Forum Archive Index - October 2002

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

Hi Dimebag,

Dimebag wrote: 

>Snoopy wrote: 
>
>>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. Shareholder funds 
>>are only around $1 Bn and total borrowings $3.4 bn."
>> 
>>"For each of the next three years CLI  " -------
> 
>>CLI is chewing up cash, and it has high debt levels!   This alone
>>would be enough to turn Warren right off this share."
>
>
>
>Buffett's most fundamental investment principle is that successful
>investment is about determining a company's intrinsic business
>value, and buying it cheaper.
> 
>He defines intrinsic value as the cash a company will generate
>between now and judgement day, discounted back to present value.
>
>



Yes but the company has to be strong enough to survive to the day of 
reckoning for this to work.  'Happy' presents a picture  of a 
company currently borrowing $3.4 for every dollar it has just to stay 
in business.  What I would like to know is how much of this 
$3.4billion CLI debt is borrowed money that has gone into buying 
commercial property as part of an insurance contract?  (This debt is 
paid from the rental income on the buildings and should be 
disregarded, as I see it, in the overall debt picture of the 
company).

And how much of the 3.4billion debt is related to the running of the 
corporate umbrella that is CLI?

I also want to know what the $200m pa that Happy asserts is needed 
for 'ongoing development of the business' is needed for.  If Happy is 
correct this means shareholders funds will be totally exhausted 
within 5 years.  Reinsurance premiums have soared since September 
11th.  No shareholders funds means, that you as a shareholder 
will have nothing.



> 
>Now the fact that the company does not generate any free cash flow
>for many years means nothing.  
>



....provided they can pay the day to day bills in the meantime. 
 
A critical part of the CLI business plan seems to be the raising of 
extra capital by agents for CLI paying up to have their options 
converted to shares.  If the share price doesn't rise there is no 
incentive for them to do this, and CLI becomes starved of capital.


>
>Where  CLI is unique is that they don't need cash to grow.
>


Their agents don't need to be paid?


>
>Writing annuity  contracts does not require an upfront 
>investment.  Yet they are  adding present value - 
>enormous cash will flow in time. 
>
>


"Don't worry about your wages workers."  "You will get a cheque in 
the mail 'in time'"


>
> 
>(Its also useful to note that CLI had approximately $1.50 per share
>in operating cash flow in the 2002 year, 
>
>

This is irrelevant as, if I understand the CLI business model 
correctly, all of this money is now tied up in insurance contracts 
and has gone into specific property purchases.  This cash flow is not 
free and cannot be used to service the CLI business operating costs 
(other than bank mortgage interest due on an associated building) 
until the insurance contract expires fifteen years down the track.

>
>and cash reserves grew 
>Cash on hand at balance day was in excess of $200m.) 
> 
>

The fact that cash on hand has grown is of no help if the bank 
debt is growing faster than the cash reserves.

>
> 
>CLI ARE NOT chewing up any cash.  
>
>

There is a clear conflict between this statement, and the statement 
that Happy makes about having to keep borrowing around $200m pa to 
meet on-going requirements.

>
>
>They should be cash flow neutral on an operating basis.  
>

I understand they are cash neutral on a 'writing annuity' basis, 
(matching rental streams with annuity and interest), but 
this was NOT the question I asked.

> 
> 
>All cashflows (rents etc) are legal fixed.  They can't change
>(except rents can rise).  
>
>

And a big business tenant could create a shelf company to rent out 
their business premises.   Then if rents get too high they could just 
wind up the shelf company completely, cutting off the cashflow to 
CLI, create another shelf company and rent another building at lower 
rent from someone else.

>
>CLI's property is top quality - 
>there will always be a ready market for it; most of the
>tenants will roll over; those that don't will have a replacement
>quickly found.  Their rental cashflows rise yearly...
>



This is all speculation.  You cannot guarantee a company will remain 
'top quality' with almost no reinvestment for 15 years.  You can't 
guarantee there will always be a ready market for it.  Tenants do not 
always roll over and good buildings can remain vacant for years and 
years....



> 
>>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.
> 
> 
>This is the return holders will get out of the EXISTING asset base. 
>ie if CLI stopped doing business today.  CLI are adding new assets
>to this base yearly.  
>
>

...and adding new shares (options) yearly.

>
>
>Their going concern value is enormous and overall returns 
>will far exeed 7.61%.
> 
> 


Only if the value of new assets is not diluted on a per share basis 
by an equivalent amount of new shares.  Isn't issuing new shares 
(options) for new annuity business a critical part of the CLI 
business plan?


> 
>
>CLI have a 33% market share in Australia.  They have gone from
>nothing to market leading in just 4 years because they have a
>superior business model that gives them a very strong competitive
>advantage.  
>


What do you mean 'market share'?   Do you mean 'new business written 
this year' or 'total funds under management'?   If the latter I find 
it difficult to believe that they have leap-frogged all the banks and 
AMP in just 4 short years so that CLI now dominate all funds 
managed across all asset classes.


>
>They can offer the highest annuity return with the least risk.
>Other life business back their obligations with equities and
>fixed interest; much riskier with reliance on asset sales to meet
>obligations.  Returns are lower.
>
>


CLI are thriving in relative terms because overseas equities have 
done poorly recently.  However, over a fifteen year period equities 
have always out-performed property.  Your bald statement that 'equity 
returns are lower' will not stack up over 15 years.  By the time CLI 
need to roll over their annuities onto someone else they will likely 
be at a competitive disadvantage to alternative annuity packages 
invested in shares


>
> 
>CLI was also first to market, now has a strong brand, is well
>managed, innovative, and will remain competitively superior.
>


Stating this does not make it so.  How are they going to fight off 
the banks, AMPs and AXAs 'me too' products? 


SNOOPY


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