Packer and LLoyd williams might be the turning poi

  1. 365 Posts.

    Very comprehensive report on CLI was released to the market today.

    CLI are near all time lows but look in a lot better shape than many thought.

    With the current PE at 3,the statement that there will be no acqusitions in the short term to drain cash, and finally confirmation that the profit on the books is turning into cash flow is all positive .

    Add the Packer factor and its hard to see why Rivkin has called this a short a week ago.

    Wouldnt be surprised to see this trend over the $2.00 price of the capital rasing in the short term.

    Will be interesting to see what the analyts have to say in the next few days and to see if we get any re ratings.

    Read it for yourself.

    I am long CLI.


    HOMEX - Sydney

    Open Briefing. Challenger Int. Chairman on Strategy

    Record of interview :


    Challenger International Limited has under-performed the ASX200 for
    the last two years despite buoyant reported profits and above-average
    underlying growth in annuity sales. What do you accept has been the
    reason for this under-performance and what does the company need to
    do to restore confidence?


    We accept that we need to restore confidence and we've done a number
    of things to achieve that. For example, we've separated the roles of
    chairman and managing director and appointed new non-executive
    directors. We know the market felt non-executive directors would
    better guide the company. And of course we've announced a capital
    raising, which comes with strong shareholder support, with major
    shareholders sub-underwriting the issue.

    From the market's perspective, our profit methodology is still not
    well understood. We need to spend more time explaining it. And to be
    candid, the re-statement of our profit hasn't helped us in the
    current market environment. In my view, the re-statement should be
    looked on as good news, because now our profit methodology and the
    profit that emerges from it have been confirmed by outside experts.
    And the re-statement didn't lose profit, just deferred it to later

    The other issue is that we've grown the business fast and had
    negative cash flow for the last couple of years. Not to a large
    extent, but enough to make some investors uncomfortable. The good
    news is we're now reaching critical mass, and most of our main
    product lines will turn cash-flow positive in the near term.

    So we need to get those messages across, and prove them up by
    performing. That should do a lot to restore confidence and our share


    At the current level of $1.66, Challenger shares are trading on a PE
    of 3.0 times the 2002 EPS of 56.6 cents per share. This suggests the
    market doesn't rate reported earnings as a reliable measure of value.
    Do you intend to maintain the current reporting methodology?


    Our current methodology is supported by external experts, so we're
    comfortable with it. However, we certainly intend to keep it under
    constant review and of course we're obliged to mark to market within
    the life company. The objective is accurate profit reporting with
    appropriate disclosure.


    Challenger has been criticised for having a high-risk business model
    in that it backs the long-term annuity obligations with earning
    streams from property investments and depends on rising property
    prices. Is the current business model sustainable?


    We believe our model is absolutely the most appropriate for
    supporting long-term liabilities. We're certainly not dependent on
    rising property prices. In fact, the model works well with steady
    property prices. If prices rise, that's cream on the cake.

    Our long-term annuity liabilities have a duration of about 15 years.
    Conventional instruments are shorter dated. Which means you'd have
    reinvestment risk, which is difficult to cover because you don't know
    what interest rates might be when it's time to reinvest.

    And the recent bear market has surely shown that ordinary equities
    are an inappropriate backing.

    In our view, a good quality property portfolio is the best form of
    backing. But it's got to be a diversified portfolio with quality
    tenants and sound risk management. The main risk with property is
    that a tenant won't pay the rent. We've found being in control of the
    properties and having an active process of management, a rigorous
    risk management system, a diversified portfolio, and good quality
    tenants under long-term leases the best way to ameliorate that risk.
    About 30 percent of our property is let to government, and the
    majority of the remainder to high investment grade companies, so the
    rent income is very secure. For the US and UK properties, all cash
    flows are fully hedged back to the Australian dollar.

    I should also say that long-term business is about half of our
    in-force annuity business. We back our short-term annuities, those up
    to about 5 years in length, with conventional financial instruments.
    And as we speak, about two thirds of our new business is short term,
    which means our portfolio overall is coming back into what some
    people would call a more comfortable balance.


    There's a perception among investors that the property-backed model
    works only because of a mis-pricing between property and
    fixed-interest instruments, against which annuities are benchmarked.
    Such anomalies typically don't last. Could your model work if
    property yields fell?


    We've certainly been able to find properties with the yields we
    require, and lock those yields in. And we think the model is
    sustainable going forward. But if for some reason property yields
    were to fall, I'd suspect yields on other backing assets would also
    fall, so you'd face the same problem. At the same time, if yields
    fall generally, the pricing of new annuities would change, so instead
    of offering tax-free rates of somewhere between 5 and 6 percent, we'd
    be offering say 4 to 5 percent. There's no simple answer. All we know
    is that to compete in this market you have to find a yield structure
    that's viable and allows you to offer annuities the public will buy.


    Challenger's business model is also seen by many investors as too
    complex, with the funds management business formed via a series of
    acquisitions seen as adrain on cash flow in recent years. What's
    your strategy for generating value from this business?


    We're very close to reaching critical mass and being cash-flow
    positive in a number of our businesses. That doesn't mean we should
    simply keep everything we have. The board takes the view that the
    business has grown big enough, with assets of over $8 billion under
    management, that we can afford to fine it down, provide a bit more
    focus, and possibly eliminate businesses that don't contribute as
    much as they could. I believe this is our task for the next few
    months. Coming out of that, we'll be comfortably placed in the fund
    management business, with positive cash flow going forward.


    In spite of the board's statement that Challenger has adequate
    capital to fund its current business plan, the recent announcement of
    a $75 million convertible note issue seems to some an admission of a
    funding short-fall. What are the funds to be used for?


    We've done an analysis out to beyond June of next year, taking our
    actuary's advice, and believe our capital resources under the current
    capital adequacy and solvency regimes are adequate to continue
    writing business at the current pace with only a modest capital

    However we had one concern, arising from the change in actuarial
    standards as of July this year, which raised our capital requirement
    by about $130 million. We still have adequate capital under this
    requirement, but because our capital is essentially the unrealised
    gains on our properties, we felt its quality wasn't as good as it
    should be. We took the view we should take on more cash so we could
    better withstand shocks that may or may not occur in the future.

    So the cash won't be used on acquisitions. It will be used to
    strengthen our reserves both in volume, and in quality.

    CORPORATEFILE.COM.AU Can the company maintain its rapid growth
    without raising further funds?


    We have to strike a balance between rates of growth, quality of
    investments and quality of book. So we're moving toward a model to
    calculate capital usage under various parameters. One parameter is
    the growth of the book, another is the term of the annuities we're
    writing. Others might be the quality of the properties and backing
    instruments we have. Obviously, the actuarial requirements are very
    tight, so if the quality of the investment were weaker, we'd be
    forced to hold more capital in reserves.

    This capital model should enable us to go forward at a sensible rate.
    It should tell us whether our current growth rate is sustainable or
    whether we should reduce the volume of sales to some extent. That's a
    very different model from one focussed on marketing hard and bringing
    in as much business as possible.


    Challenger recently announced a restructure of its board, which now
    comprises eight non-executive directors, many of whom have
    substantial holdings in the company, and one executive director,
    Managing Director Bill Ireland. What are the immediate priorities of
    the restructured board?


    First is a review of all of our operations, looking at those that are
    adding value and those that need to add more value. That may lead to
    some decisions about fining our operations down, or not focussing so
    hard on some parts of our business.

    Capital and risk management is an overwhelming priority, as is moving
    to a cash-flow positive position. On top of that, we need to ensure
    we're building a business that's sustainable in every way, and also
    is accepted as such by the market. If we can achieve those
    objectives, the board would be well satisfied.

    As a board, we have enormous confidence in the company going forward.
    We've done some tremendous things in a very sort space of time, we
    have terrific staff and we're confident the business model is sound.
    What we have to do now is refine the whole thing, increase the focus
    and move forward.


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