Forum Archive Index - October 2002

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

As an avid proponent of CLI over the last 12 months, continually citing its 
fundamental merits, while its stock price has declined from $3.40 to around 
$2.15, I can't help but think many of the comments discussed in this thread 
refer to me.
 
For those who care to refer to my analysis as 'table-top', I ask you to refer 
to the below, which I recently posted on sharetrader.  Punters can decide for 
themselves.
 
For those who think I have been proven wrong for no reason other than the fall 
in the stock price should think again.  I base my investing methodology and 
principles on those of the master - Warren Buffett.  I always invest for the 
long-term; short-term share prices are of no relevence to me, except insofar as 
they allow me to buy great businesses at bargain prices.  
 
I believe CLI is a wealth machine, who does business and accounts for profits 
an a novel way (at least on the ASX).  I believe investors have had significant 
difficulty in pricing CLI appropriately, mostly due to the lack of available 
benchmarks, and poor understanding.  This was always a receipe for a bargain 
price, for those who care to dig deep into the company's accounts and do the 
sums, and to back their judgement in the face of the crowd and hold long-term, 
will do very well.
 
Its always easy to support the majority opinion.  Being a contrarian is much 
more difficult.  But I don't care what you nor the market thinks; its my money 
and I will compound it how and as fast as I want!  
 
Here is the exerpt:
 
Regards
Dimebag
 
 
Ok guys, I think I've finally worked out exactly what they do. 

Studying the graph in the MD's presentation from a few days back, it appears 
Happy is right in that CLI do anticipate some growth in the property portfolio 
over time.

They anticipate 'nominal' (not real happy) growth in the capital value of the 
portfolio of 2.3%pa over the long-haul.

This rate roughly corresponds to the likely and anticipated long-term rate of 
inflation. Although booking future capital growth is somewhat controversial, it 
is mitigated by the fact that: 
1/ The assumption is very conservative, corresponding only to the rate of 
inflation. Over time, property valuations have significantly outperformed 
inflation and it is highly likely they will continue to do so in the future. 
2/ CLI's rental agreements ensure rents increase, at a minimum, at the rate of 
inflation. So the underlying cash-flows will grow at the at least the same rate 
over the long-haul. 
3/ The risks are incorporated by using a discount rate of 11%pa which is 
substantially above the risk free rate.

Happy however, is still misconstruing the cashflow component. CLI ensure that 
ALL annuity obligations are met by the underlying rentals.

I am now certain this is what they do:

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.

CLI then invest the $200,000 into commercial real estate. The criteria for 
purchase is long-term leases (roughly corresponding to their annuity-book 
duration), to tenants with a sufficiently high credit rating. Lease agreements 
ensure leases will rise annually at the rate of inflation, and cannot fall, and 
ratchet clauses exist to ensure reviewal with reference to market rates.

Cashflow from property yielding 8.5% = $17,000pa 
Cashflow to annuitant = $10,000pa 
Cashflow to banks (7%pa interest) = $ 7,000pa

Net Cash Flow = $ 0pa


Note: 
All cash-flows are legally binding. Exchange rate and interest rates are fully 
hedged at the date of writing the contract. 
Future interest rate / property yield (on new properties) changes will not 
alter this mix. The yield on the annuity contract is simply changed (lowered if 
necessary) to ensure cashflow obligations remain neutral.

Conclusion: 
Cash flow is not a problem

How do they then account for their profits. Anwser = like a zero-coupon bond.

Assuming their 2.3%pa capital growth, in 15 years time (continuing the above 
example), the $200,000 property will be worth $281,297. Deducting residual bank 
debt of $100,000, we get property of worth $181,297 reverting to CLI 
stock-holders with the annuity obligation fully expired.

Discounting this amount back to present value at 11%pa compound, we get a value 
today of $181,297 / (1.11) to the power of 15 = $37,892.

The implicit discount is then released to profit over the term of the annuity:

Thus Profits and Carrying Value over the 15 years would be thus: 
0 $37,892 $ 37,892 
1 $ 4,168 $ 42,060 
2 $ 4,627 $ 46,687 
3 $ 5,136 $ 51,823 
4 $ 5,701 $ 57,524 
5 $ 6,328 $ 63,852 
6 $ 7,024 $ 70,876 
7 $ 7,796 $ 78,672 
8 $ 8,654 $ 87,326 
9 $ 9,606 $ 96,932 
10 $10,663 $107,595 
11 $11,835 $119,430 
12 $13,137 $132,567 
13 $14,582 $147,149 
14 $16,186 $163,335 
15 $17,967 $181,302

The difference between $181,302 and $181,297 above is due to rounding errors.

Observations: 
The risk associated with assuming capital growth of 2.3%pa is taken into 
account by discounting at 11%pa with is well above the risk-free rate.

For those who dislike the process of accounting for future capital growth 
however, the component can be adjusted out. This can be done by multipling 
CLI's profit figures by 0.5515.

If CLI discounted only a $100,000 residual value at 11%pa, reported profits 
each year would be exactly 0.5515 of the amounts calculated above.

But 11%pa is too high without capital growth risk. For an adjusted 9%, multiply 
by 0.73.

So even if we use 0.5515 of CLI's profit figure, we still get annual profits of 
$154, x 0.5515 = $85m, or 29.5cps.

So at $2.15 you still get the company for 7.3x earnings, with earnings 
representing a purchase of a zero-coupon bond yielding 11%pa with little risk, 
and assuming ZERO property value growth, excluding rental increase cashflow 
(which will grow easily to in excess of $60m pa after tax by 2010), and returns 
from other divisions.

Excluding the extras cited, the 29.5cps will grow at 11%pa if their is no 
growth in new business. However, last year CLI grew new business by 29.5% in a 
market whos volume fell 3%.

CLI is a growth business with huge blue-sky, especially in the UK.

At these valuation how can you lose?

Dimebag



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