Forum Archive Index - October 2002

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

Hi Dimbag,
 
> 
>I absolutely detest to you refering to my positive take on CLI as
>'irrational exhuberance'.  Exhuberance maybe, but irrational?
>

'Irrational exhuberance' was a phrase coined a few years ago by Alan 
Greenspan, and was made in the context of US stock market investors 
who could only see the NASDAQ and DOW going up forever.  In their 
eyes there was no downside to the market.

Greenspan did not wish to imply that these peoples were fools.  Many 
of them were top analysts who were happy to build a rational case to 
buy a share.   The irrational bit was that they saw no downside and 
ignored all downside risks.

It is in this way that my 'irrational exhuberance' comment was 
directed.  I am not casting aspertions on your analytical skills.  
Indeed you are probably in the top 10% of investors as regards those.
The irrational bit is that you don't seem to be able to acknowledge 
any downside risk.  When I make an investment, I want to see an 
analysis of the upside risks AND the downside risks

> 
>I could just as easily say you are being irrationally
>pessimistic.
> 

You noticed huh?  You're right: I am.  I'm trying to add some balance 
to your 'irrational exhuberance'.

>
> 
>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.
> 
>

If the total annuity is amortised at 5.8% per year, this means it 
will take 100/5.8 = 17.2 years to amortize on a straight line basis.  
Not the 15 years you claim.

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

Dimebag, I know you are smart enough to know the difference between 
an amortisation of an annuity, and a one shot 'this is how it is 
today' balance sheet picture of a company.  The figures you don't 
understand are based on the original example which was your first 
post on the specifics of how the CLI annuity scheme works.  I repeat 
this below:

-------------------

(Dimebag's) Example:

CLI write a $100,000 annuity contract, entitling the
annuitant to and income stream of $10,000 per annum for
15 years.

CLI then borrow $100,000 from the banks.

--------------------

We can rewrite this example in tabular form:

----------------------------------------------
TABLE1
Annuity Purchase Money, Consequent Bank Borrowing, Income Stream
$100,000, $100,000,  $10,000 x 15= $150,000
----------------------------------------------

Now Dimebag, you have told us that the *total* annuity contract 
liability payments for CLI come to $1.3b over a fifteen year period.

----------------------------------------------
TABLE2
Annuity Purchase Money, Consequent Bank Borrowing, Income Stream
'x' , 'x' ,  $1,300,000,000
-----------------------------------------------

We can use the similarity of TABLE1 and TABLE2 to solve for 'x'

'x' comes out as $866,000,000

> 
> 
>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 patterns 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.
>
>

Yes but the only reason these ROE growth models can have any hope of 
working over say ten years is because both WHS and MHI are very 
special businesses that exhibit many of the characteristics of 
consumer monopolies.   Office space is a commodity.

>
>
>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'
> 
>

Forcing to buy: no.  But there is no doubt that the consumer wants 
to buy from both MHI and WHS.  These businesses are barely affected 
by the economy, or competitive chains and do not have a problem with 
staff turnover.  It may be speculative that this will continue, in 
the sense that nothing is certain.  However, I would argue that 
because management has proven its ability to overcome these adverse 
factors it is *most likely* that they will continue to be able to do 
so. I put it to you that it is very unlikely that they will be 
derailed by the external factors you describe.

OTOH, CLI cannot control the economy and it is a 'price taker' for 
rents.

>
> 
>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.
>
>

Only one tenant company need move out for the market to question the 
contracts on all the CLI leases.  Even if all the othe rleases are 
rock solid.

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

Again only one tenant needs to do this, for the CLI annuity model to 
come under severe scrutiny, and the CLI share price to come under 
pressure.

> 
> 
>QUOTE
>Falls in real estate values are not unprecedented over long periods.
>
>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.
> 
> 

Newmarket used to trade at around $1 because thay had rent guarantees 
(sounds much like CLI today actually) on their properties for a few 
years.  When the rent guarantee unwound, and rents were reset at 
market rates then the properties under management plunged in value.

SNOOPY



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