Sky City's buyback makes sense

By Peter V O'Brien

Friday 6th December 2002

Sky City Entertainment Group's announcement last month that it would pay a special dividend of 20c a share and its intention to undertake a share buyback programme had a succinct, non-jargon explanation of share buyback desirability.

The matter of buybacks was discussed in The National Business Review on April 5 in the broader context of efficient corporate financial management allowed in the Companies Act 1993.

Sky City managing director Evan Davies said the company's on-market share buyback programme was expected to be in the $40-60 million range. Details would be provided with the release of the group's interim result in late February. The "final scope" of the proposed buyback would be dependent on market conditions then.

Mr Davies said the special dividend and buyback initiatives reflected on the company's focus on efficient capital management of available funds.

"Sky City's strong earnings pattern and its current level of reserves means that we are well placed to make a return of capital or our shareholders."

He thereby acknowledged two of the three key factors necessary for a prudent decision to have a share buyback, whether on-market or through a pro rata capital cancellation. The third is substantial operating cashflow.

Sky City's operating surplus before unusual items and tax was $129.73 million in the year ended June 30. Unusual items related to Force Corporation's operation in Argentina and a write-off of goodwill in the investment in that company took $39.15 million before and after tax from Sky City's reported earnings. They resulted in net profit of $57.15 million after tax and minorities, 16.3% lower than the previous year's $68.31 million.

Unusual write-downs or write-offs have no effect on operating, investing or financing cashflows. They are book entries required either in the interests of common sense financial management and/or accounting standards. Sky City's operating cashflows were $122.73 million in the year ended June 30.

That was more than sufficient to carry negative cashflows of $35.35 million from investing activities, the main item being $51.2 million expenditure on property, plant and equipment. There was an offset of $21.88 million from proceeds from sale of equity investments, although another $9.42 million was paid for equity investment purchases.

Operating cashflow was also sufficient to cover $79.9 million of negative cashflows from financing activities. The company repaid $110.0 million of borrowings and gave shareholders dividends worth $49.92 million while receiving $54.3 million in new borrowings, apparently through balance sheet reorganisation.

The various cash movements left Sky City with a net increase of $7.48 million in cash held before an exchange rate adjustment of $1 million related to the Force Corporation investment. End-year cash was $48.08 million, compared with $41.6 million in 2001. Those facts should have more significance for investors than the often artificial accounting definitions of profit.

A company can report regular profits under accounting standards while heading for the receivers in terms of cashflow, although the latter will eventually the former into deficits. Sky City's proprietorship ratio (shareholders equity to total assets) was 27.72% before inclusion of outside interests in subsidiaries and 28.33% after inclusion.

The figures may seem low for a listed company but Sky City is a cash operation and has elements in common with an investment group where cash movements are the operation's base.

There were different considerations in Ports of Auckland's $132 million share buyback and Auckland International Airport's $214 million capital repayment. Those companies are effective utilities.

Their fee-earning infrastructure is in place. Maintenance costs absorb funds but, if well-managed, they should be able to carry the expenses through cashflow and profit, again emphasising the two are not the same.

A key investor consideration in a buyback/capital repayment was mentioned in Auckland Airport chairman Wayne Boyd's annual meeting address on November 18. He said shareholders would recall the repayment proposal was the subject of scepticism at a special meeting in September.

"It was therefore pleasing to note, as envisaged, the value of company's shares adjusted upward immediately following the repayment and in fact shareholders, in terms of value, were better off following the repayment."

That situation is a feature of capital reductions, particularly when made on a pro rata, one-off basis. Shareholders get a payment, their remaining shares tend to have a price increase and the capital redemption can be invested elsewhere.

Investing on the basis of potential on-market buybacks or one-off capital repayments requires careful analysis of cashflows related to capital requirements. Utilities, or semi-utilities, are the best bet.

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