Jenny Ruth: Capital poser: To sell or not to sell

The sharemarket is clearly telling AMP that it will need to raise its price if it wants to get to 50 per cent of Capital Properties.

It is offering $1.42 a share but Capital Properties has consistently traded above that level since the bid was announced in mid-September.

But would AMP be acting in the best interests of its investors if it did raise its bid? (Although AMP controls the bidding vehicle, AMP Property Portfolio Investments, the money involved belongs to outside investors.) It would certainly be increasing its asset base and, therefore, its fee income.

And Deloitte's independent experts' report on the bid also didn't take into account any synergies AMP might get from controlling Capital Properties.

But the report and Capital Properties' history shows that valuation is more arcane art than exact science.

It values the shares between $1.48 and $1.73, including a premium for control and taking into account the potential for further developments.

Given that net tangible assets per share at September 30 are at the bottom of Deloitte's range, you might still be inclined to think AMP was trying to get Capital Properties on the cheap.

But net tangible assets have jumped remarkably in the last few years. In the year ended March 2003, the company booked $17.9 million in unrealised valuation gains, the following year it booked $20 million and, in 2005, that leapt to $79.1 million.

This year's gains should be at least as spectacular. After receiving AMP's takeover bid, Capital Properties directors immediately sought fresh valuations which bumped up the portfolio's value by a further $46.3 million. That bumped up net tangible assets per share from $1.29 at March 31 to the present $1.48.

Looking at how the value of individual buildings have moved is also somewhat eye stretching.

Bowen House was deemed worth $42 million in March 2004 and a year later $50.475 million. Six months after that it was valued at $55.3 million. That's a $13.3 million gain, or 31.7 per cent, in 18 months.

Or take the Charles Fergusson Tower and Annex. Its value has climbed from $18.5 million in March 2004 to $31.2 million in September 2005, a $12.7 million gain, or 68.6 per cent, in 18 months.

Evidently it isn't only the housing part of the property market that's been booming.

Deloitte said the latest increases were due to market rents, reduced market capitalisation rates and an increase in contract net income.

The assumed yield on Bowen House has come down from 7.89 per cent in March 2004 to just 6.2 per cent in September 2005 while the Charles Fergusson Tower has declined from 11.72 per cent to 6.65 per cent over the same period (a lower yield means a higher value).

As a reality check, Westpac is offering 6.4 per cent on deposits of a minimum of $10,000 for 100 days and 7 per cent for 10 months. For five years on a deposit of that size, it is offering 6 per cent.

Are the current yield assumptions on Capital Properties' portfolio reasonable?

Only one of Capital Properties' 21 properties hasn't moved up in value in the past 18 months. The National Bank Computer Centre, an industrial property, was assessed as being worth $1.93 million in March 2004 and was still deemed to be worth that in March 2005 and September 2005.

Capital Properties' history shows this valuation game isn't a one-way street. Back at the start of the decade, it reported successive years of property value declines.

In 2000, it reported $19.7 million in unrealised property valuation losses, the following year it lost a further $12.9 million and, in 2002, it lost another $6.7 million.

According to the Deloitte report, Capital Properties has the Government to thank for the recent growth in its asset values.

"The Wellington commercial property market has been driven to a large extent by the growth in demand by Government for office space. This has been particularly evident in the Thorndon area close to Parliament."

It estimates that Capital Properties' portfolio is about 8 per cent "under rented" or below current market rents and that should add $3.6 million in rent increases during the next round of rent reviews.

Other analysts are divided on the merits of AMP's bid, although most are advising against accepting it.

Jeremy Simpson, at Forsyth Barr, notes that the $1.73 top end of Deloitte's range implies a gross yield of only 5.8 per cent in the present year and "looks aggressive". The bottom end at $1.48 implies a 6.8 per cent gross yield in 2006, although that is expected to rise to 7.4 per cent in 2007. The average in the property sector is about 8 per cent for 2007, he says. He still thinks investors should hold out for a better price.

Key factors in arriving at a company valuation using Deloitte's method are what weighted average cost of capital one chooses: the lower that is, the higher the valuation and assumptions about rental growth.

Deloitte chose a WAAC of 7.8 per cent and rental growth of 3.25 per cent annually between 2006 and 2010.

ABN Amro analyst Mark Lister chose an 8.3 per cent WAAC and assumed annual rental growth between 2008 and 2020 would be 3 per cent and came up with a $1.44 valuation.

Macquarie Equities analyst Matthew Lambourne came up with a $1.43 valuation using a 7.9 per cent WAAC and rental growth between 2 per cent and 3 per cent.

Lister and Lambourne think investors should reject AMP's offer.

UBS analyst Stephen Freundlich, the only analyst to recommend selling to AMP's offer, said the property market was "arguably in a sweet spot at present" and that a rental growth rate closer to long-run inflation, perhaps 2.5 per cent, would have been more appropriate.

Blair Cooper, at Citigroup, also confesses to "serious misgivings" about Deloitte's valuation range, although he is recommending investors wait to see what AMP does next.

In particular, Cooper is surprised that the earnings forecasts Deloitte relied on were unchanged from those published by Capital Properties last December.

"This seems inconsistent with the two significant revaluations since, both of which indicated that increases in market rental assumptions were a key driver," Cooper says in his report.

The target company statement contains further indications of differing perceptions of value. Chief executive Chris Gudgeon must have thought $1.30 a share was a good price to sell at when he sold 19,000 shares on June 29.

Chairman Tony Frankham seems to have thought $1.30 a share was a good price to buy at when he bought 75,000 shares on June 7.

Another of life's little mysteries is why some people have already accepted AMP's offer so far ahead of the closing date, November 9, and when they could have sold on market at a higher price.

AMP's latest substantial shareholders notice shows it has increased its stake from 15.6 per cent to nearly 17 per cent. AMP said it had received acceptances from 582 shareholders for a total of 2,480,467 shares.

A key indicator of what Capital Properties is really worth will be what Kiwi Income Property Trust decides to do. Will it accept AMP's offer for its 19.2 per cent stake?

Given the controversy it endured over deciding to go ahead with developing its Sylvia Park shopping centre, which is expected to yield only 7 per cent on completion, it's hard to believe Kiwi will trump AMP's bid.

Who, what, where

Capital Properties New Zealand headquarters: Level 11, the Barclays Building, cnr Lambton Quay and Brandon St, Wellington.

Profile: Capital Properties owns 21 properties, 60.8 per cent of them in Wellington where it is the landlord for about 60 per cent of all government space occupied in Thorndon and about a quarter of all government space in Wellington. A further 32.8 per cent of the portfolio are buildings in Auckland and 6.4 per cent is in New Plymouth where it owns the Centre City retail centre.

Market capitalisation: $350.4 million at $1.45.

Latest results: The company reported a 172.3 per cent rise in annual net profit to $97.1 million of which $79.1 million was accounted for by unrealised property valuation gains. Before those gains, net profit rose 15 per cent to $18.1 million.

Management: Chief executive Chris Gudgeon, chief financial officer Jeremy King and Auckland manager Nick Cobham.

Major shareholders: Kiwi Income Property Trust with 19.2 per cent, AMP with 16.96 per cent and ING with 5.8 per cent.