Holiday Economics | The Rookie as a Journo | Accountants on the Sharemarket | The Thing About Debt and Equity / by Adam Howard

Last week was a one-off.  A stand-alone, price driven, data only analysis of how much Rotto costs, and then how much our three favourite holiday destinations cost, but only in terms of getting there and staying there.  Not how much you would spend while there, or what you would do while there.

 And it was interesting, wasn’t it???  Rotto being the cheapest, by far, of the three destinations.  For the longest time the argument about Rotto has been it’s a holiday only the rich can afford…

Well, that’s wrong.  Unless, of course, only the rich can afford to go on holidays, full stop.

If you are lucky enough to know a friend with a boat, even a small one, you could even get to Rotto and back for free.

But I think the real issue is what you are looking for in a holiday.  Considering I have been to all three destinations over the past 3 years I thought I might summarise…but I need to be careful here as I am about to leave the realm of objectivity and get all subjective on all of you.

Here are the various pros and cons of each destination:

Rottnest

Pros:  Great destination for family with kids, amazing beaches, the best pub in the world, safety (no cars at all), slow pace, relaxation.
Cons:  Not much to do, limited eating options, basic accommodation for high price, expensive food and alcohol prices at the supermarket.

Down South

Pros:  Great destination for family with kids, amazing beaches, wide selection of eating/drinking establishments, slow pace, relaxation.
Cons:  Need a car, considerable distance between all potential activities, considerable price movements for accommodation between peak and off peak.

Bali

Pros: Acceptable destination for family with kids, luxurious accommodation and hospitality for very reasonable prices, very high service levels, large number of potential activities, most activities in close proximity to each other.
Cons:  Need some form of transport, potential for illness, poor standard of beaches, potentially dangerous roads.

As they all appear to be of a comparable cost, it really comes down to what each person wants from these holidays.

BUT, what is apparent is the weaker Aussie dollar has definitely changed the comparative cost of these holidays.   And THAT’S my main point.

The economics of a holiday have changed with a weaker currency, so now Rottnest and Down South are much more competitive.

And I am sure Tourism WA is happy about this.

Now, onto this week’s topic, and I’ll begin with an announcement. 

I, The Rookie, would like to announce that I have attended my first “event” as a member of the media!

Another friend, whom we will call The Networker, invited me to a function run by the accounting firm HLB Mann Judd, where the topic was the recent performance of and changing face of Initial Public Offerings (IPOs) in Australia.

The Networker is a rare creature.  Always happy to talk, always able to provide one with some time, happy to help you get connected and always provides useful advice.

Now, the data presented on IPOs over the past few years shows a move away from risk and back to certainty, which I am sure won’t come as a surprise to anyone.  It’s all contained in HLB’s IPO Watch Report, with the link attached below:

IPO Watch Report

 The following chart shows a sharp drop in IPOs in 2014, particularly in the small cap (< $100m) sector as investors opted for larger cap, more consistent performers.

The peak in small cap IPOs that you can see below from Dec 2009 to Dec 2011 was almost entirely resource sector driven, with anyone that could buy a shovel and dig a hole deciding to raise capital.

And there were obviously buyers….

But, with the recent precipitous drops in the prices of oil and iron ore the IPO market has dried up.  The exception is the large spike in Dec 2014, attributable to the Medibank Private auction.

IPO Activity by Quarter

IPO Activity by Quarter

It seems the appetite for risk has disappeared, because there’s no question there is more risk involved when investing in a small cap IPO, than something like Medibank Private.

But then I recall reading a quote from just post GFC that went something like “Investors think they have appetite for risk, but they really only have appetite for returns”.

The other focus of the presentation was on the Australian Biotech sector, which has been rebadged Life Sciences, and their fortunes with IPOs and on the share market in general.

The summary is:  there are some great biotech businesses in Australia, but any biotech hopeful looking to list has a steep hill to climb to do so.  As I said above, there is no appetite for risk at the moment and…as an investor population Australians don’t seem to understand or be that interested in anything that isn’t related to banking or mining.

Why do I say so?  Well, take a look:

S&amp;P ASX 200 index sector decomposition

S&P ASX 200 index sector decomposition

Resources are included under the “Energy” and “Materials” sectors, and when combined with “Financials”, comprise 70% of the entire market.

I don’t know about you, but that appears a little unbalanced to me…

Well, what about the US by comparison?

S&amp;P 500 Sector Breakdown

S&P 500 Sector Breakdown

The above appears pretty well balanced and might, just might be a result of the US having the world’s most “sophisticated” capital market.  Let’s define that word, because it is used a lot to describe investors:

Sophisticated:  altered by education, experience, etc., so as to be worldly-wise and not naïve.

So, Life Sciences businesses struggle to raise funds via IPOs, and end up taking less conventional paths to the share market, such as Reverse Takeovers (RTOs, also known as back door listings; a topic for a whole series of Updates).

This presentation and the underlying implications, got me thinking about Australians’ attitude to risk, at least as far as investment, debt and equity is concerned.  

And I have to say, my opinion is most Australian business people and investors may even struggle to place what they are investing in on a risk/return curve. 

So, guess what??  Here is a picture to make it really clear:

The world of yesterday

The world of yesterday

So, in this curve home loans and business loans secured by real estate are “Real Estate”, and that’s how the banks view them as well: low risk, low yield investments.

Also notice that all the forms of debt are in the low risk/low return sector, while all forms of equity fall in the high risk/high yield sector.

This is a good time for me to make a couple of clear points:

  1. The gap on the curve between the low risk debt instruments and the higher risk equity instruments is called the “equity risk premium”, where equity holders can be but are not always compensated by higher rates of return due to these higher rates of risk.
  2. THE BANKS ARE NOT EQUITY INVESTORS AND ARE NOT IN BUSINESS TO SUPPORT ENTREPRENEURIAL IDEAS!!!!

Sorry about text yelling.  I get a bit worked up as I used to get yelled at a lot as a banker about the banks’ refusal to lend on the basis of a great idea and a total lack of equity.

I used to tell the yellers “That’s what venture capital and private equity is for.”  Wasn’t received that well.

And a character from a past Update, The Inventor, also gets angry, but about a different class of investor; private equity; and for different reasons.

Private Equity (or PE for those in the know, you know) covers everything from enormous PE funds, down to high net worth individuals you get in touch with through your accountant.

And as you can see from the above placement on the curve, PE is High Risk/High Return investing.  But too many PE investors only listen to the “High Return” bit, not the “High Risk” bit.

If you are putting funds towards PE, Venture Capital or Angel Investing it should probably be money you don’t mind losing, because that’s the most probable outcome.  And The Inventor has had firsthand experience dealing with providers of PE who seem to expect a risk/return mix similar to small cap stocks.

But briefly back to our Life Sciences hopefuls.  They tag themselves long term, high risk/high return investments and their place on the curve, immediately before PE and Venture Capital confirms this.

So, maybe their lack of success is a combination of a lack of sophisticated investors, but also the more adventurous investors being badly burnt of late?

Food for thought….