My last post covered the valuation of Kiwibank and its parent company, Kiwi Group Holdings Limited. As you may know, in August, the government decided to acquire this banking group. While most of the attention focused on the sale of Kiwibank, little attention was paid to the sale of Kiwi Wealth, the group’s wealth and investment arm. It will be sold to Fisher Funds for $310 million, subject to Overseas Investment Office approval.
The sale of Kiwi Wealth has largely flown under the radar. But it is unclear why. Perhaps because many of us believe that the government acquisition was about Kiwibank, not realizing that the change of ownership also involves NZHL and Kiwi Wealth. Perhaps we believe the narrative that the sale of Kiwi Group Holdings Limited is an innocuous reshuffle of shares between the government and government-owned firms. Or is it because Kiwi Wealth will remain a New Zealand-owned company in the hands of its new owner: Fisher Funds?
Kiwi Group chair Dame Paula Rebstock, on RNZ news, said the sale was positive for Kiwi Wealth because it would be able to expand within Fisher Funds as it was gradually integrated. Fisher Funds chief executive Bruce McLachlan said the acquisition fitted its long-term growth plans for KiwiSaver and funds management in New Zealand.
As I argued in my previous post, the acquisition by the government of Kiwi Group Holdings Limited is not an innocuous reshuffle of shares. In fact, as I will explain in this post, it looks like the government wants to earn a quick buck. However, it may not realize that Kiwi Wealth, which proudly claims to be the largest New Zealand-owned KiwiSaver provider, at some point in the near future may find itself at the mercy of anonymous foreign private equity firms. These private equity firms bankroll Fisher Fund with borrowed money.
What could possibly go wrong?
Just think about it, the sale of Kiwi Wealth is a mix of a rushed government decision, a change of ownership and control, foreign private equity firms, and borrowed money to finance the purchase of a pension fund when today’s pension funds are performing poorly and markets are volatile. This possibly at the expense of hard-working New Zealanders’ pension entitlements.
I will talk you through the highlights of this transaction, and I hope you will realize that the sale of Kiwi Wealth could potentially be an embarrassment of epic proportions.
Kiwi Wealth has a lot of going for it
As mentioned above, Kiwi Wealth is a New Zealand owned and operated wealth and investment organization. Its KiwiSaver scheme is the fifth largest KiwiSaver scheme in New Zealand. Kiwi Wealth’s KiwiSaver Assets Under Management are over $6.1 billion, and it has over 250,000 KiwiSaver members. It performs well: Canstar places Kiwi Wealth’s KiwiSaver in the top ten of KiwiSaver Funds by recent returns. Returns of Kiwi Wealth’s KiwiSaver funds in the last five years have been higher than average KiwiSaver returns (National Capital). Revenue grew by fifteen percent, and dividends paid to owners increased by more than $3 million to $19 million shortly before the acquisition announcement (NBR). Note also that of the two significant subsidiaries of Kiwi Group Holdings Limited, Kiwi Wealth and Kiwibank, the former outperforms the latter: Kiwibank’s return on equity was about six percent, which is low by all means. To give you an idea how low this is: last week, Credit Suisse, a bank plagued by scandals and executive churn, announced a significant restructuring plan. The plan included a six percent return on equity target, which wasn’t good enough for investors. They sold their holdings and the share price of the stumbling bank dropped by 19 percent.
Kiwi Wealth prides itself on its values and focus on responsible investing. It is a B Corp certified company, which means that it meets high standards of verified performance, accountability, and transparency on factors from employee benefits and charitable giving to supply chain practices and input materials.
Kiwi Wealth will be bought by Fisher Funds, subject to Overseas Investment Office approval. Like Kiwi Wealth, Fisher Funds is a significant player. KiwiSaver Assets Under Management for Fisher are about $6.5 billion, and it is in the top ten KiwiSaver funds by number of members. Fisher Funds, however, is not free of controversy. It lost default KiwiSaver status on grounds of fees. There was also a kerfuffle between CEO McLachlan and NBR’s Tim Hunter about Fisher Funds’ performance and fees.
They’ve been working on this deal for a while
Kiwi Wealth’s sale was first reported by the media in January. The Australian Financial Review mentioned that the owners hired investment bank Goldman Sachs to test the waters. According to Hamish Rutherford in the New Zealand Herald, this coincided with the review of the ownership of the entire group:
Grant Robertson has kicked off a review of the ownership of Kiwibank’s parent company, which could see the bank directly owned by the Government, or – in theory at least – sold to private investors.
In recent weeks the Treasury has appointed Goldman Sachs to examine options for the ultimate ownership of Kiwi Group Holdings, the parent company of Kiwibank as well as wealth manager and Kiwisaver provider KiwiWealth, Kiwi Insurance and New Zealand Home Loans.
While Robertson’s office has not commented directly on the review, in a statement the Minister of Finance appeared to confirm the way Kiwibank was owned was under discussion. The statement appears to hint that, whatever the outcome, Kiwi Group would remain in public ownership in some form.
Note the last line in the quote above. At the time, it looked like the idea was to preserve the entire group, not sell a significant subsidiary to the private sector.
Because of the elections, the deal had to be done and dusted this year
It is very likely that the sale will be completed by year’s end. With an election year approaching, provided that everything works out as planned, the sale will probably and hopefully be forgotten about in the new year. It is no coincidence that the Treasury informed me that it will release sixty documents related to the change of ownership by early December, and not earlier. My interpretation of this delayed information release is that Treasury will make some irreversible (and potentially embarrassing) decisions before the markets go on holiday in December.
Interestingly, in an OIA reply of 15 September 2022, the Treasury promised the information release would be at the start of this month (November). However, I can see why Treasury delayed the release by a month: markets are volatile, and pension funds are taking a hit, especially since the UK’s announcement of the Mini budget.
The deal structure
This is where it gets interesting. The amount of the deal, $310 million, is too large for Fisher Funds to cough up on its own on such short notice. The deal will very likely rely on external debt funding. Let me explain why.
Basically, there are three ways to fund such a significant amount of money. First, a firm can fund internally by selling existing assets. But that is impractical. The liquidation of such a substantial amount of own investments would be disruptive. Fisher would need to sell its own investments at a discount, which would surely affect the performance of its own funds.
The second way of financing this deal is to issue shares. However, that would unlikely work for the current owners of Fisher Funds: the TOI foundation and TA Associates. The TOI foundation is a charitable trust that owns 66 percent of Fisher Funds. With a balance sheet total of $43 million, it cannot practically buy a fair share of the amount involved. The other owner, Boston based TA Associates owns the remaining 34 percent. It is a much larger firm, it has been around for more than fifty years, and over these years, it has raised close to fifty billion dollars.
It is theoretically possible for TA Associates to fund $310 million. However, in practice that means that TOI would have to surrender to TA Associates a significant proportion of the dividends it currently receives from Fisher Funds. I am therefore not convinced that equity funding by Fisher Funds’ current owners will work. This rules out equity funding by other firms as well. TOI relies on the dividends that Fisher Funds pays, it will unlikely give up that lucrative stream of income to an external, third, party.
A leveraged buyout, perhaps?
The third and most likely way of funding the acquisition of Kiwi Wealth is for some of the owners to borrow the funds in a leveraged buyout (LBO). Investopedia defines an LBO as an acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition.
Investopedia also mentions that LBOs have acquired a reputation as a ruthless and predatory business tactic, especially since the target company’s assets can be used as leverage against it. Uh oh.
As I suspected, the Kiwi Wealth acquisition will likely be financed by external debt, as confirmed by the Australian Financial Review. On 17 July, it reported that private equity firms Bain Capital and Nomura would bankroll the bid for Kiwi Wealth:
… it is understood Bain Capital Credit and Nomura stumped up debt funding for the TA/Fisher Funds bid …
From a financial point of view, a buyout involving debt makes sense in that the other funding options will not work, see my explanations above.
However, there is ample evidence regarding the downsides of such debt-funded deals. A study by corporate governance specialists Marc Goergen, Noel O’Sullivan, and Geoff Wood on Institutional Buyouts (IBOs, which are similar to LBOs), shows that:
… it is generally anticipated that private equity acquirers will seek to recover their investment and any profits within a reasonably short timeframe so may be more focused in seeking to eliminate unnecessary costs as soon as possible after the takeover, putting employees and associated costs particularly under the spotlight.
More importantly, the same study shows the effects on employment and firm performance after the acquisition:
There is a significant decrease in employment in acquired firms in the year immediately after the completion of the IBO compared with non-acquired firms. Further analysis fails to identify any parallel or subsequent increase in firm productivity or profitability. This evidence suggests that the observed downsizing has not been effective either in disciplining staff or imparting a clearer focus to activities.
Other research on employee views of leveraged buyout transactions shows that:
For Private-to-Private transactions, dissatisfaction is concentrated in non-management employees and comes mostly from how management treats them. In Public-to-Private transactions, the dissatisfaction is stronger, multi-faceted, and present for all employees, including management.
On Bain Capital and private equity, the Rolling Stone wrote in colourful language:
And that’s when the fun starts. Once the buyout is completed, the private equity guys start swinging the meat axe, aggressively cutting costs wherever they can – so that the company can start paying off its new debt – by laying off workers and cutting capital costs. This process often boosts operating profit without a significant hit to the business, but only in the short term; in the long run, the austerity approach makes it difficult for companies to stay competitive, not least because money that would otherwise have been invested in expansion or product development – which might increase revenue down the line – is used to pay off the company’s debt.
It takes several years before the impacts of this predatory activity – reduced customer service, inferior products – become fully apparent, but by that time the private equity firm has generally resold the business at a profit and moved on.
So here we are, it is not a given that this is a value-enhancing deal. I can not rule out that Nomura and Bain Capital, or whichever other lender, will want to put pressure on Fisher Funds to “manage” Kiwi Wealth.
The CEO of Fisher is on record saying that the two firms were complementary and it would be business as usual in the near term at least, but there would be some job losses as the two integrated:
There is duplication and because of that there will be some roles that go, but it’s not a cost out exercise … a significant number of Kiwi Wealth team will be retained as will a material Wellington presence, that’s our promise and that’s what we’ll deliver.
Based on the academic literature, jobs will go, and job satisfaction of Kiwi Wealth employees will likely be affected, with potential effects on returns.
It is unlikely that Kiwi Wealth will be unaffected by the acquisition. Despite the good intentions of CEO McLachlan, he cannot ignore the interests of powerful lenders such as Bain Capital and Nomura. Welcome to the world of private equity.
It is also not unlikely that the features that make Kiwi Wealth that stellar performing company will evaporate, that it will be morphed into Fisher Funds, which is a different firm. Mark the words of Dame Paula, who said the sale was positive for Kiwi Wealth because it would be able to expand within Fisher Funds as it was gradually integrated. The answers on the Kiwi Wealth FAQ about the transaction indicate that the company will stay the same in the immediate future. That immediate future could end soon.
A deafening silence
I am writing this post with limited information. Most of it originates from before September. I tried to contact many of the parties and people involved, but none of them replied, OIA requests were declined. So, much of the above may be totally speculative. But I am convinced that debt will be involved to finance the transaction. The amount involved is also large, which rules out the involvement of only domestic lenders. In any case, according to the academic literature quoted above, debt means trouble.
The recent pension fund meltdown
The parties involved in this transaction could not foresee the pension fund meltdown after the announcement of the recent UK Mini Budget.
To assess the effects on spreads and interests rates of LBO deals, I asked around on Twitter, and the only reply I received informed me that pension funds are uninvestable today.
That is a worry. If the government insists on proceeding with the deal, it may incur elevated costs. It is possible that the debt interest rate has increased since September. It is also possible that, in light of recent developments, the agreed price for Kiwi Wealth requires a downward revision. And, lastly, there is foreign exchange risk affecting US firms investing in Kiwi dollars. This does not bode well for Fisher Funds and Kiwi Wealth, because deteriorating terms of trade may incentivize the lenders to step up their efforts to manage their investment to meet return requirements.
This deal raises some important questions:
- What was the reason to separate Kiwi Wealth from the group? To me, it looks like there was a need for cash, but there may be a different reason.
- Why did the government want to keep lacklustre performing Kiwibank, but decide to sell the better performing Kiwi Wealth to a third party, which, according to the Australian Financial Review, will have it financed with foreign, private equity funded debt?
- The government made a point of keeping bank profits in New Zealand, but the same government is apparently fine with the idea that significant cashflows from Fisher Funds will, in the case of overseas debt financing, be used to satisfy the return requirements of foreign private equity debt investors. Why?
- How will the government explain this to the current Kiwi Wealth KiwiSavers, who elected the firm because of its values and its top ten performance?
- Based on the academic literature on leveraged buyouts, why would the parties involved assume that debt financing would be a wise choice?
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