Manager prospers as value falls

By BRIAN GAYNOR

The takeover offer for Kiwi Development Trust is a reminder of the dismal performance of the listed property sector over the past few years.

It also highlights the hopelessly optimistic forecasts of property experts and that the owners of management companies continue to prosper, even when investors lose money.

The Development Trust's story begins with the establishment of Kiwi Income Property Trust by Richard Didsbury and Ross Green in 1992. A year later the Property Trust issued 45 million units to the public at $1.03 each and was listed on the Stock Exchange.

The Property Trust is run by a management company that was originally 50/50 owned by Mr Didsbury and Mr Green and by the Toronto based Friedberg Mercantile Group. In April 1998 the original owners sold a 50 per cent interest to the Australian group Lend Lease, which is entitled to acquire 100 per cent from 1 April this year.

The original annual management fee was 0.75 per cent of the Property Trust's gross assets with a performance element equal to 20 per cent of any increase in asset values. The performance fee was abolished three years ago and the flat fee increased from 0.75 per cent to 0.85 per cent of gross assets.

Unit holders will be asked to approve the following fee structure at an upcoming extraordinary general meeting:

0.85 per cent on gross assets up to $750 million.

0.65 per cent on gross assets in excess of $750 million.

The management fee structure, which is totally independent of the trust's sharemarket performance, has been extremely lucrative for Mr Didsbury, Mr Green and the other shareholders. Since formation the Property Trust has made payments of $33 million to the management company and the original shareholders have been able to sell 50 per cent of their valuable shareholding for an undisclosed sum.

In late 1997 Kiwi Development Trust was established by the Property Trust to develop and own the Royal & SunAlliance Centre in Shortland St, Auckland. An initial public offering of 48 million units was made at $3.00 per share. The payments were staggered over a 30-month period as follows:

75c in December 1997.

$1.05 in June 1999.

$1.20 in May 2000.

The Property Trust received 2.4 million units in return for a proportion of the land on which the new centre has been built. The existing Property Trust unit holders were offered 20.4 million units on a one-for-five basis and the remaining units were promoted to institutions and the general public.

The Property Trust's management company was also appointed to run the Development Trust with the following fee structure:

An annual fee of 0.65 per cent based on Development Trust's gross assets, plus

an annual fee of 0.85 per cent based on the Development Trust's development assets.

The Development Trust's prospectus was extremely optimistic. Property consultant Richard Ellis presented a glowing report on the Auckland commercial property market, predicting a value of $247 million on the Royal & SunAlliance Centre when completed in December 2000. This represented a net asset backing of $4.08 for every Development Trust unit, compared with the subscription price of $3.00.

The Property Trust was granted an option to purchase the Development Trust for cash on completion of the new building. This suggested (although it did not promise) that Development Trust unit holders would get $4.08 cash per unit in 2001.

Investors were not fooled by the optimistic predictions and the Property Trust's unrealistic purchase option. Only 14 per cent of Property Trust's unit holders took up their entitlements and 11.5 million units, or 24 per cent of the issue, were left with underwriters. The shortfall was placed at 55c (for each 75c partly paid unit) in January 1998 with Property Trust acquiring 5.2 million units to bring its Development Trust shareholding to 17 per cent.

The purchase of Development Trust units by the Property Trust has probably benefited the management company through double-dipping, as it now receives fees directly from the Development Trust and indirectly through the Property Trust's shareholding in the Development Trust.

By August 1999 the Property Trust had increased its Development Trust shareholding to 34.2 per cent. It recently raised its beneficial interest to 39.2 per cent.

Kiwi Development Trust has been on a steady downward spiral since listing. Although the Royal & SunAlliance Centre was finished ahead of schedule, the trust has never traded near its issue price.

Leasing conditions have been difficult and Richard Ellis has steadily reduced its estimated value of the building from $247 million to just $202 million in September 2000.

On October 3 last, shortly after the completion of the Royal & SunAlliance Centre, Ross Green announced that the Property Trust would not exercise its option to purchase the Development Trust, although it continued to have an interest in acquiring the building.

Just before Christmas the Property Trust announced it would make an offer for the Development Trust and earlier this week it confirmed that it would offer three Property Trust units for every Development Trust unit. At yesterday's Property Trust closing price of 89c, this values the script offer at $2.67 per Development Trust unit, compared with Richard Ellis' original estimate of $4.08.

Development Trust unit holders will receive their first and only dividend payment, an estimated 5c per unit after tax, just before the takeover is completed.

In its independent appraisal report PricewaterhouseCoopers concludes that the offer is fair to Development Trust unit holders, but makes numerous references to the restrictive influences of the property trust and the management company on the Development Trust.

Not only was the Development Trust not allowed to sell the Royal & SunAlliance Centre until the Property Trust's option expired, but according to PricewaterhouseCoopers: "We believe that the prospects of a competing bidder emerging for the units of the Development Trust other than those owned by Property Trust is unlikely given the Property Trust's existing ownership interest of almost 40 per cent, and the entrenched position of the Development Trust's incumbent manager."

The more cynical unit holders are claiming that the takeover is being made to suit the management company because now that the development is completed, the Development Trust's total annual management fee falls from 1.5 to 0.65 per cent, whereas the Property Trust's management fee is 0.85 per cent.

Development Trust unit holders have little option but to accept the offer, but PricewaterhouseCoopers warns that the management company structure will have a negative influence on their Property Trust investment.

The independent appraiser believes, "the Property Trust is likely to continue trading at a discount to its underlying net tangible asset backing, due to factors including the existence of management fees and other corporate overheads which reduce the net income available for distribution to investors [and] the entrenched nature of management arrangements that effectively preclude hostile takeover activity."

This last reference is to an additional fee of 0.85 per cent to be paid to the management company if its contract is terminated.

Development Trust unit holders can also feel aggrieved because PricewaterhouseCoopers net asset backing valuation of $2.55 per unit is calculated on a different basis than the net asset forecast of $4.08 in the original prospectus. Unlike the 1997 forecast PricewaterhouseCoopers has deducted $21.4 million from the value of the Royal & SunAlliance Centre representing capitalised management fees and overhead costs. This represents 45c per unit and, if it were not deducted, the Development Trust's net asset backing would increase from $2.55 to $3.00.

It appears that investors are presented with a full and optimistic net asset forecast when being sold units but a more conservative methodology is adopted when these units are being bought back.

Management company structures can probably be justified in a bullish market, but they are hopelessly skewed against investors in a depressed environment. Richard Didsbury, Ross Green and their foreign partners have generated nearly $37 million in fees from Kiwi Income Property Trust and Kiwi Development Trust while investors, particularly in the Development Trust, have achieved poor returns.

The situation is unlikely to improve for Development Trust unit holders when they accept the takeover because of the entrenched nature of Property Trust's management contract.

* Disclosure of interest; nil.

* bgaynor@xtra.co.nz