po-THE SOUTH AFRICAN INVESTOR

THE SOUTH AFRICAN INVESTOR

Letter to the shareholders of Balwin Properties...

By Lawrence Michael
9 March 2020


"Balwin Properties has entered into transactions that seemingly benefit only a small group of individuals by selling property units
(1) At discounted prices and
(2) Binding itself to terms that will lead to further price reductions on these property units by another 15%
To a related entity which is majority-owned by a shareholder with strong connections to the board.

The remaining shareholders have to content themselves with falling gross margins and
We do not think that this is fair".


 

For the financial year ended 28 February 2019...

Balwin Properties made sales of apartments in the Greenpark-Boksburg Lilianton estate to Balwin Rentals as follows;
 

sales_rest_of

Balwin Rentals (BR) is 25% owned by Balwin Properties (BWN)and 3 of its 4 directors are also directors of BWN.

BWN builds and sells units in residential estates and has BR as a customer.
BR buys units and has BWN manage the properties on its behalf to earn rental income.


In terms of the agreement, 
BWN  manages the properties purchased by Balwin Rentals (BR) as follows:
BR_terms


From the above

We have noted that the transactions between BWN and BR;
 

(1) Enable BR purchases property from BWN at lower prices relative to the market and

(2) Can further reduce the purchase prices by up to 15% if onerous net-income targets arenot met.

This is futher debated below...


 

1. Lower property prices

For property units in the same "Greenpark-Boksburg Lilianton" development,

BR paid less per unit compared to the rest of the market.

The below table compares the prices BWN has sold apartments in Greenpark-Boksburg to BR and the rest of the market.


sales_rest_of
 

The prices charged to the rest of the market were obtained from Property 24 where BWN advertises properties for sale.


 

2. Opportunity for BR to further have the purchase price reduced by up to 15%.

    The Net rental yield of a property is

  • The rentals received less rates and property taxes, levies, maintenance, interest on the bond and income taxes.


BWN has provided BR a Net-income guarantee of 10.5% for the next 3 years.

Failure to meet the 10.5% in year 3 will lead to the Purchase prices charged to BR reducing by up to 15%.

`
 

Let us look at why this 10.5% guarantee will not be achieved by BWN.
 

Financial analysis of rental apartments

The below schedule estimates whether the BR-owned properties managed by BWN will meet the 10.5% net-income guarantee in the first year.


nel2
































Please see this document for Explanation of terms used.

 

Per our estimation above

The 10.5% net-income guarantee is only met by charging the highest rent on 2-bedroom apartments.

Save for a miracle;
The 10.5% target will not be met in the third year as BWN will earn more or less the same amount as in the first year.


 

On the 1, 3 and 2-bedroom apartments with the lowest rent charged;

BWN will concede reductions of up to 15% on the sales prices of the property units as the 10.5% guarantee will not be met.


The 2-bedroom apartments charging the highest rent and exceeding the 10.5% have a little margin of safety

(difference between the 11.1% actual net-income produced and the 10.5% guarantee).
 

This makes it more likely that the property units altogether  will not meet the 10.5% guaranteed net-income.


 

What do we have here?


We have what appears to be a coy scheme perpetuated by a small group of shareholders to siphon property cheaply from BWN.

 

BR is owned as follows:

  • 25% by BWN and
  • 75% by Yieldex Trading 2 Pty Ltd.

Yieldex Trading 2 Pty Ltd has a complex ownership structure and is further owned by

  • Tremgrowth Proprietary Limited,
  • KLT Holdings 1 Proprietary Limited,
  • Malewell 2 Proprietary and
  • Yieldex Holdings Proprietary Limited.

The directors on each of the companies above are linked to companies “The Buffet Consortium” has interests in.

The Buffet Consortium also owns 9.2% of BWN and backed the company (along with BR) prior to its JSE listing.


Therefore
The plan to diversify BWN’s income by selling units to BR to earn rental

(Which we think is smart)
However

Disadvantages BWN’s public shareholders in that properties are being sold cheaply to BR; and
terms added that further reduce the prices.

 

BWN’s public shareholders only benefit from 25% of BR's profits.

The rest of the profits are funnelled away to “Buffet Consortium” linked entities’

In our opinion greatly favours “Buffet Consortium” companies at the expense of BWN shareholders (falling gross margins on units).
 

(We disagree with the BDO opinion that the transactions are fair to shareholders of BWN).
We would suggest that shareholders engage with the board on this matter and independently assess the profitability of the BR properties
.