Forum Archive Index - October 2002

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

Hi Dimebag,

I think it was I who made the reference to the phrase 'coffee table 
 analysis' with reference to the talking up of Challenger 
International on forums verses its latest profit downgrade.  I wasn't 
referring to you specifically, and perhaps I was a little mischievous 
with that remark!   My cynicism comes from knowledge of various New 
Zealand property company collapses around 1990 and how revaluations 
apparently boosted profits before the big commercial property crash 
came and crashed these companies in a heap from which very few 
recovered..  

Let me say that I have now read all of the latest 'CLI' thread on 
'the other channel', and am now better informed as to how the 
discussion got to this stage.   I now realize that CLI were not 
writing down their property values, only the discount factor which is 
quite a different thing (not nearly as serious).   Anyway, it's the 
weekend so I'd like to give the sharechatters a few points to ponder 
on CLI:

1/ I am very impressed with your explanatory post Dimebag.   I sat 
down knowing only superficially about CLI, with my cup of Milo and 
a pencil and paper.  By the time I had sipped my mug empty I had a 
very good idea of how CLI work their profits.   Sharechatters, if you 
have a basic understanding of how discounted cash flows work, then 
it's well worth giving Dimebag's post a careful perusal: If you want 
to understand CLI!   

2/ I wish you and other CLI investors every success.

3/ I think, Dimebag, that you do not fully understand the concept of 
Warren Buffett type investing.   You have certainly adopted some of 
the principles of Buffett, but there seem to be others you have 
ignored like:

3a/ Buffett looks for business that generate lots of cash:

As 'Happy' on the other channel put it
--------
"CLI is simply not getting enough cash today to pay its future 
requirements. Its borrowing costs have doubled in the last 12 months 
and interest rates are at record lows and property prices record 
highs. Shareholder funds are only around $1 Bn and total borrowings 
$3.4 bn and this relationship will only get worse until property 
sales occur at the prices (currently at very high levels) CLI has 
predicted to go even higher."

"For each of the next three years CLI  has to keep borrowing around 
$200m pa to meet its requirements."
-------

CLI is chewing up cash, and it has high debt levels!   This alone 
would be enough to turn Warren right off this share.

3b/ Warren looks for businesses he can easily understand.  It is true 
that CLI has been going for 5 years, but it is also true that it is 
yet to roll over any of its annuities.   I'm not saying this business 
model is unworkable ( it may work very well ) but it is unproven.  

It is true that CLI may never have to sell their buildings in 
practice, but in 15 years time if new people taking out new annuities 
are to have confidence in CLI they will need to know that those 
buildings *could* be sold (which is the same thing) at the book 
price.  It also appears that the lengths of the property leases are 
less than the typical annuity they service, which means that at the 
end of the lease term the building could be vacant and have crashed 
in value.  

3c/ At one point you do a rate of return calculation based on the 
then current share price of $2.66 and the $8.00 residual property 
value, calculating an internal rate of return:

$2.66(1+i)^15=$8.00 => i= 7.61%

You should be aware that 7.61% is *way too low* for Warren.  He looks 
for around twice that rate of return.  Note that the rest of the CLI 
business is currently losing money so can't be used to boost this 
return.

3d/ Buffett looks for a business that has a strong market position, 
but it would seem that CLI is a minnow.   What is to stop one of the 
big UK insurers doing exactly what CLI is doing and snatching away 
any competitive advantage?

4/ But the main point is that you can't do a calculation like (3c) 
anyway because there may be all sorts of new shares being issued 
along the way.  There may be all sorts of share placements to shore 
up the company's position in the next 15 years that you haven't 
allowed for.


I think you are seeing this blue chip property that CLI is investing 
in as a clutch of golden eggs, while failing to fully appreciate the 
risk of them being carried in the paper basket that is CLI itself.

In summary, this is a high risk investment.  There is a potential 
for a great return if it comes off, but I wouldn't be betting my 
entire superannuation on it.   

SNOOPY



---------------------------------
Message sent by Snoopy 
e-mail  tennyson@caverock.net.nz
on Pegasus Mail version 2.55
----------------------------------
"Sometimes to see the wood from the trees, 
you have to cut down all the trees."



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