September 09, 2010 3016 VIEWS
Proshare

 

There is a feeling that investing in the capital market is easy and when you are making money that is true. But the true test of a stock market investor or trader is when things are going badly. The Investor or trader is required during a downturn to have the willpower to hang on despite his decisions, methods and outlook being questioned; and more importantly his capital is diminishing steadily. This is the side of trading that is often not talked about - the ability to come back from adversity. He can only discharge this if he is able to appreciate the principle of investment cycles and market rhythms. (Note: Investment cycles work if an investor purchased stocks that are fundamentally strong prior to the downtrend).
 
We have spoken before about the rhythm of all markets - they fluctuate from overvaluation to undervaluation with fair value being only an interesting crossing point (a bit like the 200 day moving average).
 
There has been a bear market in equities before and it might go on for another year yet. Who can say? If anyone does predict a bull market then it is only a guess that should not be taken seriously, anymore. We have had such bull predictions and the dawn of a new day all year; yet, as at today, we are back at March 2010 levels, 6 months after…we presumed we had crossed that bridge.
 
In our NCM report for August 2010 - http://www.proshareng.com/reports/2876; and in spite of the factual indices churned out by the market, we had chosen to retain optimism about the market because of this belief.
 
This was in part inspired by the knowledge that a bull market will come and the economy will get better; and mostly because that is the only responsible option to take given the textbook steps taken so far to re-energise the failing structures we have built on. We considered it our responsibility to encourage optimism in the market and the economy.
 
We did and still believe that we need to have a little faith and adopt an attitude that ties up with the future we seek, despite what today’s headlines indicate - the economy will bounce back, we simply have to believe that it would.
 
Yet, since the beginning of September, we were confronted with market realities that have now compelled a revision of the market outlook, further informed by market developments, which require more clarity than has been churned out as part of the engagement process for a restoration.
 
 
A Season of Muddled Signals
It appears that the market regulators have found themselves managing out of a state of chaos, firing on all cylinders and issuing muddled up communications. The situation appears akin to throwing darts on the wall to see what sticks, and any experienced and knowledgeable investor can see through this. We will take a look at five (5) key communications this week and present an outlook that reflects the current market sentiments.
 
The five developments are:
1.    The Suspension of Listed companies for non-compliance with listing rules;
2.    The commentary by the SEC DG on Islamic products and Exchange Traded Funds in the NCM;
3.    The 10% 'speed limit' set by the CBN for all banks exposure into the stock market and recall of outstanding N1.1 trillion margin loans;
4.    The Listing by Introduction of the M&A between the Dangote Cement & BCC; and
5.    The 14 days unabated uptrend in the shares of AP Plc.
 
 
The Suspension of 55 Listed Companies
 
The National Council of The Nigerian Stock Exchange approved the suspension of some quoted companies while placing others on a ‘watch list’ – to enable them complete their recapitalization activities, submit outstanding financial accounts (audited and interim), hold their Annual General Meetings, clear all regulatory issues with the SEC and have a satisfactory site visit report from the Exchange.
 
The fifty five (55) affected companies (http://www.proshareng.com/news/11979) had defaulted in their post-listing requirements, especially in financial reporting of their operations and payment of annual listing fees. Consequently, the companies have been placed on full suspension (there will be no transaction on their shares) for failure to meet these obligations as at 6th September 2010. This is what we have been advocating for over 3 years and a good step by the regulators.
 
Of the 55 firms, 15 companies were placed on full suspension and 40 companies were warned on the implications of non-compliance to post-listing requirements.
 
This is a natural part of the NSE’s responsibilities and, save for the drama and communication impact of the action as a ‘this is a new regime’ – the import has little effect but the cosmetic impact of establishing authority. If this was about establishing confidence, sanctions ought to follow.
 
The more important point has been made by the subsequent response of sixteen (16) companies who notified the NSE on Wednesday about the performance of their companies’ activities. For example, and according to the 234Next report of today, Ikeja Hotels notified the NSE yesterday that its board is scheduled to meet on September 14, 2010 to consider the audited financial statements of the company for the year ended 311209 and to recommend a final dividend in respect of the financial year. Dangote Flour Mill equally confirmed that the company’s board had notified the NSE of its AGM scheduled for September 24.
 
The NSE did well but could and should consider doing more to ensure this action serves as a deterrent and that the market is promptly informed when firms miss the scheduled reporting date; and take actions on activity on the stock, in the absence of such compliance. This was a plus for the regulators overall.
 
 
The commentary by the SEC DG on Islamic Products and Exchange Traded Funds in the NCM
 
The venue was London, the occasion was the BIAE organised Economic Briefing by Nigeria's Hon Minister of Finance, Mr Segun Aganga held on 3rd September, 2010.
 
There were a number of speakers who commented on the economy, our markets and their assessment on developments. One comment however stood out - that of the SEC DG – that we are now thinking about Islamic products?
 
This is curious and disturbing – not only for the ‘dramatic effect’ it represent but the implication on the SEC’s role as a ‘regulator’. What are we doing now? Are we engaged in market regulation, market reform, market liberalisation or market development? Which phase of this intervention are we in?
 
Islamic banking and ETF’s are tested innovative products but not on our exchange and in our clime. Why is the SEC talking this up now? Why is the SEC considering Islamic Products and ‘marketing’ it?
 
There is nothing wrong about such religion-based initiatives, but Islamic products are not based on the tenets of capitalism (i.e., profitability) on which the Nigerian Capital Market (NCM) is predicated. Is this the job of a regulator or of the exchange to advocate?
 
The whole thing looks muddled in the eyes of the public and no one should attempt to advance an argument that the market reform promised is a multi-layered engagement that is happening simultaneously. That would be disingenuous. We appear to be adopting the CBN post-August 2009-intervention rulebook: going to London to woo foreign investors, talking about Islamic products, etc. No one is buying that as the cure for a battered and decimated investing public.
 
If SEC wants to support the introduction of real derivative products, fine; and this enjoys the support of stakeholders in the market. It can do this by focusing on its responsibility – licensing other exchanges and platforms that support such initiatives - providing alternative markets for investors (crude and esoteric investors) as well as set necessary rules and regulations for such esoteric products.
 
 
The 10% 'speed limit' set by the CBN for all banks exposure in the NCM
 
For what it is worth, the public did not receive any public announcement from the CBN describing the new regulation that limits banks investment to the capital markets to 10%.
 
We want to believe that this is not true. It reminds the market of the 2008 NSE’s policy of one percent (1%) maximum downward limit on daily price movement, while the five per cent limit on upward movement is retained.
 
When this policy was issued by the NSE; we issued a joint release with InvestIQ titled “The fallacy of the 1% Policy as a market tool” on 16 Sep 2008 that “This policy has an upward bias and in the long run negates what the NSE is trying to achieve, which is to prevent the continued decline of the capital market. With this new policy of one percent downward price movement limit, it will take longer for the market to complete its current downtrend, because the policy will never completely allow stock prices to truly bottom out. For the markets to truly correct, sellers in the market must be completely washed out. Although this may sound callous, studies have shown that until most traders (or gamblers) not investors throw in their towels saying that they can’t take the beating any more, the market downtrend will continue. The truth of the matter is that some investors in the Nigerian stock market for the 4 years prior to March 2008 saw the NSE as a casino that paid out large sums of money. As a result, some of these investors invested heavily in the market by buying every secondary or initial public offering and throwing caution to the wind with some of their speculative trades. Some of these investors were caught in the downtrend and are still waiting in the wings to sell their shares. Since the Nigeria bull market had a prolonged run (approximately 4 years), it is safe to believe that there are many speculators in this category and significant up trend will be sold into”.
 
If the ‘speed limits’ are therefore true, we must ask the question - How can the NSE turn around when historically, banks were major participants in the NSE and provided most of the funds that investors used to purchase shares? Without funds from banks or some form of injection of funds into the market – we do not see how the NSE will fully recover from the current downtrend.
 
Who is going to buy the shares that are being dumped by the banks? Bank holdings are not only limited to bank shares? As the dumping continues, it will increase the NSE float further depressing prices of most listed stocks.
 
With the NSE’s large float, investors do not have the "deep pockets" to absorb the shares that will be dumped by the banks to comply with the regulation.
 
What the CBN and NSE/SEC do not understand or understand, but have issues with unknown to the public; is that the major source of liquidity in Nigeria are the banks (okay – politicians and what have you - but their funds will not sustain a bull market on a long-term) especially now that small investors have been wiped out of the market.
 
In a developed market, you have large investment houses, brokerage firms, hedge funds, etc that have the funds to move the market, but it is not the case in Nigeria.
 
The result of alienating the banks could be catastrophic for the NSE and all businesses related to the exchange (i.e., brokerage firms, investment houses, capital market related platforms, etc). The CBN policy has to change. There should be a limit of how much capital banks should invest in the capital markets, but 10% is too low.
 
Could this well intentioned desire to adjust the weight/leverage of the banks on the NSE be what has informed media reports (ahead of the SEC/NSE’s formal communication) of the listing by introduction of the Dangote/BCC Merger – which sought to promote the reduced leverage of the banking sector in the NSE’s total market capitalisation? http://www.proshareng.com/news/11953
 
 
The Listing by Introduction of the M&A between the Dangote Group and BCC
 
Is it okay to promote/pitch the Dangote/BCC merger and listing as a good panacea to the leverage banks has on the NSE? Yes, it would appear so – without sentiments.
 
That is – unless such sentiments are devoid of questions about the process, communication management, and the perception related thereto or arising therefrom. Let us take a look at some five issues ahead of the analysis that is to come from the scheme of merger:
 
First, in managing the news communication, information had filtered out weeks back about the alleged granting of waivers on fees, given the amount involved. This had led to more interest from the market, long aware of discussions on the planned merger before the breakdown in corporate governance ethos at the NSE. The eventual newspaper expose therefore, of factual internal decisions from the SEC, and ahead of the NSE’s decision was considered a fait accompli. This in itself suggested that this was a deal that needed to go through, presented as an indication of market confidence return and without any investment justification or discussion on the investment rationale or benefit to the average investor.
 
Since no formal business combination document was publicly released before the NSE approval, it would be safe to assume that the newspaper reports were no more than corporate press releases, rather than market news.
 
 
Second, We recall that one of the problems with this deal with the then NSE management was the contentious issue of compliance with the market rule that no one person holds more than 75% of a publicly listed company (i.e. NASCON) and the information that only 4% was offered to shareholders of BCC Plc. This matter requires a public clarification, including a confirmation of consent from the shareholders of BCC Plc.
 
It is instructive that we clarify that the percentage which BCC Plc shareholders will own is dependent on how many shares the new company is issuing. BCC Plc shareholders that do not want to be part of the merger should/could be bought out – as is standard practice.
 
 
Third, it would appear that the decision to approve the merger was not contained in the Agenda and final resolutions at the last AGM of BCC Plc – the listed company on the bourse. We are to assume that this must have been obtained at an extra-ordinary general meeting held before the documents were presented to Sec and the NSE, as part of what the regulators would have had to review.
 
It would appear that we do not have the type of situation experienced with Unipetrol Plc and Agip Plc, both quoted firms – but more of the situation in Zenon Oil’s attempted takeover of AP Plc with us. In this latter incident, the shareholders of AP Plc were consulted at an extra-ordinary general meeting held at Ibadan and their resolution forwarded to the SEC who rejected the deal and remains the reason why the AP/Zenon merger never took place.
 
Yet as we can see from the petitions making the rounds from insiders, both companies are being run as one. This might prove an instructive parallel in the days ahead as the shareholders role in assenting to such a deal gains traction. How did the SEC/NSE approve the deal without the shareholders consent given its public interest mandate?
 
The scheme of merger (court ordered document) has now been released and sent out to shareholders.
 
Further to the SEC/NSE approval, and preparatory to the listing of the new company, shareholders of BCC and Dangote Cement will now hold separate court-ordered meetings on September 28, 2010 in Kano to endorse the scheme of the arrangement. While the meeting of shareholders of BCC will hold at 11.00 am, that of Dangote Cement would hold at 10.00 am. Specifically, 15.494 billion units of the expanded company would be listed at N135 per share – a record high for a listing by introduction in the annals of the exchange http://proshareng.com/news/11978
 
 
Fourth, it is important to the market that a clarification is provided on the status of the new company and if the other Dangote cement operations in other countries will form part of the new Dangote Cement Plc. It is instructive to note that the Dangote Cement operations extends to existing entities in Zambia, Senegal, Benin, Ghana and South Africa which are reported to be viable operations, albeit with lower annual production outputs.
 
 
Fifth, Perhaps more important to the practice of M&A in our capital markets is the need to bed the conflict of interest possibility that appears to exist in the transaction – based on communications so far.
 
It would appear that the financial advisor representing the unlisted Dangote Cement Limited on the one hand and the listed BCC Plc on the other hand is the same entity – Afrinvest Limited.
 
It is curious that the advisers on the buying side equally appear on the selling side of the transaction – with all the implications on transparency, pricing, and the ‘who is working for whom’ question. Was a special approval sought and granted by the SEC?
 
 
Sixth, the market could not ignore the timing impact of this decision, four weeks after the SEC acted on a petition by the promoter of the companies merging, to take over the NSE – having his merger plans now approved with dispatch. It is a curious co-incidence but since we do not live in a world devoid of co-incidences, we have to assume that nothing untoward is/was at play.
 
The notion that the merger, as explained below, could effectively make the promoter potentially responsible for more than a third of the market capitalisation however raises questions that impacts on the demutualisation agenda – a subject for another day.
 
The total market cap of the banking sector as 6th September is N2.371 trillion out of a total market cap of approx. N5.901 trillion (minus the 2nd tier which contributes N4.155bn) – if the total Dangote company market capitalisation before the merger is considered i.e. Dangote Flour N85.150bn, Dangote Sugar N196.680bn, BCC N246.913bn, NASCON – N16.161bn; we have a total of N0.595 trillion - already 10% of the total market share. BCC’s and Dangote Cement had revenues last year of around N33.35bn ($230m) and N188.50bn ($1.3bn) respectively.
 
With the expanded company - to be known as Dangote Cement Company Plc, this should add about N2.13 trillion to the market capitalisation of the NSE and effectively bring the Dangote Group to an effective 43% of the total market capitalisation as at September 6, 2010. That is an interesting scenario to contemplate.
 
We reiterate that we have nothing against the initiative and we recall that UACN Plc – the conglomerate is equally listed on the bourse with a separate and distinct board; having related companies such as Grand Cereals and UACN properties listed on the exchange. This has never been promoted or reported as a ‘block’.
 
There must be some reasoning in the two approaches and the market may need to take time to discern the emerging trends.
 
 
Seventh, the last listing by introduction we had, of this magnitude was the November 2006 approval given by the Council of The Nigerian Stock Exchange through its Quotation Committee to the Transnational Corporation of Nigeria Plc's listing by Introduction of 18.55 billion ordinary shares of 50kobo each at N6.00 per share. The shares which was listed on Thursday, November 23, 2006 with a market value of N111 billion is now priced at N0.50k.
 
Most companies listed by introduction on the NSE in the last 3 years were generally weak companies and are currently facing dire straits – MTS Plc, IHS Plc, MTech Plc, etc are currently trading below listed prices; and a few are facing current NSE sanctions for failure to meet post listing financial reporting requirements less than twenty four (24) months after listing.
 
There are only a few sterling example of listing via introduction – GT Bank Plc for example which listed at N10 per share in 1996 and later conducted an IPO at the onset of the banking consolidation programme; which established the bank as a value based company – and we are all living testimony as to the strength and character of this commercial lender, now one of the top three banks in Nigeria.
 
The parallel with Transcorp Plc should not and must not encourage a comparison with this current bid by the new Dangote Cement Plc but should raise concerns at the SEC/NSE, which has not had a history of high value listing by introductions – a traditional approach usually deployed for weaker companies seeking listing outside the primary market.
 
The point being made here relates to the point made earlier; the high price of listings by introduction relative to the current market realities and the rules for listing by introduction that should have safeguards to protect investors in the secondary market.
 
The true test of a company of Dangote’s mettle must be the primary market – the offering of the shares of the merged company, after a listing in no less than 6-12 months should address this concern.
 
This is not a notion unique to Nigeria or a recommendation specific to the company. There is a growing debate about the place of listings by introduction and investors protection that we must consider given our recent past.
 
For example, the Philippine Stock Exchange (PSE) has suspended listings by introduction, other than those applications filed before February 17, 2010 and is reviewing its rules. Companies can list their shares on the PSE by introduction as long as they agree to hold an IPO within 12 months.
 
The PSE said that "we are reviewing the rule on listing by way of introduction…. to make sure that the rules are consistent and clear so that issuers can be guided correctly and at the same time ensure that the investing public is fully informed of the developments with the issuers," PSE Chairman Hans Sicat said in a statement on February 2010.
 
The PSE bourse temporarily blocked companies from listing by introduction last February 18. While it gave no explanation for the suspension, the move came as share prices of companies that had taken this route — listing stocks without necessarily selling these to the public — skyrocketed.
 
The action followed a similar move by the Hong Kong Exchange to halt listing by introduction unless issuers can show they have taken steps to ensure ample liquidity and an orderly market, and until the bourse finds ways of dealing with potential price fluctuations.
 
At the HHE, the new practice follows an opening day surge and plunge in shares of Asian Citrus Holdings Ltd., China’s biggest orange plantation owner, that prompted investors to criticize disclosure rules.
 
Generally, several companies that listed their stocks by introduction in most markets; have seen dramatic increases in their share prices, raising concerns that a loophole was being used to drive up prices.
 
It is this point that we have yet to receive assurance on from our market regulators in Nigeria.
 
Closing Remarks on Matters Arising from the Merger:
 
Finally, the movement to the capital market arising from the Dangote Cement/BCC merger is a welcome development. Such significant components of our economy including the telecoms, power and Oil & Gas sectors should be encouraged to approach the NSE for listing.
 
It must however be clear that this in itself would not absorb the large float from other listed companies arising from the developments in the market and the CBN directive. This listing will only help Dangote Cement Plc.
 
On the economic front, Dangote Cement Plc would prove a beneficial proposition to the economy and investors; if this industry monopoly is able to meet the national requirement without impacting on the ‘competitive landscape’ for other firms – importers and producers – to thrive – such as nudging government to implement import quotas to prevent competitors from importing cement just to keep prices up.
 
Already, the Dangote Group plans to double operations to 10m tonnes a year, with a further 5m tonnes from a new site. If this is combined with BCC’s 3m tonnes, the new group should by 2012 boast of a production capacity of 18m tonnes a year for the Nigerian market, outside importations.
 
 
The 14 days unabated uptrend in the shares of AP Plc
 
In the last 14 days, AP Plc shares has enjoyed an un-abated uptrend in its prices – in a sector and market that has been on a decline, with the ASI back to March 2010 levels. We are unable to rationalise what was driving the uptrend of a company that:
 
1. Has not yet released its financials for 2009 financial year end;
2. Has relieved the CEO, Financial Director and Company Secretary of its duties;
3. Had its Chairman declare that he was staying in exile due to threats to his life?
4. Has a petition against it at the SEC and NSE;
5. Has a petition of its own against some individuals over unpaid shareholding: and
6. Has a case of price manipulation ongoing and yet unresolved.
 
There appears to be no fundamental basis or market information on what is driving the share price of African Petroleum Plc. It has all the appearance of a smokes and mirrors situation.
 
The up trend in AP needs an explanation – for towards the end of the decline, 4 million shares were dumped, and the price has been going up on more than the average volume (i.e., average volume through July 15th was 423,000).
 
So why is the AP Plc stock the only one within its sector experiencing such an up trend when a cursory look at Oando Plc during the same period – and by the way, a better run company shows that share prices have been declining? Is there any big news or event in the horizon? 
 
Questions are now being placed before the SEC and NSE in the open court because if the regulators are really serious about curbing price manipulation, they should be able to tell the investing public what is moving this particular stock at this time.
 
 
The Market Outlook
 
The issues raised above are to the point. They represent the market perceptions that have held investors back from allowing the market rhythm principle to catch on.
 
Against all patriotic sentiments and personal allegiances to the persons/firms mentioned in this article – we truly do not see the market recovering to the levels we saw in 2006/2007.
 
The market has not witnessed any sustainable recovery since September 2008 when the government began with the idea of a presidential team on capital market recovery for several reasons, some of which include:
 
1. The large float, which resulted from several IPO, secondary offerings, and bonus offerings by banks; the lack of liquidity to absorb the large float;
 
The new 10% rule is along the same line like the limit downward price movement to 1% and upwards constant at 5% instituted by the NSE in 2008. We do not understand why the CBN is implementing such a rule. This is not what the market needs at this point in time. The market needs liquidity infusion and the banks remain the primarily the source of the liquidity. This rule will stall the market recovery.
 
3. Brokerage firms are cash-flow challenged and near insolvent, issuing houses are struggling, registrars are near broke (no new issues/offers to distribute prospectuses/forms including new share certificates - just the rudiments - AGM’s, dividend warrants, etc)
 
4. Investors (local and foreign) know where the real market problems exist: process and practice of stock investing in Nigeria - manipulations of those huge banks/other IPO’s, deliberate delays in release of share certificates for verifications, collusion of brokers/issuing houses/advisors with banks in shares allotment, usage of bank depositors' funds to buy shares of same banks, approval of dubious share offerings by SEC between 2005 and 2007, dubious and non-performing mutual funds floated by banks and others between 2005 and 2008 left unaddressed, and many more.
 
Conclusion
 
Sadly, it appears that till the fundamentals are corrected, this market isn't heading anywhere upwards; anytime soon. However, the fundamentally strong stocks (i.e., NB, Guinness, WACO, Mobil, Nestle, etc) on the exchange will continue to do well.
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