Eurobond raisings slightly exceeded raisings in Japan: A$1.4 billion (US$1.08 billion) against A$1.1 billion. But, in the previous nine months there was little between the two markets.
Some of the recent strength of the Australian dollar is said to derive from the active purchasing of Australian paper in Japan and to nervousness about China’s recent belligerence.
In March, at the height of the Chinese war games near Taiwan, the Australian dollar jumped to a 15-month high of US77.67 cents.
Now nervous Macao tailors have joined the Belgian dentists and the Madame Satos to create a significant base for the retail underpinning of capital markets.
Domestic equity offerings fill market to bursting point
Government sell-offs will soak up much of the equity in the Australian market. Albert Smith looks at the effects
The Australian equity markets will reverberate this year to the effects of the landslide general election victory by the Liberal Party and National Party conservative coalition which swept the Australian Labor Party out of office on March 2.
With all the characteristic cleansing passion of a new government, the conservative coalition is promising to move the budget into surplus as soon as possible, using vigorous spending cuts and state sell-offs as the means. For the equity markets, asset sales will become the order of the day for the coming three years, and most likely beyond.
John Howard, the new prime minister, built up this theme during the election campaign. But he also tied specific sales to select government programmes. For example, he promised a A$500 million (US$387 million) programme of environmental improvements, which will be financed by the sale of one-third of the giant telecommunications company Telstra (formerly Telecom). Telstra will be on the auction block along with other government assets, whose sales have been delayed during the electoral process.
The new government wants to begin the programme of sell-offs quickly – some would say with a sense of urgency – and so is pushing hard to have some part of Telstra on the market by the second half of 1996.
The choice of Telstra itself is also significant. It is the jewel in the crown of Australian utilities, holding many natural monopolies and dominant market positions. It is almost impossible to value in a strict equity market sense. Its tangible assets are vast and valued far below replacement cost. It owns and controls, almost totally, Australia’s telecommunications networks and has ventured into international markets. The company has even flirted with other business avenues, including banking, seeking a wider role than that of merely a telecoms provider.
Telstra’s half-year gross profit to December 31 of A$2.06 billion disappointed some analysts. Nevertheless, it points to a market valuation of about A$28 billion. At such a figure, just one-third of Telstra, if listed on the Australian stock exchange, would have a higher market capitalization than all but eight of Australia’s largest companies, and would be just ahead of the giant gold, uranium and nickel mining company, Western Mining Corporation.
Listing the whole of Telstra at this valuation would place it second in size on the stock exchange to the Broken Hill Proprietary Co (BHP), and ahead of both Rupert Murdoch’s News Corporation (the international publishing, television and entertainment group) and National Australia Bank (the country’s most profitable banking group).
However, the prime minister has stated that not more than one-third of Telstra will be sold in the government’s first term (three years) and that there will be tight limits on levels of foreign ownership. This exclusion means that Telstra will have to be bought largely by domestic equity buyers – an almost indigestible chunk for the market to swallow.
Worryingly, the Telstra sale is not as advanced as some of the other planned sell-offs: notably the government’s remaining 50.1% stake in Commonwealth Bank of Australia (worth about A$4.7 billion), the Federal Airports Corporation (A$1.6 billion) and the Australian National Line (A$100 million). The airports and the shipping line look certain be sold to a strategic investor, but at least part of the airport deal is likely to be listed eventually. No matter which way the assets are sold, these transactions will take significant amounts of liquidity out of the system.
The new government is trying to accelerate the sale of its half of Commonwealth Bank in order to clear the decks for the Telstra sale. In turn, it is putting some gloss on its budget outcome for the current financial year, which ends on June 30. Whether the sale can be completed by then is doubtful, but the government’s asset sales taskforce has instructed the lead brokers to press ahead as a matter of urgency.
This means that the bank will be sold in one tranche, perhaps with some inducements (like a partly-paid element) to make it more attractive to smaller investors. According to the Australian Financial Review, the country’s financial daily, this sale will constitute the “largest single-block share sale in Australian history”.
The government is determined to overcome the five-week hiatus caused by the election campaign, and this may cause it to sacrifice a buy-back by the bank itself of up to A$1.2 billion of the government’s remaining shares. The bank proposed the buy-back when the sale was first announced by the former Labor government. But David Murray, the bank’s managing director, admitted in March that the election campaign had put the proposed sale and buy-back behind schedule.
The delay was due to the bank being required to have an independent expert analyze the merits of the proposed buy-back and prepare a report for shareholder consideration at a special general meeting. The question now is whether shareholder approval can be obtained within the government’s timetable. If not, the buy-back could well be abandoned.
The price of the government’s remaining 478 million shares will be determined by a global tender. Existing shareholders are likely to be offered shares at a 5% discount to the tender price.
However it is arranged, the sale will be a once-and-for-all affair that will certainly test the limits of both the capacity and appetite of the Australian equity market. International interest is considered vital for a successful sale, as most Australian institutions and fund managers have large existing holdings in the banking sector already.
The lump sale of Commonwealth Bank means that the Telstra float will almost certainly have to be sold in two or three tranches, just to smooth the cash-raising process and allow the market time to absorb the entire issue. Alternatively, the shares could be sold as partly paid, with the unpaid element of the price to be settled in two or three instalments.
Before the government takes Telstra to the market, it has one major political hurdle to jump: getting the legislation for the sale through parliament. Although it holds a healthy 47-seat majority in the House of Representatives, it does not control the Senate, the upper house. It is just two senators short of an absolute majority.
The balance of power in the Senate is held by the Australian Democrats and the Green Alliance. The Democrats have said they will oppose the Telstra sale; the Greens are undecided. However, because the sweeping environmental programme proposed by the government hinges on selling Telstra, it is possible that the Greens will support the sale.
The big question is whether the market can digest two such large government issues in succession. Leading brokers estimate that the Australian market can absorb A$6 billion-worth of stock in any one quarter without experiencing indigestion. There are exceptions to this general rule, and demand for new stock varies seasonally. Therefore, the eventual success of the Telstra sale, both in price and volume terms, depends almost totally on market sentiment. The trick will be to time this large issue so that the market will not choke on oversupply.
If, as is probable, the actual sale of Commonwealth Bank is not completed until after June 30, the rush for cash on the Australian stock exchange is likely to seriously test the limits of the market’s capacity.
Total equity raisings in the 1994 financial year were A$24.05 billion; in the 1995 financial year (as yet unfinished) new equity raisings are likely to be about A$11.23 billion. However, with Commonwealth Bank and Telstra, this year seems most likely to be back to 1994 levels, perhaps even higher.
Clearly, it will not take many of the flutters – particularly of the kind world equity and bond markets experienced in the first half of March – to skim off the cream that the government hopes to realize from its asset sales. Although the Australian market has been erratic over the past 12 months, it traded very close to its highest-ever levels just before the March 8 sell-off on Wall Street spread to the rest of the world.
However, the government seems most likely to be able to capitalize on the wave of investor confidence that swept the country after the election and the honeymoon period usually accorded to new administrations. If the government handles the sales prudently, it should be able to get the sales away successfully, but this will leave precious little room for any other large issues.
