Deep Value Or Value Trap by Sanjay Bakshi, via Slide Share
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Charlie Munger: Invert And Use “Disconfirming Evidence”
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“It always seemed, and still seems, ridiculously simple to say that if one can acquire a diversified group of common stocks at a price less than the applicable net current assets alone — after deducting all prior claims, and counting as zero the ?xed and other assets —the results should be quite satisfactory.” – Graham
Value Investors Look at all Spinoffs
Case on Gesco
Part of the ?xed assets are income producing
- Earning stream is of very high quality
- Growing stream
- Highly Predictable
- How to value this income stream?
Part of ?xed assets are not producing any income.
- Not NPAs
- They are valuable, but idle assets.
Capital WIP is an ongoing project which will complete within an year or so.
- At the moment it is not producing any income.
Fixed assets are traded in a market of their own and their value can be independently verified.
Nehru Place Property
Total built-up area: 51,810.07 square feet. The building is let out to various multinational companies like Microsoft, Cisco, Heinz, and Royal & SunAlliance. The property managed by Gesco Corp. The tenants pay Gesco Corp. a composite sum which includes rent and maintenance charges.
Building has been constructed to international quality standards, and has been rated as one of the best commercial buildings in New Delhi by an international property consulting ?rm and has been rated as class “A”.
Bhikaji Cama Place Property
Total built-up area: 54,973.35 square feet.Most of the ?oors are let out to Erricson at Rs 150 per square feet per month.
The lease deed also provided for an escalation of 25% on the rent on every extension of three years.
The property is managed by Knight Frank, a company in which Gesco Corp. had a 16% stake.
This building too has been ranked as one of the best commercial complexes in Delhi by Richard Ellis.
Valuation of two properties
We now knew the rents being paid by tenants of both the Delhi properties to Gesco.
In case of the Bhikaji Cama Place property, this was Rs 125 per square feet per month, and in case of Nehru Place property, this was Rs 95 per square feet per month.
The annual rental revenue from the Bhikaji Cama Place property came to Rs 8.24 cr.
The annual rental revenue from Nehru Place property came to Rs 5.90 cr. The total rental income came to Rs 14.14 cr.
This tallies with the income statement of the company according to which the total income from operation of commercial complexes was Rs 14.09 cr. and the business center revenues were Rs 0.68 cr.)
We were have also informed through market sources, that both the properties were fullyleased and the typical lease term is either 6+3years or 3+3 years, with escalation clauses of 25% after every three years which translates into an annual increase in rents of 7.8%.
If we ignore the escalation clauses built into the lease agreements for the above two properties, and further assume that the quality of tenants will remain unchanged, then the annual rental income of Rupees 14.14 cr from these properties would resemble coupon payments on a high-grade, perpetual corporate bond.
At that time, such a bond would produce a yield-to-maturity of 12% per annum (implying a multiple of 8.33).
Using this capitalization factor of 8.33, which we felt was extremely conservative, given the location and the quality of these properties, the value of these properties came to Rs 117.78 cr. Notice, however, that this valuation ignores:
- The increase in value due to rent escalation clauses. If we assume a perpetual growth of only 3% p.a. intents, then the value of these two properties becomes Rs 157 cr.
The reduction in value due to a clause in agreement with DDA which requires that 50% of unearned increase is to be surrendered to DDA. The presence of this clause will have an impacton the resale value of the property but will have no impact on the earning power value because the earning power value is based on rents which are unaffected by the presence of this clause.
If both the above points are taken into account, it is, in our opinion, safe to assume a minimum earning-power value of Rupees 100 crore for these properties. This valuation of Rupees 100 crore for both properties translates into Rupees 9,364 per square feet. Now we can compare this earning-power valuation ?gure of Rupees 9,364 per square feet with that of the prices fetched by other commercial properties in Delhi.
According to Knight Frank, the outright prices for non-prime commercial properties in various commercial business districts of Delhi were as under:
- Connaught Place: Rs. 7,000-9,000 per sq. ft.
- Bhikaji Cama Place: Rs. 3,500-4,000 per sq. ft.
- Nehru Place: Rs. 3,500-4,000 per sq. ft.
- Rajendra Place: Rs. 3,000-3,200 per sq. ft.
- South Extension: Rs. 4,500-5,000 per sq. ft.
- Gurgaon: Rs. 2,500-3,500 per sq. ft.
According to Knight Frank, “A” grade buildings in these areas having power back up, air-conditioning, latest ?re ?ghtingequipment etc., were quoted at significantly higher rates than the above rates.
In fact, on our inquiries from market sources, class “A” retail trade buildings in Delhi were commanding outright sale prices as high as Rupees 15,000 per square feet (in Ansal Plaza, for instance). The price range for class “A” properties in commercial centers of New Delhi (such as Connaught Place, Nehru Place, and Bhikaji Cama Place), according to market sourcesrange from anywhere between Rupees 9,500 to Rupees 10,000 per square feet.
Therefore, our earning-power estimate of Rupees 9,364 per square feet appeared to be reasonable, considering the prevailing market rates of such properties in New Delhi. Indeed, in our discussions with various property brokers in Delhi, it has emerged that the sale value of both the Gesco properties is in the region of Rs 12,000 to Rs 15,000 per square feet. However, we stuck to our conservative valuation of Rs 9,364 per square feet.
See full slides below.