Forum Archive Index - October 2002

["Lyall W Taylor" <lyall.taylor@lycos.com>]

SNOOPY:

I absolutely detest to you refering to my positive take on CLI as 'irrational 
exhuberance'.  Exhuberance maybe, but irrational?  Its the pinical of arrogance 
to think that anyone who doesn't see things the way you do is acting 
irrationally.

Indeed, I could just as easily say you are being irrationally pessimistic.  
Whats more, your analysis is still riddled with errors and inconsistencies.

Take this:

QUOTE
Working backwards, a 'total policy liability' of $1.3b spread 
over 15 years equates to total annuity contract payments of $866m, 
which is matched by an equivalnet bank debt of $866m.  This gives a 
total debt associated with the annuity business of $866m + $866m = 
$1.73b.   This is only about half the total CLI debt of $3.4b.

With shareholders funds of of only $1b, that means there is around 
$1.70 of debt for every dollar of equity.
END QUOTE


I have absolutely no idea where you have plucked these figures from.  The 
policy liability is accounted for as if it were a normal loan, being amortised 
over duration of their annuity term.

Their annuity contracts currently yield 5.8%pa for annuitants.  So each year, 
5.8% would be charged to the liability, and payments deducted.  By the end of 
the term the liability is completely amortised; simple.

I don't know how you get $866m but this is wrong.

QUOTE
I was talking re-insurance in relation to the rest of the business of 
CLI, not the annuity side of it.  Also presumably the buildings that 
CLI own are all insured and that entire risk is not taken by CLI.
END QUOTE


CLI has no re-insurance at all.  Re-insurance is only insurance provided to 
other insurance providers.  CLI is not in the insurance business at all. 



QUOTE
The first point is that the two things that you have linked together 
I do not see as linked so I will deal with them separately.

1/ 'Shelf Company Business is completely out of Left Field'.

Pick a company, any big company.  I chose Telecom and put that name 
into the search engine at the NZ companies office, here:

http://www.companies.govt.nz/search/cad/DBSSITEN.Main

There you will find a company:  'Telecom Leasing Limited' that has 
been struck off and now 'Telecom Mobile Leasing No.1 Limited' exists 
as does 'Telecom Mobile Leasing No.2 Limited'.   The setting up and 
destruction of shelf companies is something that happens all the 
time.   Far from being 'out of left field' it is normal business 
practice.   


2/  Accusation of Speculation

I define 'business speculation' as a business plan where success 
depends on someone buying you out of a business at a higher price 
than that at which you bought in, somewhere down the track.   The 
path between where you buy in and sell out is largely determined by 
external factors beyond your control.

Compare this to 'business investment' where a businessman uses his 
own talents and specialised knowledge to build the buisness and the 
increase in the value of the business depends on direct application 
of his expertise.

You assume speculation is a bad thing.   There is good and bad 
speculation.  I would class the CLI annuity scheme as 'good 
speculation' in the sense that the assumptions are conservative and 
are broadly in line with historic norms.   This does not mean that it 
is not speculation though.

Whether the CLI business plan comes to fruition largely depends on 
the performance of the tenants in their different fields of 
endeavour. This is out of the control of CLI, and the reason why I 
said it was speculation.
END QUOTE


Snoopy, you can attempt to carve speculation up into different pieces, and 
distinguish them if you wish, but the reality is that all investment is 
speculation by your definition.

When we value WHS or MHI, we 'speculate' as to how much money they are likely 
to earn in the future.

We use ROE growth models (ie ROE times new retained earnings), and historic 
growth paterns etc, but this is no more than 'speculating' about how well 
management can reinvest the earnings.  Also, using historic growth is 
'speculating' that historic patterns will continue.

Nobody is forcing the consumer to buy, and the business has no control over the 
economy, competitive forces, key management personal staying etc etc.  These 
are also all 'speculative'

The bottom line is that all investment requires the punter to estimate, using 
certain assumptions, how much cash a company is going to generate for its 
shareholders.

You appear to believe the following assumptions are appropriate:
1/  That there is a significant risk that a large number of blue chip 
corporates will, after having reviewed their long-term intentions and signed in 
a bona fide way a long-term lease yielding market rates, try to screw CLI over 
by bailing out early, shifting premisses to rent another property at market 
rates, inconveniencing all their employees, and serverly tarnishing the 
company's credit rating and reputation.

2/  That there is a significant risk that none will role over, bailing out at 
first opportunity, whereby downtown high density real estate will become 
suddenly worthless without a tenant to be found.

3/  That there is a strong likelyhood that a strongly diversified, top-quality 
commerical property portfolio sselected by experts (not certain select 
underperforming segments) will depreciate substantially over a 15 year period 
despite its long history of reliabilty, continued inflation and economic 
growth.  (I say this because I have already demonstrated that even if CLI's 
property is worht can be leased in 15 years time at todays rates, you will 
still make a forture).


These sound more irrationally pessimistic than my 'irrationally exhuburant' 
comments detailed below.

When CLI select their property acquisitions, they adhere to the following 
criteria:
1)  High yields
2)  Long-term leases to blue-chip, high credit-rated tenants.
3)  Quality Targets with STRONG LONG-TERM CAPITAL GROWTH POTENTIAL
4)  Fixed minimal rental increases at the CPI inflation rate (the fact that all 
their tenants agree to these terms shows they are reasonable and they expect to 
adhere).

   
My opinion is that:  (the punters can decide what is more irrational)
1)  CLI's property is likely to appreciate at at least 2.3%pa over the 
long-term, given that the inflation rate is likely to be at about this level, 
and rentals will increase at a similar rate.  This is also well below historic 
averages.

2)  That tenants will agree to the lease terms they have signed themselves into 
and not try to screw CLI over, since they have entered them with a bona fide 
attitude, and have no intention to tarnish the company's reputation nor 
inconvenience employees.

3)  That a large number will role over, and those that don't will have 
replacement tenants found in 12 years time at at least TODAY's rates.



Am I promissing this will happen?  Absolutely not.  No investment comes without 
risk.  Everyone knows this.

However, IMO, the above assumptions are NOT THAT UNLIKELY.  I think most would 
agree they are the most likely sequence of events.

And what is the upside if they do transpire?  In 15-20 years CLI will be in a 
position to pay out more than today's entire market capitalisation every year 
in dividends.  (about 1.5x at todays capitalisation and annuity sales level.  
If their property is only worth today's valuations, then around 1x).

The upside is literially huge, and investors have not recognised this long-term 
upside.

Also:

QUTOE
Australian companies have a poor reputation when exporting their 
supposed expertise to the USA or Europe  (eg the Homeside mortgage 
Saga from NAB, billions in writedowns by Newscorp on broadcasting 
assets).
UNQUOTE


Newscorp actually has many other very successful operations outside Australia.  
Many other companies like Billabong, Globe, Flight Centre, who have a winning 
strategy and have stuck to their nitting (and not followed the acquisition 
trail) etc have done very well overseas.

  
QUOTE
Falls in real estate values are not unprecedented over long periods.  
Indeed CBD values in Wellington and Christchurch (and some in 
Auckland) for fifteen year old buildings are *right now* well below 
where they were 15 years ago.  That's what low inflation and not 
keeping up with technology does to your 'prime' real estate 
investment.

This is evidenced by the number of New Zealand listed property 
companies trading well below asset backing (e.g Newmarket, Trans 
Tasman).
UNQUOTE

Good points.  It would be interesting to see what yields the property was 
trading at 15 years ago.  This is also the exception not the rule but good 
point none the less.


CLI are not risk free.  But what investments are?


Dimebag


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