In mid-March the Australian government decided to follow up on the success of its initial privatization of Telstra by selling off the whole of the Australian telecoms company. The sale will be the most significant event in the country’s capital markets in the decade-and-a-half since financial deregulation was introduced.
The sale in November 1997 of a 35% tranche of Telstra established the mood, and the demand, for shares in the country’s dominant telecoms company. Partly-paid shares in Telstra (dubbed instalment receipts) sold for A$1.95 ($1.32) and rallied steadily to A$3.80 by mid-March.
Last year’s IPO attracted 1.8 million people to the telecom’s share register. Half of these shareholders made their debut as individual share investors, a choice the financial services industry hopes these novices will soon repeat. The government also wants to use privatization as a means to develop a share-owning culture among Australian householders.
One long-term bonus of Telstra’s privatization is that it will swell the market capitalization of Australian equities, attracting more international capital to the stock market and increasing its liquidity. “It’s important in terms of spreading ownership and lifting the free float of the market,” says Trevor Rowe, the Sydney-based chairman of Salomon Smith Barney’s Asia-Pacific operations. “It’s important for the development of the capital market. Given the size of the offering, it will be well received.”
The Telstra share sale may change calculations for firms seeking capital and for institutions picking a portfolio. For one thing, Telstra will account for between 10% and 12% of the Australian Stock Exchange’s benchmark All Ordinaries Index up from 4% now.
Salomon Smith Barney’s Rowe says institutions will want it: “It will be a pretty good surrogate for the Australian economy,” he says. “It’s going to be large enough and a sufficiently large free float to enable market volumes to rise.”
Institutions, limited to small and severely underweight stakes in one of the country’s leading stocks, have consistently soaked up shares since Telstra’s listing. Even the announcement of the forthcoming sale of the government’s remaining 65% stake caused barely a ripple in the price of Telstra’s shares. Australian fund managers need Telstra in their portfolio and remain prepared to buy it. Institutions hope to secure a bigger allocation in the forthcoming share sale in order to better balance their holdings, though the share distribution policy may once again favour small investors as the government seeks to boost wider share ownership.
But Telstra and other privatizations will not be Australia’s only source of new equity. Says Salomon Smith Barney’s Rowe: “Countries in our region might raise $20 billion in equity and near equity in a year. Australia will do that this year even without Telstra. For all the hype about Asia, people are surprised to realize the significance and the size of our market.”
Some of that share issuance will come from demutualization. For example, insurance company AMP’s stock-market listing is expected in June or July. Though it raises little new equity, the offering, like the Telstra sale, will create a headache for those fund managers who need to maintain a weighting in certain sectors. AMP will distribute shares to an estimated 800,000 policy holders. Less than one-third of these shares are likely to become available for sale to new investors, leaving institutional investors once again paying high prices to coax small holders to part with their stock.
For fund managers, this is a familiar story. Shares in two other demutualized insurers, Colonial and National Mutual (controlled by French insurer Axa), have outperformed the market as a result of the need for funds to buy into the stocks.
Another interesting equity listing in 1998, although not a large one, will be for the Australian Stock Exchange itself. A mutual organization owned by its stockbroker members, the stock exchange should hit the market late in the year. The exchange’s board contemplated listing in Singapore, rather than on its own exchange, to avoid the prospect of having to engage in market surveillance on itself. But in the end, it chose to list at home on the grounds of credibility and practicality.
The listing of the stock exchange raises wider questions about how it will expand as a business to provide the dividends and capital growth its shareholders expect. The betting is that the exchange will try to merge with the Sydney Futures Exchange, which, like the Australian Stock Exchange, plans to shed itself of the remnants of open-outcry trading by early 1999.
The futures exchange is owned by much the same group of banks and brokerages which own the stock exchange. And these members still recall with some annoyance a lengthy and expensive battle in court in 1994 over which exchange could trade certain types of financial derivatives. With the Sydney Futures Exchange’s profits looking shaky, and new contracts struggling to win acceptance even as bread-and-butter interest rate contracts roar ahead analysts expect the stock exchange will revive old ideas of a merger.
The chase for Telstra shares, combined with low interest rates and strong domestic demand, has recently driven the All Ordinaries Index of shares to the record level of 2770. While stock markets in other developed countries have also reached new highs in early 1998, the buoyancy of the Australian market is more surprising, given the country’s heavy exposure to the Asia crisis.
One-quarter of Australia’s exports go to Japan, a country headed for recession even according to its own officials, and another 10% go to Korea, fighting its way back from a liquidity crunch. There are also concerns about the wider regional repercussions of Indonesia’s unstable political and economic situation.
Money markets have pushed short-term interest rates below the central bank’s target and flattened the yield curve, in the expectation that the Reserve Bank of Australia will ease monetary policy as exports drop later in the year.
The central bank, however, has quietly spread the word that no such rate cut is contemplated. It believes a reduction in interest rates would invite a flight of capital and give Australia some of the same problems as its neighbours.
While the Telstra sell-off will boost the equity market its effects on Australia’s debt market could be just as important. The privatization will allow the federal government to pay back about half its outstanding bonds of A$95 to A$100 billion. This will jolt the bond market. After that windfall to the government’s finances, and the fact that the 1998/99 budget should move into surplus, investors in Australian government bonds will be scrambling to find stock.
“[The Telstra sale] will certainly accelerate the contraction in fixed-income assets in Australia that was occurring anyway with privatizations and the general reduction in government borrowing requirements,” says Jason Carley, head of securities research at ANZ Investment Bank. “It will just happen in one go rather than over a few years. It will definitely create a fixed-income shortage.”
Competition to invest in those bonds will be sharp. Banks need about A$15 billion to meet prudential (and their own) liquidity requirements. Life companies and superannuation funds in search of low-risk, capital-guaranteed investments may soon swallow the rest.
ANZ’s Carley thinks the banking regulator will ease the requirements for banks to invest in government bonds and allow banks to count investments in other Australian dollar-denominated AAA rated securities, such as mortgage-backed issues or bonds sold by supranational issuers, for their liquidity requirements.
As it happens, 1997 turned out to be a record year for the sale to local investors of Australian dollar-denominated bonds by both local companies and some international issuers. The flowering of an Australian corporate-bond market has been forecast for a decade. But investor caution, competition from bank lending and the availability of cheaper rates offshore has always held the local market back.
Asset-backed transactions, mostly to fund housing loans, accounted for the bulk of the corporate bond market for much of the 1990s. But deals from issuers such as Arnotts (the Australian subsidiary of US food company Campbell Soup), UK conglomerate BTR, petrol company Caltex and Australian conglomerate Howard Smith, demonstrate the scale of issuer and investor demand.
The biggest change, from the borrower’s perspective, has been in investor expectations. For many years onshore fund managers expected a greater yield pick-up on corporate debt than issuers could provide. Corporate borrowers were better off selling local-currency debt directly into Europe or issuing US dollar debt into the 144a market and swapping back into Australian dollars.
The sale by US mortgage funder Fannie Mae of a A$1 billion global in the third quarter of 1997, including the distribution onshore of some paper to Australian fund managers, provided a clear demonstration of how far the market has come.
More than A$10 billion in paper in 1997 lifted the total stock of corporate bonds to over A$31 billion at the end of 1997. ANZ Securities estimates issuers will bring more than A$12 billion to the bond market in 1998.
New types of assets are turning up as collateral in asset-backed deals. Citibank provided a first for the local market with a A$580 million bond backed by commercial loans. Westpac, the bank which has sold more home loans into asset-backed bonds than any other, is thought to be preparing a similar offering.
Investment banks have found fund managers prefer to buy asset-backed securities as short-term commercial paper rather than as longer-term bonds. Several programmes, among them ACE from Société Générale, have resecuritized asset-backed FRNs into asset-backed commercial paper.
Changes to tax rules play another part in the growth of local issuance. In December the government announced that corporate bonds issued and paying interest in Australia would be exempt from interest withholding tax when sold to offshore investors, a step which enables the distribution of bonds out of a single programme.
