Forum Archive Index - October 1999

["Brent Wheeler" <brentw@bwcl.co.nz>]

I have been meaning to try & write a bit on leases for a while and people
have been very forgiving of various Email problems we have had (I am
gratefull for that) , so here goes.

You may recall some questions people had about leases and TRANZ Rail and
what it owned.  Some points:

*    ownership may be 9/10ths of the law but it is not always 9/10ths of the
profits. Leasing can be great sense for the company but hard to understand
for the investor.
*    to get an idea of what leasing means we have to remember the issue is
to earn a return on capital (risk adjusted).  We are indifferent to
ownership arrangements assuming a relatively competitive market and
transaction costs which (either way, owning or leasing) are not prohibitive.
*     we can "capitalise the lease" of assets back into the balance sheet by
capitalising lease payments, ie divide the lease payments by the cost of
capital of the firm (ideally, the segment of the firm but the firm's cost of
capital will do as a proxy). So for TRANZ Rail that might (roughly)  mean
dividing the lease payments by 0.14 to get a lump sum.
*    to get a "balance" in the sheet we have to say this is an asset
financed either by debt or equity.  Lets use equity since it simplifies tax
issues and interest complications.  It is a simplification tho'.
*    so we now have a balance sheet which reflects the assets upon which a
return must be made.
*    final adjustment is to drop the lease payments out of the P&L since we
are now "pretending" we have an asset in the balance sheet without an
operational commitment to paying a lease - so do that.

Finally - do we now have a risk adjusted return which meets our cost of
capital???  That is the big question.  And of course, how does it compare to
other options available to us.

There are numerous other twists and curves to all of this and it may sound a
bit complex.  But it really is not and if there are big opportunities
(liabilities) they will stick out even by the super crude "Brent" method.

For more read the Stern Stewart works, especially "The Quest for Value" by
Bennett Stewart.

If confused, flag it and buy another security!

Maybe this helps.

B


Dr Brent Wheeler
Director
Brent Wheeler & Co. Limited
AUCKLAND


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