Brambles' Horse Sense

When rugby union players use the term "use it or lose it", they’re referring to a rule that says if you don't use the ball effectively in attack, you have to give it to the opposition so they can attack you.

I think the same term applies to investing and to capital allocations within companies.

Brambles clearly decided to "use it" yesterday. They have decided to exit all under-returning businesses, and return excess capital to shareholders via buying back the discounted UK dual-listed scrip. Since the restructuring, the high-return CHEP will account for 85% of earnings before interest and tax. I also suspect the exit prices of the assets to be sold will positively surprise the market. There will be tension from private and listed equity in these non-core asset sales. They are not bad businesses; they just aren't as good as CHEP.

Many of you will be asking, "Is that really using it?" My answer: “absolutely”.

Many commentators said today the dual listing did not work because UK investors were simply not prepared to pay the same price/earnings (p/e) multiples for BIL Plc as Australians are for BIL. That's true, but it ignores one vital factor. The main reason Australians pay up to 13% more is simply called "compulsory superannuation".

This arbitrage was all about the power of compulsory superannuation, and the higher p/e rating you can achieve in Australia if you feed the compulsory superannuation horse. Remember, most management teams are now remunerated on a "total shareholder returns" basis, and the highest TSRs are to be found in Australia if you harness compulsory superannuation effectively.

Don't underestimate how powerful that thoroughbred is. In 2005-06 it is forecast that total inflows into managed Australian equity funds will be $65 billion. Of that figure, it is estimated that $24 billion will come in from compulsory super, $30 billion from dividends, and the remainder from buybacks and the receipts of merger and acquisition transactions.

While we see $65 billion of inflows into managed Australian funds this financial year, we again see a supply deficit, which will again lead to a net cash buildup in Australian funds, or will basically support the index on pullbacks. The net inflow/outflow surplus could be up to $30 billion again in 2005-06, and that's enough to take care of T3 pretty easily '” if that ever gets away.

BIL is correctly bringing its main listing to Australia to feed that compulsory super horse in a larger way, and effectively increase its ability to access that legislated pool of growth capital. BIL will generate a higher weight on the ASX200 index when this dual listing structure is collapsed, and that basically means they have access to greater amounts of growth capital, and at an effectively lower cost.

The deal leaves you with a stock with pure GDP-plus growth businesses, and cheaper and larger available funding for those growth businesses. It is a great deal, and its success is likely to set an example for corporate Australia to follow.

THIS BRINGS me to a larger debate, about why domestic investors put some much pressure on companies to return capital? I have no issue with companies returning capital if they have no appropriate use for it, but more often than not there is an appropriate use for it, yet the board is listening too much to investors, and not enough to themselves.

Telstra spent years returning excess capital to investors, when it should have been investing extensively in new growth technologies. All investors wanted were special dividends and buybacks, and now look where the under-investment in growth has got that company!

The banks have spent a decade returning capital, scared of what the analysts will write if they go on a growth phase, and have all missed the once-in-a-lifetime opportunity to buy AMP. By their collective obsession to return capital, they effectively allowed Macquarie Bank (MBL) and Babcock & Brown (BNB) to emerge to dominate all new forms of corporate and investment banking. They have also allowed St George to emerge from being a small building society into a genuine fifth force in retail banking.

Why do we all want our capital back when we have no use for that capital anyway? Cash levels are high, inflows are strong, and global GDP growth is accelerating.

I think companies are feeling too much pressure from bearish investors, and not backing their own internal judgements. If I'm getting larger chunks of capital back from a company it basically implies to me that they have no real growth options. If that is so, it also suggests the given company’s p/e is too high. Companies need to realise that whatever they give back, will be given to someone else, and through time the effective reallocation of growth/risk capital will lead to another company taking your "excess p/e".

I would rather companies had an "educated go". If I have faith in a given management team and board, I don't want my capital back; I want them to have a go at adding value to the capital I have stumped up as a minority investor.

I don't mind if they go for six months or a year with some excess capital while they assess opportunities to put that excess capital to work, but they shouldn’t just give it back to me because other minority investors are pushing them to.

Interest rate rises are coming to an end; in Australia you've seen the rate tightening cycle finish, which means the 5.50% cash rate is my alternative if you give me my capital back. If companies can't beat the cost of capital by a substantial margin, then I believe they’re simply not trying.