REFER to the Dr Money column by Larry Haverkamp, 'Trust the way to make money?' (The New Paper, 26 May).


While Mr Haverkamp is entitled to his view, we are surprised that he has ignored relevant and salient information that was stated in the Prospectus of Pacific Shipping Trust, information that we had on at least two occasions highlighted to him.

First, as we had pointed out to Mr Haverkamp in our phone conversations with him, it is not meaningful to compare the depreciation methodology of a ship to a handphone.

Handphone values are driven more by perception rather than functionality as they are increasingly regarded as a fashion statement.

Powerpuff could be the flavour of the month, but next year when Spider Man (or whatever) takes over, the Powerpuff phone may be devalued significantly or even to zero even though it remains perfectly functional.

SHIPS REMAIN FUNCTIONAL

Fortunately, container ships do not suffer the same fate. They typically remain functional and can generally be gainfully employed throughout their useful life of between 25-30 years.

Mr Haverkamp has highlighted the accounting effects of depreciation which is not incorrect.

But this is only half the story. He has chosen to exclude the earnings capabilities of the ships over their entire life span of 25-30 years.

As we've stressed, even though the present charter agreements run out in 8-10 years' time, the ships do not become incapable of generating income or have zero resale value beyond the eighth or 10th year.

The Prospectus showed figures from Drewry Shipping Consultants Limited, a leading shipping consultant, which listed the second hand prices of 10-year vessels from 1996 to 2005.

Neither do we have reasons to believe that they will face difficulties being deployed again at the end of the existing charter agreements, as the supply-demand situation for these vessels is well explained in the Prospectus.

In Mr Haverkamp's article, the terminal value of his handphone was stated nil. This is not the case for ships. Their scrap value is the price of steel multiplied by the tonnage of the ship.

In addition, Mr Haverkamp failed to point out to your readers that when the loans on PST's vessels are paid down over the course of the charter periods, the entire revenue streams and any capital appreciation from a sale, net of expenses, flow wholly to unit holders.

Unlike companies, business trusts, in common with Reits, distribute income out of cash profits rather than accounting profits which are net of depreciation.

All things remaining equal, this manner of distribution generally accelerates rather than thwarts returns on capital for investors.

But whether the income is distributed out of cash or accounting profits, depreciation is provided for in PST's books.

The yields of 9 per cent in forecast period 2006 (annualised) and 9.5 per cent in projection year 2007 were based on projections of future cashflows and economic depreciation.

Such projection is based on the assumptions set out in the Prospectus of PST and the units of PST being purchased at the issue price of 45 US cents of the initial public offering of PST.

In 'Corporate conflicts of interest,' Mr Haverkamp again presented one side of the picture.

While conflicts exist, how they are addressed is not revealed even though they had been conveyed to him both in the phone conversations and in the Prospectus.

These conflicts are addressed not just in theory, but in practice as well, evidenced by the independent valuation and the independent financial adviser's evaluation of the charter rates.

Having more than half of the Board represented by independent directors and having in place procedures for interested party transactions all ensure good corporate governance.

Mr Haverkamp made it all seemed a sinister affair that PST should buy its initial portfolio of eight ships from Pacific International Lines (PIL), and that PIL should own a third of the trust.

Many trusts, whether business trusts or REITs, have at their initial public offering a sponsor who provides the backing to the business and whose long-term commitment is critical for investor confidence.

That's the message we get from our investors. They want to be assured that PIL is not quitting the scene after kick-starting the business.

We note from the response to the IPO that investors do not share Mr Haverkamp's view.

Despite the very volatile market conditions in the week before and during the IPO launch, the institutional book was fully covered and the retail tranche was 10 times subscribed.

- Captain Subhangshu Dutt
CEO, PST Management Pte Ltd

Extracted from DrMoney, TNP

REITS is the new form of investment that has taken Singapore by storm. It stands for real estate investment trust.

It works like this: A property company will take a few office buildings or shopping malls and put them into a fund, similar to a unit trust. Unlike other funds, you buy and sell it like a stock, using a broker.

The Reits craze started in July 2002 with the launch of Capital Mall Trust. We now have 10 that are worth a whopping $15 billion.

Reits are popular because they pay out their profits in dividends. If the Reit sells for $1 and pays 6 cents per share, its dividend yield is 6 per cent. It looks high but there are risks. Unlike a fixed deposit, the price fluctuates. If it drops 6 per cent, your net return is zero.

A new version of Reit is a business trust. It permits more than just property investments. The first business trust - Pacific Shipping Trust (PST) - went public last week and raised $271 million which it will use to buy in eight container ships from Pacific International Lines (PIL).

PST makes its money by leasing the ships back to PIL. Its advertised yield is 9 per cent. Believe it or not, our two young daughters have entered into a similar transaction. Their experience shows the pitfalls of business
trusts and Reits.

KIDS BUSINESS TRUST

Last week, our oldest daughter (age 11) offered a wonderful deal to her sister (age 8).

She said: 'I know that your entire life's savings comes to $250. Please use it to buy me a Power-Puff Girls Handphone. I love it. My three best friends have one.

'Here's the deal: You will own it but I will rent it from you for $1 per week for 5 years. That comes to about $50 per year. You get $50 on a $250 investment.

'It's a super return of 20 per cent per year. Please, please do it!'

Her little sister didn't understand but took the deal anyway. Later she came to Mrs Money and me to ask if it was fair. Was it a good deal?

We told her that a 20 per cent return was very good. But she wasn't really getting 20 per cent.

Why? Because after 5 years the handphone would become obsolete. It would probably have no resale value.

Over the next 5 years, the handphone's value would gradually decline from $250 to $0. On average, it would lose $50 per year ($250/5).

The $50 depreciation turns out to offset the $50 income. It means that her return is not 20 per cent. It is 0 per cent.

Another way to look at it is she invested $250. Five years later, she got back $250. It is a break-even deal. Break-even means no profit. The return is 0 per cent.

In the end, our youngest daughter was happy with the deal because she also likes Power-Puff girls and wanted her sister to have a cool handphone.

But as a hard-nosed investor, you need to worry about whether your investment depreciates. With Reits and business trusts, this is not easy.

Why? Because they never tell you the depreciation rate. You must calculate it yourself. Next, calculate the net yield, after depreciation. Of course, it is always smaller than the advertised yield.

Like our daughter, many investors are dazzled by the 9 per cent cash dividend a business trust like PST pays.

Like her, they fail to see the value of their investment will decline to zero. For Reits, this decline is slow. A Reit with a 99-year lease would depreciate at 1 per cent per year (1/99).

For a business trust, it could be much faster. PST owns container ships with an expected life of 22 years. It means the depreciation rate is 4.5 per cent each year (1/22).

This cuts its 9 per cent yield in half. Your return is really 9.0 - 4.5 = 4.5 per cent. While 9 per cent is a good return, 4.5 per cent is only average.

On top of that, there is risk. The ads say: 'A stable yield of 9 per cent.' That is true for the first 10 years of the ships' 22-year lives. But after that, all of PST's leasing contracts expire. In the final 12 years, the returns are less certain.

Corporate conflicts of interest

There are conflicts everywhere.

Pacific International Lines (PIL) has sold the 8 container ships to the business trust PST. But it retains a 30 per cent ownership in PST. This gives PIL substantial control of PST since it is the largest unit holder.

PIL also owns 100 per cent of PST management.

It is the company that manages PST and receives a yearly fee of 4 per cent of leasing income. It comes to about $1.4 million per year.

Through PST management, PIL also receives 1 per cent of the purchase price when it buys new ships for PST. It gets 0.5 per cent when it sells a PST ship. Does this give it an incentive to over-trade the ships?

Finally, PST leases its 8 ships for 8 to 10 years to - you guessed it - none other than PIL. Should they renew the lease, it will serve PIL's interests to renew at a low price. It will be in PST's interest to get a high price. That is another conflict. In theory, all could proceed with an arm's length relationship with good corporate governance. In practice, many of the incentives are in the wrong direction. PIL could have at least a psychological influence over the affairs of PST by virtue of its owning 30 per cent of PST plus 100 per cent of the company which manages PST.

Extracts fm Lim and Tan Report dated 22-May-06,

• Weak market sentiment and the weak US$ have forced PST to lower its IPO price to US$0.45 per share, and hence push up the first year yield to 9%, and the second year yield to 9.4%. (A total of 222mln units are being offered for subscription, whichcloses at 12 noon on May 24th.
  
• Not helping matters is The Edge highlighting the fact that Omega Navigation now offers 12%, while soon-to-list Pacific Basin, which operates bulk carriers, is expected to yield 16%.
  
• There are however important differences, especially the fact that PST has locked in long-term charters (8-10 years) for its 8 container vessels at US$94,600 a day for trade within Asia, vs Omega’s much shorter charters for its 2 bulk carriers and 4 product tankers, ie if rates do not recover in 3 years time, Omega will have to cut dividends.
  
• As noted by management, capacity increase over the next 3 years in the segment that PST operates in (<4,000 TEUs) is projected at only 9% vs % 24% for the larger vessels segment.
  
• PST has the option to buy and lease 13 more vessels, which can carry a combined 48,684 containers, from Pacific International.
  
• A major deterrent may be the pricing of the IPO in US$, which is universally seen as a weak currency. Yet, the impact of a weak US$ is the same on shipping stocks whether priced in US$ or S$ like NOL, which however reports in US$, ie any US$ weakness will affect profitability, hence dividend, even if declared in S$.

-- Edited by KK at 01:40, 2006-05-23