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Report on aspects of the initial public offering of Vertex Group Holdings Limited in 2002

THE OFFER DOCUMENT

Disclosure Requirements

89. Offers of securities to the public must be made in compliance with the Securities Act 1978. This requires issuers to register a prospectus and to produce an investment statement. Each of these documents must contain certain information that is relevant to investors' decisions whether or not to invest in the securities being offered.



90. The purpose of these documents is to allow prospective investors to make an informed decision about their investment.



91. A registered prospectus contains detailed historical and prospective financial information, and information about the issuer, its directors, promoters, and substantial security holders, and the terms of the offer of securities.



92. An investment statement is designed to provide key information to assist the "prudent but non-expert" person to make an investment decision, and to draw to that person's attention the fact that more information is available in other documents. The investment statement must contain prescribed information answering eleven important questions about the offer of securities.



93. The prospectus and investment statement disclosure requirements are set out in the Securities Act 1978 and the Securities Regulations 1983. Both the registered prospectus and investment statement must disclose risks associated with the offer of securities.



94. The purpose of risk disclosure in a prospectus or an investment statement is to inform prospective investors about matters that may impact adversely on their investment. In the course of operating a business it is ordinarily the responsibility of the management and directors of a company to consider risk factors and to take decisions based on assessment of those risks. However, where a company decides to raise money from the public the securities laws require these material risk factors to be publicly disclosed so that prospective investors and their advisers can assess the desirability of investment in the company.



95. Whether or not a risk or a fact must be disclosed in a prospectus or an investment statement depends on whether it is "material". When this term is used in securities law it means that a matter is one that would be likely to influence a reasonable person in making a decision whether or not to subscribe for the securities, without necessarily being determinative of the decision.



96. Information is material if it is needed to enable a reader of the prospectus or investment statement to properly assess the risk of an investment. Because of this the disclosure of risk factors in a prospectus and an investment statement is particularly important. The investment statement



97. One of the questions to be answered in the investment statement is: "What are my risks?" Under this heading the investment statement must set out:
    
    
    1. "A brief description of the principal risks of-
       
       
       1. The money paid by a subscriber not being recovered in full by the subscriber:
       2. A subscriber not receiving the returns referred to in the investment statement:
       3. A subscriber being required to pay more money in respect of a security than is disclosed as the subscription cost or any amount payable in insolvency.
    
    
    2. If it is reasonably foreseeable that, on termination of any security at any time, a subscriber will have received, in total, less than the amount paid to the issuer or an associated person for the security, a statement to this effect and a brief description of the circumstances that may produce this result."


98. All the information that is required to answer this question must be set out together in the investment statement under the "What are my risks?" heading.

99. A registered prospectus for shares must contain certain information that is prescribed in regulations. These regulations include a catch-all obligation requiring the registered prospectus to contain "particulars of any material matters relating to the offer of securities".



100. One of the specific disclosure requirements relates to prospects and forecasts. The relevant provision says the registered prospectus must contain:
     
     
     1. "A statement as to the trading prospects of the issuing group, together with any material information that may be relevant thereto.
     
     
     
     2. The statement required by subclause (1) of this clause shall include a description of all special trade factors and risks that-
        
        
        1. are not mentioned elsewhere in the registered prospectus; and
        
        
        
        2. are not likely to be known or anticipated by the general public; and
        
        
        
        3. could materially affect the prospects of the issuing group."


101. The disclosure requirements of the Securities Regulations 1983 do not limit the information that an issuer can put in a registered prospectus. These Regulations provide that if any statement that is required to be in a registered prospectus would be misleading if additional information were not also included, then the prospectus must also contain that additional information.

102. Vertex combined the registered prospectus and investment statement into one document. This is allowed under the Securities Act 1978, although the Commission has warned in the past that care must be taken in doing this to ensure that neither document is concealed by the other. Each must remain clearly distinguishable and prospective investors must be able to easily find the important information they require.



103. The offer document discussed risks in several places. The principal discussion about risks material to the offer of securities was set out in a section entitled "Risks and Risk Management".



104. The Risks and Risk Management section began on page 32 of the offer document. This section detailed risks and special trade factors and also referred readers to the general risks set out in the investment statement part of the offer document. The investment statement part of the document, under the question "What are my Risks?" on page 77 of the offer document discussed general risks and also referred readers to the Risk and Risk Management section of the offer document.



105. The risk factors described in the Risk and Risk Management section were:
     
     
     • Foreign exchange and the level of the New Zealand dollar;
     
     
     
     • Loss of major customers;
     
     
     
     • Raw materials costs;
     
     
     
     • Dispute with the vendors of the Securefresh assets;
     
     
     
     • Business disruption/information technology risks;
     
     
     
     • Dependence on key management;
     
     
     
     • General economic conditions;
     
     
     
     • Technology risk;
     
     
     
     • Regulatory risk;
     
     
     
     • Shares eligible for future sale; and
     
     
     
     • Environmental factors.


106. Under the heading "Loss of Major Customers" on page 32, the offer document states:
     
     "[T]he Group has a number of major customers, the loss of whose business would be likely to adversely affect the future short to medium term performance of the Group. Moreover, it is typical of the industry that supply contracts with customers are relatively short term in nature with no certainty of rollover".



107. The Commission is of the view that this risk disclosure accurately describes the risk associated with potential loss of business for the company as a whole. However, there is no mention of specific business risks relating to uncertainties regarding Technical Injection and Securefresh.

108. The Commission is of the view that the prospectus should have contained specific risk disclosure about Technical Injection and Securefresh. There are two reasons for this:
     
     
     1. These growth business units received special attention in the marketing of the IPO, as the main contributors to future company growth; and
     2. Directors recognised uncertainties about the future prospects of Technical Injection and Securefresh.

109. A prospectus must disclose "material" information about a share offer. Something is material if it is likely to influence a reasonable investor. The Commission is of the view that the likelihood of information about a specific section of a company influencing a reasonable investor will be determined in part by the emphasis given to that section of the business in marketing the offer.



110. In the Commission's opinion, where an offer document for securities places particular emphasis on any specific feature of a business as being attractive to investors, for instance because it offers very good growth prospects, then the offer document must also emphasise the risks associated with that part of the business. Often a high growth venture carries particular risks that differ from those facing an established business. If an investment is promoted on the basis of its high growth potential (or any other special feature) then it is important that risks associated with the growth business are given equal prominence in order to allow investors to make an informed decision. Where an offer document does not clearly set out such risks the offer document is likely to mislead investors.



111. The established history of Vertex's core business was emphasised in the offer document, in particular as a likely source of dividend returns for shareholders. However, Vertex's offer document also made frequent reference to the growth prospects for the company resulting from new innovation and technology, referring to Technical Injection and Securefresh in particular. Examples include:
     
     "Vertex believes its differentiated product range offers opportunities to expand outside New Zealand. Furthermore, recent innovations in the areas of fresh meat packaging and technical componentry offer significant growth opportunities" (p 1)
     
     "Our [Technical Injection] design and tooling centre team plays a vital role and their skills are contributing to our rapid growth. Revenues doubled from FY01 to FY02 and are expected to increase by over 50% from FY02 to FY03. This exciting business will relocate to a new, GMP-compliant facility later this year to better serve its growing export customer base." (p 20)
     
     "The Technical Injection business unit utilises the skills of the Group's design and tooling centre. It is the fastest growing Vertex Group business (revenues having doubled from FY01 to FY02 and being forecast to increase by over 65% from FY02 to FY03) and is also the most export-focused (80% of its sales are exported by its customers). Six additional machines have been installed or are on order for the period FY01 to FY03 at a total cost of $0.8 million to meet expected growth" (p 23)
     
     "When the Group sells Securefresh machines, a packaging supply contract is offered for the supply of trays and pouches for any goods packed with the Securefresh machinery. Margins are earned on the machines, trays and pouches that are supplied through the Securefresh business unit. Sales are forecast to double from FY02 to FY03. The Securefresh business unit also offers significant growth potential to the Vertex Group with expressions of interest for packaging and trays coming from international meat processors...Sales of specialised trays into the United States have grown from zero to well over $1 million from FY01 to FY02." (p 24)



112. The importance of the growth business units to the potential attractiveness of Vertex as an investment was reinforced by director Barry Watts in his evidence to the Commission, in which he stated:
     
     "The growth [in the plastics industry] comes through pretty much from new products, and changes in technology. There aren't dramatic new plastics becoming available for detergents or for soft drinks. The last big introduction of a new package was PET, for soft drink and since then there's been nothing really dramatic and unless you have that, growth becomes fairly stable in the market...
     
     The interesting thing about technology in the Technical Injection business is that it is very unique. It's not like making a PET bottle which a dozen people can make. Technical Injection's pretty much revolving around the very clear skills of the people that are in that business, and there are few in the world that do that sort of business. So, it's a rather unique part of the plastics business and if you've got good technology and good people you can get good growth, so it's quite a large market."



113. Vertex directors told the Commission that they focused on the "portfolio" effect of the business. They expressed the view that, in the context of the company as a whole, problems in the two growth business units were not material. For that reason, the Commission was invited to conclude that it was not necessary to single out the two growth business units in the risk sections of the offer document.



114. The practice of adopting a portfolio approach to managing a company is a matter for directors. As a matter of disclosure, the Commission is of the opinion that where an offer document singles out particular business units of a business, highlighting their growth potential, those business units become more material to an investor's decision to invest. As a corollary to that, in the Commission's opinion, a corresponding emphasis is required in the offer document on any risks specific to the growth elements of the business.

115. The forecast growth prospects for Technical Injection were based on information from customers. The evidence heard by the Commission indicates that this customer information, in particular the information from Prima, was not regarded as being entirely reliable.



116. Vertex management made a business decision regarding the extent to which Prima's anticipated orders should be discounted. The discounting was significant, in the region of 50 to 60% overall. In his evidence to the Commission, Mr Starnes stated that he applied a 10% discount to the value of Prima's November 2001 anticipated orders. The question was put to Mr Starnes:
     
     Q:  "Was there any science about 10%? I mean, why was it not just 5, or why was it not 20? Just a matter of judgment?"
     
     A:  "Yeah, it is a matter of judgment; you look at the type of products, who the customer is."



117. The absence of established sales patterns and the surrounding uncertainty was a risk, as Mr Pillar's evidence demonstrates:
     
     "In both instances [referring to Technical Injection and Securefresh] there was a very high degree of rigour applied to really understanding what the customers were likely to do, because they are - - there is less of a track record. Is there necessarily a lower certainty of those sales coming through? I think definitely yes, but what we tried to do in the case of Technical Injection was then discount where we felt that there was a degree of uncertainty in order that the final numbers that came out were as hard as the core business numbers."



118. Although the discounting was not based on a scientific analysis, in view of Prima's relatively short history, and an absence of established sales patterns, it appears that the figures were not capable of such analysis. The discounting was, in the opinion of the Commission, a reasonable attempt to exercise caution. The Commission accepts that Vertex could not have predicted the extent of Prima's orders, given the information Prima was providing to it at the time.



119. Securefresh's business manager, Miles Patterson, was asked how the budget projections for the case-ready part of the Securefresh business were calculated. He replied:
     
     "That was probably more difficult in the sense that we were reliant totally upon the expectations of our customers, and they were saying to us, yes, we plan to do Case-ready by such and such a date, we will need the equipment installed by here, and this is their packaging requirement, whether it be a commercial trial or whether it be fully-you know, a full commercial operation, and that's-as I say, it's all emerging, it's all new and there's no sales history, obviously, against that".



120. He later went on to say:
     
     "Case-ready is an emerging new market and this system probably constitutes about 20% of the investment that a customer would have to make in going Case Ready, and there are a huge number of drivers that impact on that decision. And whilst the customer might say to us, I'm definitely going to do it by this date, because of a whole raft of other factors that can impinge on the decision and because it's a very large capital investment, often what they commit to verbally they can't actually follow through with in actual practice, and that's something that we-you know, it has been a surprise to us, to be honest".



121. Business necessarily involves uncertainty, and business judgments must be made by directors. In the context of a public offer of securities the Commission is of the view that, where directors have identified a specific risk relating to a part of the business that is material to the offer and have made a specific judgment about this, then that risk and material factors relating to the judgment should be fully disclosed in the offer document. In this way, investors are given the opportunity to assess for themselves the soundness of the business judgment and the possible effects of that judgment on the investment. Vertex's offer document did not disclose the specific risks around the business judgments made in respect of expected future Technical Injection and Securefresh sales.

122. Vertex has submitted to the Commission that in its view, the risk of the growth business units' customer orders not being placed was adequately disclosed by the general risk statement on page 32 of the offer document (quoted at paragraph 105 of this report). The Commission does not agree with this assertion. The risk statement relating to loss of major customers is of a very general nature, and does not reflect the actual uncertainty surrounding the orders for the growth business units.



123. The Securities Act 1978 provides that a statement included in a registered prospectus is deemed to be untrue if it is misleading by reason of the omission of a particular which is material to the statement in the form and context in which it is included.



124. The evidence shows that Vertex recognised specific risks regarding the future prospects of Technical Injection and Securefresh, as a result of the lack of sales history and the lack of certainty around customer sales plans.



125. Generally, the risk section of Vertex's offer document gave the impression that the risk was at the same level across all business units. Except for one matter relating to potential litigation there was no mention of any specific risk in relation to Technical Injection or Securefresh.



126. The Commission is of the opinion that in view of the emphasis given to the growth prospects of Technical Injection and Securefresh in the offer document, the risk factors associated with these business units would have been likely to influence a reasonable investor in deciding whether or not to buy shares.



127. The Commission considers that by omitting to disclose specific material risks relating to Technical Injection and Securefresh, the offer document was likely to mislead.