Saturday, March 04, 2006

Brian Gaynor: Mysterious art of number crunching

The controversial Calan Healthcare Properties Trust independent appraisal report has reignited debate over listed property valuations.

Why is there so much controversy on the issue and what is the most appropriate valuation method?

As the accompanying box demonstrates, there are four widely recognised valuation methods: Net tangible assets (NTA), discounted cashflow (DCF), capitalisation of earnings and dividend yields.

The NTA method is the most widely used in Australia.

When Trans Tasman Properties made a takeover offer for Australian Growth Properties in 2003, Grant Samuel was appointed the independent adviser. It assessed the different valuation methods and concluded that the NTA method was the most appropriate.

Listed Australian office trusts were trading at a 3 per cent premium to NTA at the time, and 2002 and 2003 takeover offers had an average NTA premium of 14 per cent.

Grant Samuel concluded that Trans Tasman Properties' 85Ac a share offer was not fair because the target company had an NTA of A$1.01.

When Macquarie Office Management made a takeover offer for Principal America Office Trust in 2004, Deloitte was appointed independent adviser. It determined NTA was the most appropriate method because the trust was an asset-holding business.

The Deloitte report concluded that the four Australian-listed trusts with US assets were trading at a 20.1 per cent premium to NTA while the five Australian-orientated office trusts were at a 3.1 per cent premium to NTA.

The Deloitte analysis showed that five listed Australian trusts were successfully acquired in 2003 at NTA premiums ranging from just 2.2 per cent to 27 per cent. The average was 15.4 per cent.

Deloitte determined that the fair value for Principal America Office Trust was a 10 per cent to 20 per cent premium to NTA. As Macquarie was offering a 25.5 per cent premium to NTA, the independent adviser concluded the offer was fair.

Deloitte also prepared the valuation report when Multiplex bid for Ronin Property Group in 2004 (this is how Multiplex ended up with a 27.7 per cent AMP NZ Office Trust stake, a large proportion of which was sold this week). NTA was used to determine whether Ronin's offer was fair.

Deloitte concluded that the control premium over NTA for Ronin should be in the 10 to 15 per cent range (the shares were trading at a 6 per cent premium to NTA before the offer).

As the consideration being offered, which included a scrip component, represented 15 to 19 per cent above Ronin's NTA, the offer was considered to be fair by Deloitte.

The conclusion from these and other independent appraisal reports in Australia is that the NTA method is the best way to assess the value of listed property entities because they are asset-based organisations.

When Kiwi Income Properties Trust made an offer for Kiwi Development Trust in 2001, the PricewaterhouseCoopers' independent appraisal report valued the target company by the NTA method. This was cross-checked by the DCF process.

The independent adviser determined that the target trust's NTA was between $2.44 and $2.65 a unit but the DCF valuation was only $1.72 to $2.31 a unit. This reinforced PricewaterhouseCoopers' view that NTA was the best way to value Kiwi Development Trust.

PWC considered the offer to be fair as the NTA of the target trust was between $2.44 and $2.65 a unit and the bid, which was a scrip offer, was worth between $2.60 and $2.75 a unit.

When AMP made a $1.42 a share offer for Capital Properties last year, raised to $1.48 a share, Deloitte was appointed as independent adviser.

Deloitte decided that DCF was the most appropriate valuation method with NTA used as a cross-check.

It is difficult to know why Deloitte used the DCF method as most investors, whether in residential, commercial, retail or industrial property, put a greater emphasis on capital values over income.

Deloitte estimated that the DCF valuation of Capital Properties was between $1.48 and $1.73 a share and the NTA value at $1.44. The independent adviser noted that the $1.44 NTA valuation did not recognise the potential for growth or include a premium for control.

As most successful listed NZ property vehicles are trading in excess of NTA, it is reasonable to assume that Capital Properties' shares were worth at least $1.58 when a control premium is included. This is 10 per cent above Deloitte's NTA valuation.

Shareholders didn't agree with this assessment, and AMP reached its 90 per cent target this week and is moving to compulsory acquisition.

Ferrier Hodgson, the independent adviser to the Calan Healthcare Properties Trust offer, used the DCF method with NTA as a backup.

Its DCF valuation of Calan is $1.41 to $1.55 a unit and $1.26 on a NTA basis, excluding any premium for control. These compare with the estimated cash equivalent value of ING's offer of $1.21 per Calan unit.

Ferrier Hodgson noted the average NTA premium of the listed property sector, excluding Capital Properties, was 9.4 per cent at February 14.

The Calan independent appraisal is disappointing because it over-emphasised the DCF method and offers little new information. One of its biggest flaws is the absence of analysis of the healthcare property market or comparisons with property values in this sector in other parts of the world.

Ferrier Hodgson prepared the June 2005 Oyster Bay Marlborough Vineyards appraisal report that was subject to a Takeovers Panel inquiry.

The Oyster Bay report used DCF, which was between $2.39 and $3.15 a share, as the primary valuation and NTA, which came to $3.26, as the back- up (the latter was effectively a DCF valuation because it was based on an income-based valuation by property valuers Logan Stone).

In short, Delegat's had to make a new offer because the panel decided that the Ferrier Hodgson report did not put enough emphasis on the market value of the land (NTA).

The second independent adviser's report, which was prepared by Grant Samuel, used the capitalisation of earnings method because Oyster Bay's land is encumbered. This method produced a valuation of between $3.96 and $4.67 an Oyster Bay share whereas the backup DCF valuation was $4.09.

These different valuations methods are confusing and subjective. The DCF method is particularly subjective because the independent adviser has almost complete control over the valuation process, whereas property experts have a major input into NTA.

This input is important because property valuers should know a great deal more about this asset class than general corporate advisers.

With this in mind the most appropriate base valuation for Calan Healthcare Properties Trust is NTA, which is $1.26 a unit. Unfortunately, the Ferrier Hodgson report doesn't give us any indication whether the premium for control should be 10, 15 or 20 per cent above this figure.

Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management.


Property valuation methods

* Net tangible assets (NTA) method
* This method estimates the value of an entity based on the realisable value of its net assets.
* Discounted cashflow (DCF) method
* The value is estimated by discounting an entity's future cashflows to a net present value.
* Capitalisation of earnings method
* Earnings or cashflow are capitalised at a multiple that reflects the risk and stability of a business.
* Dividend yield method
* The value is estimated by comparing the dividend yield to other listed property entities.

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