Eureka Report

Number 207, April 1, 2010

WEEKLY REVIEW

Telstra and the NBN

The legions of shareholders who bought Telstra from the
government have a lot to worry about these days, but
much of what you are seeing in the media is wide of the
mark. I don’t buy the repeated assumption that the NBN
will be bad for Telstra. In my view, Telstra will either
be paid a lot of money to be the NBN’s anchor tenant or
it will milk its copper network for another decade. And
that’s just the start.
herd. Rudi Filapek-Vandyck makes the case for the ASX
to push through 5000 in April. Doug Turek unveils his
inflation-fighting portfolio. Monique Wakelin puts for-
ward her predictions for house price growth, and there’s
much, much more.
Your Eureka Report weekly review is ready to print.
I hope you enjoy it.

Tim Treadgold looks at the changing iron ore market

and finds there is still plenty of money to be made.
James Frost explains how GFC capital raisings will
impact EPS for years to come. Robert Gottliebsen asks Best wishes,
readers to follow their investment instincts and not the Alan Kohler

INSIDE THIS ISSUE

4 GFC-hardened blue chips By James Frost
Capital management during the GFC has defined a
new generation of blue-chips.
6 Investing’s unexpected lessons By Robert Gottliebsen
Learn to follow your instincts, not the herd.
8 Computershare gets a free kick By Ivor Ries
The ACCC blocks its rivals from merging.
20 Investment Road Test: CBA OzAsia By Tony Rumble
A disappointing new product fails to deliver.
21 Retail’s best buys By Guy Carson
Smaller stocks are often better performers.
23 Research Watch By Luke McKenna
‘Death-crosses’, the “China’ brand, Greeks bet
against themselves, the GFC board game.

2
9 Get more from iron ore By Tim Treadgold 25 Collected Wisdom By Alex Liddington-Cox
There’s still plenty of money to be made in iron ore. Buy Worley, hold Premier, sell IAG, newsletters say.

Don’t discount Telstra
By Alan Kohler
There’s a lot of confusion and
misinformation surrounding Telstra and the
NBN. It’s time to set the record straight.
11 Beating volatility the easy way By Mark Carnegie
Don’t be tempted to revise your asset allocations.
12 Taxman warns on contributions By Bruce Brammall
Should you be worrying about your contributions?
14 Transurban’s wish list By Tom Elliott
Transurban threatens to bulk up, strange moves at
Alinta and the ACCC’s Easter eggs.
16 To 5000 and beyond By Rudi Filapek-Vandyck
This time valuations support a breakthrough.
18 How to prepare for inflation By Doug Turek
Ensure your portfolio is correctly positioned.
27 ValueLine: Directors behaving badly
By Roger Montgomery
Good managers, but bad at investing your money.
29 The Speculator By David Haselhurst
A buzz grows around our favourite biotech.
31 How far can property rise? By Monique Wakelin
Experts tip 10% or more. What do you think?
34 Letters of the Week By Eureka Report subscribers
35 Week in View: The Saturday email briefing
B y Alan Kohler

Eureka Report is published by Eureka Report Pty Ltd Publisher Alan Kohler Managing editor James Kirby Assistant editor James Frost
22 William Street, Melbourne 3000. Sub editor James Harrison Superannuation editor Bruce Brammall
T: (03) 8624 3000 F: (03) 8624 3088. Chief reporter Alex Liddington-Cox

www.eurekareport.com.au

Back to Contents
Published in Eureka Report on March 29
Don’t discount
Telstra
By Alan Kohler
PORTFOLIO POINT: The telco’s shares are being priced according to what
might go wrong with the NBN’s arrival. In fact, it’s a win-win for Telstra.
Telstra shareholders have plenty to worry about these days, but a split on the
board or damaging politicking among management over the NBN is not one
of them. Much more important is the question of functional separation, and in
my mind neither that, nor the NBN, is bad for Telstra or its shareholders.
The Financial Review carried a long article this morning by Pamela
Williams quoting a “senior Telstra insider” as saying: “the Stanhope forces
have taken control”, and “the board is split on the negotiating strategy to
adopt with the NBN …”
If that were true, it would be dynamite. You would have to consider
selling your Telstra shares and getting out. There is almost nothing more
value-destructive than a board split or a management mutiny, especially
at a difficult moment for a company. And moments don’t come much more
difficult than this one for Telstra.
But I’m sure the story isn’t true. I have a lot of respect for Williams and I
don’t suspect that the quotes are anything but genuine, from decent sources,
but someone has the wrong end of the stick.
Telstra has a board sub-committee of four dealing with the NBN: David
Thodey, the CEO; John Stanhope, CFO, Catherine Livingstone, the board chair;
and non-executive director Russell Higgins. Geoff Booth and Kate McKenzie
are also on the committee: McKenzie is head of marketing for Telstra and
Booth is the chief negotiator on the NBN.
I’m sure these six people have vigorous debates about what to do about
the government’s determination to build an expensive fibre-to-the-home
network and what the shut-down value of Telstra’s own network is, but that’s
different to a “split”, or to the “forces” of one of them “taking control”, as if
they were like generals and consuls in ancient Rome.
These are pragmatic business people who are engaged in a tough
negotiation that may or may not end in a difficult decision (it could be an easy
one if the Minister, Stephen Conroy, and the NBN board refuse to make an
offer that can be accepted).
Even if Thodey and Stanhope do fundamentally disagree (the suggestion
is that Thodey is soft and Stanhope hardline), Catherine Livingstone and
Russell Higgins, neither of whom is anyone’s patsy, would not tolerate for a
moment anything more than healthy debate.
Any deal thrashed out between Geoff Booth and NBN chief executive
Mike Quigley would have to go to an extraordinary general meeting of
shareholders for ratification. The last thing any executive or director wants
to do is agree to something that shareholders will knock back, or even vote
against in any significant numbers at all.
So Thodey, Livingstone, Stanhope and Higgins have to balance the
long-term needs of Telstra against the short-term emotions of aggrieved
shareholders, and the decision will be driven entirely by the numbers: can
2
Telstra make more money by doing a big deal with the NBN now to switch to
that network as soon as it’s built, or staying with the copper for a few more
years?
In my view Telstra is in a rare, almost unique, win-win position. It will
either be paid a lot of money to be the anchor customer of the government’s
NBN and host to its cables in Telstra’s underground ducts, or it will be able to
milk its copper assets for another decade before switching to the NBN at a
time of its own choosing.
The only problem is the prospect of functional separation, and the only
potential problem in that is a set of one-off costs, not ongoing profitability.
And what makes this a unique situation from an investors’ point of
view is that the share price is being suppressed by the apparent uncertainty
about regulation, specifically the so-called “split legislation” that will force the
company to separate or lose access to 4G mobile spectrum.
This piece of legislation, released by Stephen Conroy in September last
year, has become mixed up in the debate over the NBN. Strictly speaking it’s
quite separate, although of course there is an element in it of providing Telstra
with an incentive to use the NBN: it would be a convenient way of separating
its network and retail functions.
But while that legislation seems to have added uncertainty to the NBN
issue, it’s worth thinking about the two things separately, even though they
are connected to some extent.
For Telstra the NBN is a straightforward question of timing: does Telstra
use the NBN to carry its traffic from the start, in return for cash, or does
it wait awhile and make more cash from using the copper network in the
meantime.
The decision has a lot to do with trading off the cost of maintaining the
copper network ($800 million to $1 billion a year) against the price of renting
space on the NBN. It all depends on the price of the NBN and the upfront cash
on the table.
The commentary about “split legislation” is confused and emotional,
partly because of the way it has been mixed up with the NBN and partly
because it’s a complicated topic.
•••••
There are three ways for incumbent telcos to split to help create competition:
accounting or operational separation, functional separation and structural
separation. The first is no separation at all, just the appearance; the second
is common ownership of the wholesale and retail divisions but separation
internally into different subsidiaries; the third refers to separate ownership.
Accounting separation is what Telstra does now and it is widely believed
to be a joke. Telstra is supposed to separately account for its wholesale
network and retail operations, but the ACCC and the government don’t believe
a word of the numbers, and it hasn’t changed the number or vehemence of
the complaints from competitors.
Conroy’s legislation requires Telstra to commit to “functional separation”
not “structural separation”.
That means stories talking about a “break-up” of Telstra are wrong.
The minister has explicitly decided not to go for a break-up: he is simply
demanding a more effective form of operational separation. It’s true that the
aim of the exercise is to reduce the benefits to Telstra of vertical integration,
but how it would work will depend entirely on the extent to which the
government is intent on punishing Telstra.
I’m not suggesting the legislation will have no teeth at all, and it
certainly has muddied the swimming pool in which the NBN and Telstra
negotiators are playing water polo, so you can’t see what their legs are doing.
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And if the government and the ACCC required full functional separation,
including entirely different IT systems, it would be quite expensive and
disruptive to set it up.
It’s also true that doing a deal on the NBN would solve both problems at
once, since that would result in full separation eventually and would result in
the government withdrawing the legislation entirely. And you have to assume
that that would be a good result for Telstra, otherwise the board would not
recommend it to shareholders (for fear of being savaged at the EGM).
So the question to be resolved for Telstra investors is whether the so-
called “split legislation” would make it impossible or less profitable for Telstra
to operate outside the NBN framework if there is no deal.
It would certainly be difficult. The NBN would be angry to find itself
competing against Telstra for wholesale customers and would do whatever it
could to make life hard, but it wouldn’t necessarily be unprofitable.
The legislation calls for Telstra to provide an enforceable undertaking
that it will “functionally separate”, which could take years to complete.
By that time Telstra might well be ready to start using the NBN instead of
maintaining its copper network (depending on the NBN access price of
course).
And don’t forget we’re talking about a separate “Copper Co” subsidiary
of the Telstra holding company, with no integration with the retail subsidiary.
The copper subsidiary will have to compete with the NBN or die, so it will
compete hard, both to hang on to Telstra Retail as a customer and to get other
customers among ISPs and retail phone companies. And if the separation
were genuine, those customers would not mind using Telstra if the price was
right.
It will be a long time before the higher speed of the NBN is a decisive
advantage because the content simply won’t be there to take advantage of it.
It will be there eventually – mainly HD video – but not for the first few years.
That means a functionally separated Telstra network business should be
competitive and profitable for years to come as it competes against the NBN,
even without full vertical integration with Telstra’s retail business.
So it seems to me the only way Telstra loses out of this situation is
if there is no deal with the NBN, and a very expensive form of functional
separation is imposed immediately.
And the good news for investors is that the market can’t see the wood
for the trees at the moment and is therefore pricing the stock on the basis of
what can go wrong. If I’m right, it’s cheap.  u
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Published in Eureka Report on March 31

GFC-hardened
This means that while profits have recovered strongly, there is now a
much bigger pool of shares to service. Working off numbers from the most
recent reporting period, analysts have estimated company profits increased

blue chips
on aggregate by 7% but earnings per share declined by 3%. Granted, that
doesn’t sound like a huge amount but by lining up the EPS forecasts of rivals
side-by-side the devastating consequences become all too clear.
The winners – the new blue chips – include BHP, Commonwealth Bank,
Woolworths and Westpac. The losers include a range of stocks much loved by
a generation of investors including ANZ, NAB, Rio Tinto and Wesfarmers.

By James Frost The grocers

Company ASX 2007 2008 2009 2010 2011 2012
PORTFOLIO POINT: There is a huge gap opening between our biggest and Woolworths NPAT WOW $1.3b $1.6b $1.8b $2b $2.2b $2.5b
best-run companies and the rest of the corporate pack. EPS 107 131 148 162¢ 172¢ 197¢
Wesfarmers NPAT WES $786m $1b $1.5b $1.8b $2.3b $2.3b
A new pecking order is being established among Australia’s premier EPS 193 180 187 153¢ 192¢ 199¢
companies in the wake of the GFC. Source: Aspect Huntley/UBS
The new blue chips share many similar qualities: prudent capital
management, sparing use of gearing and capital raisings that treat Wesfarmers has been widely criticised for paying far too much for
shareholders equally. Coles after it spent about $20 billion for the supermarket chain at the peak
And while this new elite circulate their credentials to the investment of the market. Not only that but it was then forced to go to its shareholders
community, a list of one-time investor favourites look set to fall by the repeatedly over the next few years to raise another $7.1 billion.
wayside – thanks to a combination of poor capital management, heavily But the real measure of just how costly it will be for shareholders is the
dilutive capital raisings during the GFC and share issues that have been unfair abysmal growth in EPS, which is expected to remain virtually steady over the
to retail shareholders. five years from 2007 even as net profit triples. Meanwhile, shareholders in
A single bad habit is not terminal for a company, but several combined rival Woolworths will book those increases in net profit almost immediately as
have the potential to ensure what was once regarded as a reliable investment EPS gains.
will be consigned to the bottom drawer. This distinction between our well-run companies and our not-so-well-
Why? Because poor capital management leads to unwise acquisitions. run is equally apparent in the mining sector, where BHP Billiton and Rio Tinto
Bad investments lead to massively dilutive share issues which, when are constantly measured against each other.
conducted in an inequitable fashion, have the potential to leave once great Rio Tinto’s ill-fated $43 billion takeover of Alcan has now assumed
stocks friendless. almost mythical proportions. Its strategy to avoid being taken over by its arch-
By contrast, the characteristics shared by the new blue chips are equally rival led it to take on a monstrous amount of debt that saw it almost fall into
intertwined. Prudent management teams only bought assets at the bottom of the arms of the Chinese, lose a chairman and conduct one of the biggest and
the cycle. Conservatively geared balance sheets didn’t require refinancing in most dilutive capital raisings on record: a 21-for-40 share issue that raised
the first place. Capital raisings that treated all shareholders equally generated $19 billion, the results of which you can now see below.
positive sentiment among all shareholders. The miners
For share investors today, there is no metric more important than Company ASX 2007 2008 2009 2010 2011 2012
earnings per share (EPS). For long-term investors EPS figures are more BHP Billiton NPAT BHP $7.2b $16b $15.8b $16.2b $23.6b $23.2b
important than share prices, which have snapped back over the past 12
EPS 275¢ 285¢ 246¢ 291¢ 425¢ 416¢
months, making a share price comparison an unreliable way of picking the
Rio Tinto NPAT RIO $5.4b $5.3b $8.2b $12.2b $13.2b $13.7b
stars of tomorrow.
EPS 521¢ 908¢ 399¢ 621¢ 673¢ 699¢
But it is EPS and EPS projections that matter most; moreover, they
Source: Aspect Huntley/UBS
should offer the most reliable guide to future share price performance. EPS
is calculated by dividing the number of shares on issue by a company’s net It could be argued that BHP shareholders dodged a bullet after
profit. It is EPS that powers dividends and future investment. management aborted a takeover of its rival, but this can perhaps be attributed
The EPS ratio gets back to the very heart of owning shares. As a to the number of options its executive team had spent years assembling.
shareholder you are a part-owner of a company. The earnings per share Although the numbers aren’t as striking as the previous example, EPS at Rio
shows the benefit that you have received from each individual share that you Tinto will grow at 34% from 2007 to 2012. At the same time, its better-run
own, and if earnings per share have decreased while overall company profits rival, which was not forced to raise expensive and dilutive capital, will grow
have increased it is worth examining why. EPS at 51%.
Many companies that bought assets at the top of the market – Rio Tinto/ In defence of Rio Tinto, its share issue was at least fair to all
Alcan, Wesfarmers/Coles – were unable to access functioning credit markets shareholders. In fact, despite its size, the pro rata renounceable share issue
in 2008 and found themselves with billions of dollars that needed refinancing. used by Rio Tinto is the optimum structure for a capital raising that treats all
They had no choice but to raise money from shareholders at steep shareholders equally. Essentially, it consists of two parts.
discounts to the already low prices shares were trading at. Investors were The pro rata basis means that the number of shares on offer
forced to produce the dough or end up with a smaller slice of the company. corresponds to the number of shares already owned. For example, an offer
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might allow all investors to subscribe for one extra share for every 10 shares
held. Each shareholder, either retail and institutional, can apply for new
shares in proportion to the number of shares held.
A renounceable rights issue means the rights can be traded if you do
not want to, or cannot, purchase the additional shares. This allows you to
receive a financial benefit from the discounted capital raising, even if you
don’t participate; whereas in other non-renounceable issues, the shareholder
is either forced to participate or suffer being diluted.
Rio Tinto’s offer is in stark contrast to the billions raised by the banks,
which chose a markedly different route. The banks, when faced with the
need to raise capital, placed strict limitations on the ability of shareholders
to participate. These raisings, which we addressed here and here limited
participation to blocks of shares worth $10,000 or $15,000.
But the key difference here isn’t so much how they issued new shares
but what they did with the money. While all the banks used the opportunity to
shore up their capital ratios (or money on hand) and make provisions against
bad debts the mix of assets they bought was decidedly different.
While ANZ and NAB went about assembling a collection of diverse
businesses and unwanted divisions from overseas banks, CBA and Westpac
seized the opportunity to make the game-changing acquisitions of BankWest
and St George respectively. You can see how the difference in approaches is
reflected in the expected gains in earnings per share in the below table.

The banks
Company ASX 2007 2008 2009 2010 2011 2012
ANZ NPAT ANZ $4.2b $3.3b $2.9b $3.9b $4.9b $5.7b
EPS 205¢ 148¢ 167¢ 185¢ 213¢ 247¢
CommBank NPAT CBA $4.5b $4.8b $4.7b $5.9b $6.9b $8.0b
EPS 340¢ 344¢ 293c 391¢ 453¢ 502¢
NAB NPAT NAB $4.6b $4.5b $2.6b $4.6b $6.1b $6.8b
EPS 268¢ 261¢ 122¢ 219¢ 268¢ 308¢
Westpac NPAT WBC $3.4b $3.9b $3.4b $5.7b $6.5b $7.2b
EPS 185¢ 197¢ 123¢ 199¢ 230¢ 253¢
Source: Aspect Huntley/Citi

Banks are, of course, particularly complex beasts and changes in EPS

reflect many variables. But its telling how the acquisitions of rival banking
operations are expected to produce markedly different outcomes in the EPS
forecasts. While CBA and Westpac are expected to deliver gains of 48% and
37% over five years respectively, ANZ and NAB are only expected to deliver
gains of 20% and 15%.
It’s hard to make a discussion about how companies choose to raise
money all that exciting – except when you start to look at the bottom line.
It’s also interesting to note that those businesses that could be accused of
a cavalier approach to acquiring assets are the same ones likely to short-
change loyal shareholders. Something that a true blue-chip stock would
never do.  u

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Published in Eureka Report on March 26
Investing’s
unexpected lessons
By Robert Gottliebsen
PORTFOLIO POINT: The US housing collapse and Australia’s housing boom
contain lessons on why investors should tread their own path.
This week three dramatic housing-related events were brought to my
attention, two in the US and one in Australia.
First, although I haven’t finished Michael Lewis’ new book The Big Short,
this week I was alerted to the fundamental subprime investment lessons
contained in it by my former TV producer, Jackson Hewett, who is now in the US.
A day later I suddenly I found that my friend the US mortgage expert
was in town and he updated me on what will be the next unfortunate chapter
in the US mortgage crisis. Finally I discovered a significant upward thrust
looming for the Australian housing construction market.
Excerpts from The Big Short, in the latest issue of Vanity Fair (click
here), reveal the incredible story of Michael Burry, who discovered he had
Asperger’s syndrome at the age of 35. Recognising the condition went some
way to explaining his remarkable ability to analyse prospectuses and absorb
vast amounts of detail.
Lewis says people with Asperger’s can’t control what they are interested
in and it was a stroke of luck that Burry’s special interest was financial
markets and not, say, collecting lawn mower catalogues.
Burry also began to make significant conclusions about investing. He
did not think investing could be reduced to a formula or learned from any one
role model. The more he studied the legendary investor Warren Buffett, the
less he thought Buffett could be copied.
Indeed, the lesson he learned from Buffett was that to succeed in a
spectacular fashion you had to be spectacularly unusual. “If you are going to
be a great investor, you have to fit the style to who you are,” Burry says.
Burry ran a hedge fund called Scion and started off by obsessively
studying prospectuses, to select which stocks to buy or short. By 2005 his
Scion fund was up 242%.
But in 2004 his interests shifted from shares to the subprime mortgage
market. Lewis says he noticed money was being lent to borrowers who had
little or no collateral, and usually at low “teaser” rates that would skyrocket
after a few years.
Burry concluded that after the “teaser” rates had expired, the borrowers
would default on their loans in waves and the value of the securities in the
risky mortgage bundles would plummet. So he began purchasing “credit
default swaps”, essentially forms of insurance on certain subprime mortgage
bonds. Burry devoted himself to finding exactly the right mortgage bonds to
bet against. He started in earnest in 2005 but he had to wait two years before
the market began to crack.
Sometimes when you get a good investment idea, whether it be on
the up side or on the down side, it can take a long time before the market
catches up with what you believe is going to happen. And nothing illustrated
that better than the Michael Burry experience.
6
It wasn’t until about June 2007 that he noticed that strange things
beginning to happen in the subprime market. The person he was dealing
with at one investment bank suddenly disappeared; others got sick and left
work for unspecified reasons. Subprime securities were beginning to unwind,
causing deep internal problems in the trading houses. Then in 2007 it became
apparent that some of the big trading houses had started to buy insurance
themselves, exactly what Burry had been doing for the previous two years.
But at the end of each month they would suddenly push the market up and
paper over the looming crisis so that they could get more insurance.
Here is another lesson from Burry: When you see strange behaviour in
a market, particularly at the end of the month or the end of the day, it often
means that the big institutions are trying to meet a particular objective. Be
wary not to be trapped. And of course in the US it wasn’t long before the
market collapsed and Burry and his investors made a fortune, as did a few of
the trading houses.
Now we come back to my US mortgage friend, who spends much of his
time these days trying to salvage value in defaulting US mortgages. The US
situation now is dramatically different from the early subprime days and most
of the loans that men like Burry bet against have defaulted, so the subprime
crisis has passed.
But what my friend alerted me to is that between 2005 and 2007 there
were an enormous number of three to five-year “teaser” loans established. In
the true subprime market, the majority of borrowers simply had no money at
all, whereas in these three-to-five years loans a large number of people did
have a job or some equity at the time the loan was taken out.
Since 2005–07, the value of their houses has slumped and many have
lost their jobs. In the second half of this year a huge rump of these loans will
suddenly convert from low interest rates and low repayments to much higher
rates and repayments.
Vast numbers of people simply will not be able to pay what the loan
agreements require, which will often be increases of 50% or more of their
current repayments.
There is another rump of the “teaser” loans due to expire in 2011.
A recent newsletter from market watchers The Tagsall Group says there
hundreds of billions of dollars in loans are coming in the next few months and
it is likely that 40% of those loans will be delinquent.
•••••
The 2011 delinquencies are likely to peak between September and
December. Most of the banks have written down these loans already but
the sheer volume of them means that the banks will simply not be able to
process them and they will go into default, which will see a whole new wave
of people leaving their houses. My friend emphasises that this problem is
regional with a large number of these loans being in Florida, Nevada and
California. I don’t think the markets have factored in the enormity of this
looming problem.
Meanwhile, as my American friend walks around our cities he is worried
about the level of house price rises in Australia, particularly given the warning
from Westpac that it will need to raise rates higher than the looming Reserve
Bank increases. But of course if migration remains high our house prices will
be well supported and people who get into trouble will be able to sell their
houses without suffering losses.
My third encounter was with a builder who is constructing houses
in eastern states capital cities. Demand in the outer suburbs of each city,
including Sydney, is soaring (see Bubbles on the fringe). This sharp jump in
likely housing construction means that building suppliers are going to do very
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well indeed, particularly those who have operations concentrated in Australia,

such as GWA and Brickworks (see Building materials ready for high rise).

Footnote:
For those who are interest in the theory of investment, here is some more
wisdom of Michael Burry:
“At one point I recognised that Warren Buffett, although he had every
advantage in learning from Ben Graham, did not copy Ben Graham but rather
set out on his own path and ran money his way, by his own rules.”
“I also immediately internalised the idea that no school could teach
someone how to be a great investor. If it were true, it would be the most
popular school in the world, with an impossibly high tuition. So it must not be
true.”
“Investing is a blend of art with science. Book smarts with street smarts.
Seeing the forest from the trees. Creativity, emotional intelligence, being able
to bet against the crowd. There are people who have made money by being
lucky but there IS a skill to investing just like there IS a skill to poker. Sure
you could get lucky, but you increase your odds of success by improving your
skill.”  u

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Published in Eureka Report on March 26
Computershare
gets a free kick
By Ivor Ries
PORTFOLIO POINT: The ACCC unexpectedly blocks two of Computershare’s
competitors rivals from merging.
The ACCC is called upon to make hundreds of decisions about competition
but every now and then it does something that just makes you scratch
your head. This week it was expected to announce its position on a merger
between two small share registry companies, Link and Registries Limited.
The consensus in the industry was that this merger would just be waved
through; after all, the $7 billion Computershare behemoth is such a dominant
player in the industry.
But in a bizarre decision, the ACCC has decided to oppose the merger.
Computershare is facing structural and regulatory change in key
markets around the world. It’s not expected to lose any market share but
it will have to work hard to make sure that doesn’t happen. Meanwhile in
Australia, it is a protected species.
There a shades of another decision from a few years back in this one.
Dulux is the number one paint company in Australia, and has been for many
years with about 60% of the architecture and decorator market.
Now rival paint firm Wattyl had been having a difficult time of things
and sought to merge with Taubmans. The newly merged entity wouldn’t have
accounted for more than 30% of the market but the deal was knocked on the
head in the interests of competition and today Dulux is stronger than ever.
Link Market Services was picked up by private equity firm Pacific Equity
Partners a few years ago, which then began to cobble together a few other
share registry companies in New Zealand, South Africa, India and the US.
The proposed merger between Link and Registries would really give
them the kind of scale it needs to compete. It would also have bulked up the
How Computershare’s share price has moved
8
company and given PEP an opportunity to organise a float in the next few
months, but who knows if that is going to take place anymore?
If we look at these companies in isolation, you can see just how
bizarre the whole situation is. Computershare accounts for about 60% of the
Australian share registry market. If the merger between Link and Registries
had gone ahead the combined entity would have been lucky to be half
Computershare’s size – just like Wattyl and Dulux.
It’s really quite an odd situation. On the one hand you’ve got Chris Morris
of Computershare running around the world trying to find ways to spend his
money, and on the other you have Link being prevented from making a $50
million acquisition.
On back-of-the-envelope sums, Computershare probably turned over
about $1.9 billion last year, while Link was probably lucky to do $100 million.
Computershare will spend $70–80 million improving its core systems this year.
Remarkably, the ACCC has previously mentioned that the key to success
in the sector is ongoing investment in infrastructure, and that failure to
continually upgrade computer systems was a key reason for the departure of
a previous player in the share registry space, BT Registries.
Having recognised these issues, the ACCC has decided to go ahead and
block the merger anyway.
Computershare made a net profit of $315 million last year; Link a much
smaller, but still respectable $26 million. Who do you think is going to be able
to invest more?
Nine out of 10 times the ACCC makes the kind of decision you agree
with, where you can see how it arrived at a particular decision and how it will
keep the industry competitive.
Then it does something like … I don’t know … allow Westpac to merge
with St George and you just start to wonder.
For the guys at Pacific Equity Partners, it couldn’t come at a worse
time. Corporate activity is really starting to build up worldwide. About $170
billion worth of takeovers have been announced in the past seven weeks.
This is bread and butter business for these share registry companies and
a successful merger would have delivered these guys a good uptick in
business.
But for Chris Morris and the legions of investors in Computershare this is
like a big free kick.  u
Ivor Ries is head of research at EL&C Baillieu Stockbroking. He may have
interests in any of the stocks mentioned.

Back to Contents
Published in Eureka Report on March 26
Get more from
iron ore
By Tim Treadgold
PORTFOLIO POINT: BHP Billiton and Rio Tinto are earning strong margins on
their iron ore exports. Investors cannot afford to ignore them.
The iron ore game might seem like old hat in 2010. Investors can be all too
easily distracted from the task at hand by the “next big thing”.
Right now the dumbest thing you could do is ignore what is happening
in the Pilbara. Make no mistake: there is still plenty of money to be made in
iron ore and you simply must have exposure to quality large-cap producers in
your portfolio.
There are plenty of distractions: The ACCC has produced a 26-page
statement of issues on the proposed Pilbara tie-up between BHP Billiton
and Rio Tinto; Stern Hu and other Rio Tinto executives are in China awaiting
sentencing on bribery and spying charges; and the iron ore spot price has
gone up 10% over the past two weeks, to $147.50 a tonne.
Serious investors will be able to cut through this background noise to
see which business offers the best exposure to iron ore; they will know that
the differences between our headline acts and the support players in the
sector is all in the margins.
While the premier players BHP Billiton and Rio Tinto enjoy eye-popping
margins of 60% or more as a result of their high-quality deposits and huge
investments in infrastructure, it’s a vastly different story further down the
pecking order.
When governments begin to withdraw stimulus it will become
immediately noticeable in commodity pricing, making margins even more
important than they are now in the boom times; some are predicting
increases of 90% or more in the benchmark rate.
Studied individually, there is very little to separate the iron ore divisions
of BHP and Rio Tinto, for three reasons:
n Iron ore is very important to BHP Billiton and Rio Tinto, but it is just
one business unit inside broadly diversified companies.
n By 2012 the BHP Billiton and Rio Tinto iron ore divisions in WA will be
almost identical on every performance metric.
n The proposed merger of the iron ore divisions is looking more and
more uncertain, and was probably always doomed by the history of the
European Union, which started life 60 years ago as a coal and steel customs
union with strong anti-cartel credentials.
The reputations of these two companies couldn’t be more different.
BHP has the kind of derisked balance sheet and project pipeline that many
companies can only dream of. Rio Tinto, on the other hand, has taken plenty
of risks, some which haven’t quite paid off as management had hoped.
This is reinforced by average price targets from Australian brokers,
where BHP is trading 15% below anticipated highs while Rio is trading 17%
below its expected peak.
Before looking at the near-parallel performance of the iron ore divisions
of Australia’s two biggest mining companies, there is another aspect to
9
investment in iron ore: the emerging producers, and explorers.
The gap between major producers and emerging producers is immense.
In fact, they fall into completely different asset classes.
The attraction of emerging producers (and explorers) is their capital gain
potential, and little in the way of earnings and dividends. The big producers
have the earnings power, but their capital gain potential is hidden inside a
large and diversified corporate structure.
A month ago I looked at an assortment of smaller iron ore plays (see Join
the iron ore rush). Most have delivered handsome profits. The four top picks
among the emerging iron ore stocks: Brockman Iron, BC Iron, Giralia and Iron
Ore Holdings. Since then, Brockman has risen from $3.11 to $3.54, a gain of
13.8%; BC Iron is up from $1.14 to $1.37 (20.2%); Giralia is up from $1.64 to
$2.03 (23.8%); and Iron ore Holdings is up from $2.31 to $2.47 (7%).
Four other small iron ore stocks were also mentioned: Atlas, up from
$2.02 to $2.39 (18.3%); FerrAus, up from 77¢ 96¢ (24.7%); Golden West, flat
at 70¢; and Magnetic, down from 49¢ to 42¢ (–7%).
The point of going through that list of small stocks is to demonstrate
the capital gains available as demand for iron ore in Asia (particularly China)
continues to strengthen, and to show how well most of the chosen stocks
have performed against the leaders, and the overall market.
While some of the smaller iron ore stocks rose by 20% and more in a
month, the leaders were less impressive. BHP Billiton has risen from $41.10
to $43.24 since February 26, a gain of 5.1% and almost precisely in line with
the ASX 200 index which is up by 5.2%
Rio Tinto has risen from $70.50 to $77.90 (10.5%), outperforming the
ASX 200 and the metals and mining index, which has risen by 7% over the
past month.
Some credit for the rise of the two resource leaders goes to their iron
ore divisions, but the question is emerging whether the market has yet fully
priced in the effect of the rumoured 90% increase in the iron ore price, or
whether confirmation of a sharp price hike will trigger a fresh rerating of the
entire sector.
•••••
Prices in the short-term (spot) iron ore market indicate a substantial rise
in the benchmark price, or its successor, but confirmation of a big increase
in long-term contract prices would be a significant boost to all participants:
producers and explorers.
One of the more interesting attempts to analyse the two iron ore
divisions was undertaken recently by the stockbroking firm JBWere. In a note
to clients dated March 1 the broker said BHP Billiton “does better on price,
but Rio Tinto has a great unit cost result”.
Another important observation was that last year a different marketing
approach by BHP Billiton had enabled it to receive a higher average price than
Rio Tinto. In 2009, BHP Billiton’s average WA iron ore price was $US75.47 a
tonne. Rio Tinto’s was $US58.51.
The problem with looking back at that performance, which appears
to indicate that BHP Billiton runs a better iron ore division than Rio Tinto, is
the distorting effect of different balance dates (June 30 for BHP Billiton and
December 31 for Rio Tinto), and the effect of global trade dislocation incurred
between late 2008 and early 2009.
It is more useful to look forward and consider forecasts such as the
latest iron ore price tip from ANZ Banking Group, which expects iron ore fines
to rise from US97¢ per iron ore unit (the formula under which iron ore is
traded) to US164.9¢ by June 30, a 70% increase, and then up again next year
to US181.4¢, another 16% increase.
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Confusing this view of iron ore pricing is the matter of the annual who refuse to believe in a near-doubling of the benchmark price little more
benchmark pricing system and whether it will continue, or whether steel than a year after the GFC. They might be in for a surprise.  u
mills and miners can agree on a new pricing mechanism, such as quarterly
adjustments.
JBWere’s view of the iron ore divisions of BHP Billiton and Rio Tinto is
shown in the table, along with its view of Fortescue Metals.

Iron ore producers compared:

Company 2010 2011 2012
BHP Billiton (WA operations)
Ore mined (million tonnes) 135 145 172
Revenue $US billion 7.98 10.1 11.9
EBITDA ($US billion) 5 6.9 8.4
Average price received ($US/tonne) 69.6 81.6 80.9
Costs ($US/tonne) 25.91 27.71 24.24
Pre-tax profit ($US/tonne) 40 49.46 52.54
Pre-tax profit margin (%) 57 61 65

Rio Tinto (WA operations)

Ore mined (million tonnes) 168 170 174
Revenue ($US billion) 11.4 12.3 12.2
EBITDA ($US billion) 7.7 8.6 8.5
Average price received ($US/tonne) 75.41 80.83 77.91
Costs $US/tonne 24.23 24.31 23.89
Pre-tax profit $US/tonne 41.59 46.58 45.1
Pre-tax profit margin % 62 64 64

Fortescue Metals Group

Ore mined (million tonnes) 38 48 53
Revenue ($US billion) 2.2 3.4 3.7
EBITDA ($US) 985m 1.8b 2b
Average price received ($US/tonne) 58.7 71.5 70.6
Costs ($US/tonne) 32.48 33.49 31.89
EBIT ($US/tonne) 20.16 32.34 33.15
Pre-tax profit margin (%) 34 45 47

The key measurements are the volumes produced, which in the case of
BHP Billiton and Rio Tinto, reach roughly the same level in 2012 as expansion
programs are completed, BHP Billiton at 172 million tonnes a year and Rio
Tinto at 174 million.
The average price received per tonne will still be in BHP Billiton’s favour
– $US80.90 vs $US77.91 – while Rio Tinto will have slightly lower costs per
tonne at $US23.89 compared with BHP Billiton’s $US24.24.
Profit margins for both divisions improve, along with the iron ore price,
with BHP Billiton working on a margin of 65% by 2012, and Rio Tinto at 64%.
Far in the distance is Fortescue, which is tipped by JBWere to be
receiving a lower price per tonne ($US70.60 in 2012), and have higher costs
($US31.89), for a pre-tax profit margin of 47%, good by the standards of most
industries, but well below the margins of its big rivals.
The investment message from the complex world of iron ore is that you:
n Buy BHP Billiton and Rio Tinto for exposure to the earnings power of
their iron ore divisions.
n Buy emerging producers and explorers for capital gain.
Overlaying those comments is the potential for the entire sector to be
substantially re-rated if a 90% price iron ore increase is achieved in the next
few weeks, because there are still participants in the iron and steel industry

Back to Contents
Published in Eureka Report on March 26
Beating volatility
the easy way
By Mark Carnegie
PORTFOLIO POINT: Investors with long-term goals should resist the impulse to
react to market volatility.
The question I am most often asked by small investors is what to do when
the market starts imitating a roller coaster?
Nothing troubles small investors more than the sorts of gyrations that
have again become a feature of global equities markets: up 3% today, down
2% tomorrow, and so on.
Some investors see danger, others see opportunity but they nearly all
feel that they ought to be doing something to react to such volatility. As I said,
I am regularly asked what they should do.
My answer is both brief and simple: nothing. Make no changes to
your asset allocation and do not revise your savings plan. Savings plans are
devised with the long term in mind and that is what matters.
Recent volatility is essentially a reflection of the dominant role that
computer trading plays in today’s market (see Robo trading here to stay).
The big operators spend many billions on computer power and complex,
sophisticated models to run their trading operations.
Basically, their computers both track the market and make the market
at the same time. They computers detect tiny movements in share prices
and crunch stupendous amounts of information about those movements to
detect all sorts of patterns. Essentially what computer traders are doing is day
trading to earn millions of tiny profits.
The giants of quantitative trading – hedge funds such as Reliance
and SAC and the proprietary trading desks at Goldman Sachs and others –
endlessly refine the software programs’ effectiveness to collect these tiny
profits and to sell out of loss-making profits at the first sign of downward
movement.
Small traders have no hope of competing against that sort of computer
power and financial muscle. When volatility hits, you have almost no hope of
outperforming the big operators. Hence my simple advice repeated again: do
nothing.
All good investors have a savings plan that takes into account the
fact that over the long term shares need to be at the core of an investment
portfolio. Without them, even low levels of inflation will eat away at the
purchasing power of your savings.
If you are committed to holding even 100% of your portfolio in equities
and saving $10,000 a year, then the fact the market has a period of high daily
volatility is irrelevant. What determines your asset allocation and savings
rate is the particular circumstances you find yourself in: your age, the school
commitments of your children/grandchildren, helping with house deposits
and whether you want a holiday house.
It is only during the extremes, when the world has clearly gone mad in
some asset class, that you should change your asset allocation or savings
plan. This happens perhaps once every two or three years and you can only
11
capitalise on this by overcoming your primal urges to be scared or greedy
when everyone is the opposite and you are too.
If you see opportunity too often, then you are not thinking properly.
Before you spend a cent, pressure-test your thinking: be absolutely sure
that you are not being driven by either greed or fear; in fact, ensure that you
are doing the opposite.
There are, of course, some opportunities that can arise even in a
computer dominated market. Occasionally, computer trading breaks down
when market movement becomes extreme. For instance, there was clearly a
time when the dotcom bubble was way out of line and bound to burst.
Equally, the downward movements in reaction to the Asian crisis and the
GFC were too savage. The computers were unable to identify the bargain-
buying opportunity that had opened up.
The computers also failed to tell their owners that the dotcom bubble
was a great short-selling opportunity. These options were there for clear
thinking small investors – shorting the dotcom bubble or buying somewhere
near the bottom in both the GFC and the Asian crisis.
I can claim to have only capitalised on two of these opportunities. I did
not short the dotcom bubble but I did go long during the Asian crisis and my
column from November 2008 (see In defence of the king) contains my advice
for the GFC.
In fact, before your say these opportunities are only evident in
retrospect, you should remember it’s not so: they are evident to all. They are
just really difficult to act upon.
Computer trading makes it too hard for small investors to have short-
term strategies because the cycle is so much faster now. Computers have
massively increased what people have taken to calling the “clock speed” of
financial markets; ups and downs that used to take months now happen in
days.
Those that want to become investors have to learn to resist the allure
of the markets’ short-term song and the bright and flashing lights of a share
that has just doubled in price.
No doubt there are traders out there who believe they can outperform
the computers, pay for brokerage and outgoings and still finish in front. I’m
happy to wish them luck, but I wouldn’t want to lend them money.  u
Mark Carnegie is a principal of the corporate advisory and private equity firm
Lazard Carnegie Wylie and an investor in Eureka Report.

Back to Contents
Published in Eureka Report on March 31
Taxman warns on
contributions
By Bruce Brammall
PORTFOLIO POINT: Advisers and trustees trying to skirt contributions limits
have been put on notice.
The small world of self-managed super fund legal eagles sounded like a
henhouse with a fox loose yesterday, when news broke of the sternest of tax
office warnings.
The ATO warned that it was aware of several law firms selling trust
deeds (and potentially recommending associated strategies) designed to
get around enormous penalty tax provisions for those who exceed their
contribution caps.
In its press release, it said it was concerned that some of these
arrangements were designed to “avoid excess contributions tax”. The
accusation is, therefore, “tax avoidance”, a giant leap beyond tax evasion.
And there is no bigger sin in the eyes of the taxman.
The tax office made it clear it was as prepared to nail the advisers giving
the advice and the trustees who’d agreed to break the law.
There are very few top-line SMSF lawyers in Australia. Their egos are
as big as their fees. It’s a highly competitive industry and there’s no love lost
between most of the top players.
If they have any mutual respect, it’s grudging. At the recent SMSF
Professionals’ Association of Australia (SPAA) conference in Melbourne, two of
the biggest names had a proper barney on-stage during a forum.
So, when several of the top lawyers were named in the one
article that discussed tax avoidance, the emails and phone calls More than 1.4 million Australians
started and the noise was decidedly catty.
So, what’s the issue? And should Eureka Report readers be will be impacted by the cut
panicking?
The issue is that the tax office believes some trustees – at to the government co-contribution
the urging of some legal advisers – are trying to get around
the concessional and non-concessional contribution limits. The
government was clear and set strict laws that it wanted anyone who put in
extra to face a taxation wallop.
Eureka Report readers will be familiar with those two limits. The
over-50s have a few more years left where they can get in $50,000 a year
in concessional contributions (the under-50s have a $25,000 limit). The non-
concessional limit is $150,000 a year.
The tax office has reviewed some trust deeds that, in essence, direct
the trustees to hold any excess contributions in a separate trust (even if the
assets, or cash, are intermingling with the rest of the super fund). It says
the aim of the arrangement is that, by holding it in another trust, the money
will not be deemed an excess contribution and will therefore not be taxed at
penalty tax rates, which can be as high as 93%.
Too clever by half, says the taxman.
“These clauses are an attempt to avoid the excess contributions tax if
they exceed the relevant cap, even though the amount in question was clearly
12
intended as a contribution and was treated as part of the super fund by the
trustee,” tax commissioner Michael D’Ascenzo said.
“The ATO has reviewed these arrangements and considers that they are
ineffective. Anyone involved in or considering these arrangements should be
aware that they face close examination by the ATO.”
Could you be affected? If you know that you haven’t been breaching
your contribution limits, then you’re probably OK.
However, if you believe that you’ve been given advice that suggests
that you can get in “extra” contributions through such a strategy, seek more
independent advice immediately.
By all means, head back to your legal adviser and ask them whether
they believe that you or your super fund are impacted by the tax office
statement. Get the response in writing. If you’re still uncomfortable, seek a
second opinion. Get that in writing too.
In the notes to the taxpayer alert, the tax office hints that could issue
huge fines to individuals and trustees. But, more scarily for any legal
representatives involved, the tax office has said it could seek to have those
recommending the schemes declared “promoters”. By all accounts, the
penalties there are real fire and brimstone, in the form of injunctions and
fines.
•••••
A year ago, when the deepest, darkest budget in a generation was being
framed by Treasurer Wayne Swan, two short-term decisions were made in
regards to the normally long-term investment vehicle of superannuation.
One was to halve the concessional contribution limits for everyone.
This is a decision that was most painful for those over 50 who are trying
to shovel money into super after decades of paying down mortgages and
raising children; certainly tens of thousands of people and perhaps as many
as 100,000.
The second one has grabbed fewer headlines: the reduction of the
government co-contribution. This is partly because it hasn’t kicked in yet. The
reduction was 33% – from the $1500 of recent years down to $1000 – but it
doesn’t cut in until the end of the current financial year. So at this point it has
impacted precisely no one.
However, in terms of the overall number of people who will be affected,
the co-contribution changes will have a far wider impact. And, given that it’s
aimed at roughly those earning below the average wage and arguably need
the most help saving for their retirement, the one that made the least sense.
Last week we found out how widespread the impact will be. More than
1.4 million Australians will be impacted by the cut to the government co-
contribution, judging by how many people received it last financial year.
The tax office said it paid out $1.22 billion for 2008-09; the previous
year it was $1.137 billion. (And it was still paying out millions for previous
financial years as well.)
The government co-contribution is a favourite. It’s designed to allow
people on lower taxable incomes to be able to put a sum of up to $1000
of non-concessional contributions into their super fund. In previous years,
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the government would match it with $1.50 for each dollar of qualifying
contributions.
However, in last year’s budget, the co-contribution was reduced and is
due to be dollar for dollar for 2010-11 and 2011-12. For 2012-13 and 2013-
14, it rises back to $1.25 for each dollar. And from 2014-15 financial year, it’s
due to go back to $1.50.
But with the Australian economy having dodged the GFC bullet, the
coming budget should be anything but scary. And with any luck, the federal
government might decide to reinstate the program at full value immediately.
For the current financial year, you’ll get a full $1000 co-contribution
when you contribute $1000 if your income is less than $31,920. It phases out
between $31,920 and $61,920.
The tax office figures, which split contributors into salary ranges, show
solid support by people of all incomes. This is a popular program, which has
the desired result of getting Australians to put away for their retirement. Let’s
stop watering it down.  u

Bruce Brammall is director of Castellan Financial Consulting and author of

Debt Man Walking.
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Published in Eureka Report on March 29

Transurban’s wish list

the price. This is a textbook defensive move from Transurban. By spelling out
what it hopes to acquire it is trying to scare off predators. But to acquire just
the top three assets Transurban would need about $2.5 billion and it simply
doesn’t have the money, which means it may have to raise equity.

By Tom Elliott
PORTFOLIO POINT: The tollroad operator spells out what it would like to own;
GPG builds it Alinta stake; and is the ACCC timing an announcement?
Transurban (TCL). Shares in the tollroad company fell last week when news
emerged that the Future Fund has ended talks with the Canadian pension
funds over a $6.8 billion tilt at Transurban. The Canada Pension Investment
Board and Ontario Teachers’ Pension Plan already have 28% of Transurban
and quite a lot of firepower to go with it, so the Future Fund was really only
there to offer a friendly Australian face to go with the deal. Unsurprisingly,
Transurban shares fell from $5.15 to $4.80, but have since recovered a few
cents. The interesting part of the statement wasn’t what it said, it was what
it didn’t say and it didn’t say that it’s no longer interested in Transurban,
because I think it would quite like to own Transurban outright. Investors
considering taking a position in Transurban, however, should be very careful
because if it suddenly finds itself friendless there is a considerable amount of
downside.
Two days after this statement was released, Transurban held a
presentation for investors that took the seemingly unusual step of outlining
secondary assets it is monitoring: stuff it would like to own. At the top of the
list was Melbourne’s ConnectEast with a market value of $1.7 billion, then
came BrisConnections at $447 million and the Rivercity Motorway at $157.9
million. The company went on to say that the Bligh government’s sale of
Queensland Motorways may be attractive, before it explained that it regards
itself as the natural owner of both the Lane Cove Tunnel and the Cross City
Tunnel. That’s quite a shopping list! Most companies about to start acquiring
assets would never share those details with the market for fear of bidding up
Alinta (AEJ). Last week we spoke about how this $60 million WA power
company was reportedly told it needs $1 billion to battle its $2.7 billion
debt burden. I said that taking on Alinta would be a mad idea, but on cue
Guinness Peat Group steps in to grab a 19.9% stake in the company; if it
wants any more it will have to bid. What you have to remember is GPG has a
very complicated investment structure, and trying to decipher its intentions
is more difficult than you might think. GPG was already on Alinta’s register
and the shares are trading down around 7¢ a share. If GPG had a sniff of
a takeover offer then why not snap up as much as possible. Or, there’s the
possibility that it’s effectively stuck with its stake, so why not increase that
holding to ensure a seat at the table when decisions are being made about
its future.
BUPA Australia. Speaking of Guinness Peat Group, Sir Ron Brierley is also
expanding into life insurance and wealth management with a $195 million
takeover of Bupa Australia through listed vehicle MMC Contrarion, of which
his company owns 68%. MMC will buy MBF Life and financial advisory
business ClearView Retirement Solutions through a $135 million capital
raising at 50¢ a share, with existing cash reserves filling the gap. GPG will
put in $50 million for the deal and emerge with 45% of the group. MMC also
grabs a 10-year exclusive alliance with Bupa to market its own products to
the target’s 2.9 million customers.
This deal strikes me as a little strange because Bupa looked to be a very
sellable asset. The question arises of whether MMC was the only company
willing to bid for it, or the only company willing to pay that price. If the latter is
the case then we’ll have to see whether it has snapped up a bargain that the
market underestimated, or overplayed its hand.
DMC Mining (DMM). Cape Lambert has stepped in to grab the remaining
shares in DMC Mining that it doesn’t already own. It paid 40¢ a share, valuing

Takeover action, March 22-26, 2010

Date Target ASX Bidder (%) Notes
08/03/10 Arrow Energy AOE Royal Dutch Shell and Pet- 0.00
roChina
16/03/10 CBH Resources CBH Toho Zinc 24.10 Recommended offer for
49.9%.
08/03/10 Coote Industrial CXG Elph 25.00 Rejects offer for further 35%.
17/03/10 Corporate Express Australia CXP Staples 58.60
23/03/10 DMC Mining DMM Cape Lambert Resources 36.20
24/02/10 Forge Group FGE Clough Operations 19.99 50% proportional offer.
26/02/10 Gloucester Coal GCL Macarthur Coal 0.00 Recommended.
12/03/10 Indophil Resources IRN Zijin Mining Group Company 43.63 Directors accept.
22/03/10 Mesa Minerals MAS Mineral Resources 0.00
25/03/10 Nufarm NUF Sumitomo Chemical Company 8.73 Offer for 20%.
18/02/10 Orion Petroleum OIP Octanex 7.08 Opposes Gas2Grid merger.
02/12/09 Rey Resources REY Gujarat NRE Minerals 12.00 Rey rejects offer.
16/02/10 Solverdi Worldwide SWW LincolnHill Capital Partners 0.00
19/02/10 Tandou TAN Guinness Peat 20.67 Rejects new offer.
17/03/10 Tusker Gold TKA Barrick Gold 20.00 Controlling holder to accept.
26/02/10 Warnambool Cheese and Butter Factory WCB Murray Goulburn Co-Operative 5.00 Rejects revised offer.
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Scheme of Arrangement
10/03/10 Aurox Resources AXO Atlas Iron 0.00 Vote May.
14/12/09 AXA Asia Pacific Holdings AXA AMP and AXA SA 53.93 Revised scheme rejected.
17/12/09 AXA Asia Pacific Holdings AXA National Australia Bank 0.00 Recommended.
30/11/09 PacMag Metals PMH Entrée Gold 0.00 Vote April.
03/02/10 Rusina Mining RML European Nickel 0.00 Vote May.
16/03/10 CBH Resources CBH Nyrstar 0.00 Rejected.
23/03/10 Transurban Group TCL Canada Pension Plan Invest- 0.00 Future Fund drops support for
ment Board and Ontario Teahc- merger.
ers’ Pension Plan
Foreshadowed Offers
13/01/10 Australian Renewable Fuels ARW Wasabi Energy 0.00 Scheme proposed.
09/03/10 Centrebet CIL Unnamed party 0.00 Discussions.
29/12/09 Rocklands Richfield RCI Meijin Energy 0.00 Offer raised.
23/12/09 Warnambool Cheese and Butter Factory WCB Unnamed party 0.00 Rejected.

the target at $34 million. Shareholders in the company would have been very
happy with the news because the stock was ticking along at 30¢ before Cape
Lambert spoke up and the shares are now above the bid at 41.5¢. The board
has recommended shareholders take no action yet. But Cape Lambert already
has 32% of the target and with the offer representing a premium of roughly
25% you’d have to say it’d be pretty unlucky to lose this one.
Santos (STO). The stockmarket thrives on speculation but very rarely do
companies comment on it. Last week, however, a rumour was doing the
rounds that was so ridiculous the CEO it referred to was moved to speak
out. What happened was that major daily newspaper carried a story saying
Woodside Petroleum was considering a takeover offer for Santos. I’ve said
many times that Santos is a takeover target but never in a million years would
I have listed Woodside among the likely predators. Woodside is a giant of the
sector and needs to raise billions of dollars over the next 10 years to develop
assets a range of assets including Pluto, Browse and Sunrise (LINK TIM T). So
why would Woodside all of a sudden start looking to coal seam gas projects
on the east coast? CEO Don Voelte was then quoted at a conference in Perth
as saying: “We don’t speculate on market rumour, but I can also just tell you
that there’s nothing in it,” You won’t find a much more emphatic denial than
that.
AXA Asia Pacific Holdings. While we are on rumours, another one doing the
rounds is that the ACCC will hand down its findings on the bids from NAB and
AMP early. The original self-imposed deadline of April 1 is the day before the
break. Newspapers don’t publish on Good Friday so that means it will only get
very limited coverage. So it looks like being released sometime earlier this
week … exactly when, we don’t know.
a fellow Chinese automaker called Beijing Automotive signed up a technology
deal with Saab, while the rest of the company went to Dutch company
Spyker.
Beijing Auto grabbed the rights to Saab’s old models so they can learn
from the technology and then produce it for the local market. The technology
is still advanced for its markets and you have to remember that developing
them is still very expensive: welding together an engine is not as simple as
you might think. So the big question is, if Ford couldn’t make a profit from
Volvo, can Geely?
There have been a multitude of takeovers, rescues and last ditch tie-ups
in the auto industry over the past few years and it might be a reasonable
time to ask if auto makers are at the bottom or whether this is part of a
structural decline. It’s entirely possible that the Chinese companies could end
up coming back to the West with better products after honing their technique.
This is all against a backdrop of climate change and getting auto emissions
down.
I agree with Alan Kohler’s line of thought that there exists a tipping point
when the move towards renewable energy becomes inevitable (see Wheels
of fortune). But we’re not there yet and there are many other things that will
happen before then. I think you could reasonably expect to see lighter cars,
more efficient engines, better roads and vehicles that deliver less pollution
before we electric cars take over the roads. But in the end, who knows?
Maybe those developments will come out of China after all.  u
Tom Elliott, managing director of MM&E Capital, may have interests in any of
the stocks mentioned.

iiNet. This West Australian-based company has continued its expansion

plans by acquiring an unlisted east coast rival, Netspace, for $40 million. This
will give it scale and is part of a broader consolidation trend we are seeing
in the telcos, with TPG’s bid for Pipe Networks and the merger of Hutchison
and Three last year. There is a lot of this jostling for position going on in the
lead-up to the NBN and in this particular case it’s about iinet getting as many
subscribers on to its books as possible.

Volvo. Chinese company Geely has grabbed Volvo from Ford Motors for $1.8
billion, after the American carmaker paid $6.8 billion for it back in 1999. This
is a proper takeover by Geely, in that it has bought the company outright, but

Back to Contents
Published in Eureka Report on March 26
To 5000 and beyond
By Rudi Filapek-Vandyck
PORTFOLIO POINT: The 5000 level is approaching fast for the market; expect
a breakthrough in April.
Risk appetite is back in global financial markets, there can be no doubt about
it. More and more economists are updating their projections on the basis of
recent insights and indicators, growth projections for 2010 continue moving
higher – for the US, China and Australia.
The only region that seems to be missing out on this global phenomenon
is Europe where austerity measures by the Greek, Spanish and now
Portuguese governments are just one reason for reduced growth expectations
this year (see Research Watch, page 23).
This flood of constant upgrades is pushing up expectations for corporate
profits and this, as I have explained in the past, is providing global equity markets
with a free bonus on the valuation side. In other words, stockmarkets have
become relatively cheaper (thus more attractive) over the past month, even
though they have risen quite strongly since the last bottom in mid-February.
Probably the best way to illustrate this is by making a straight
comparison with mid-January when major Australian equity indices were at
(more or less) similar levels as they are this week.
In my first column of the year on January 22 (see Is all the good
news priced in?) I calculated the average price/earnings (P/E) multiple for
the Australian stockmarket at the time had risen to 14.5 – on fiscal 2011
estimates.
The long-term average for the Australian stockmarket is 14–15 on
present year financial forecasts, not on next year’s estimates. That, plus the
fact that we were still eight months off from gaining updated insights about
2009-10 profits explains why I declared at the time that investors had once
again taken their enthusiasm a few bridges too far.
We didn’t have to wait long before selling pressure started to build,
pulling equities down by nearly 10%.
How the ASX 200 has moved
16
This time around, however, we are two months closer to the end
of 2009-10, but above all we are back at similar heights with increased
valuation support. Today the Australian stockmarket is reflecting an average
P/E multiple for 2010-11 of about 13.7, 0.8 lower than in January.
To put this in perspective: were the Australian market multiple to rise
again to 14.5 (similar to January) and with all else remaining equal, the ASX
200 index could potentially rise to 5190.
It is this difference in valuation potential that has been supporting the
stockmarket’s gradual uptrend since mid-February. Other commentators look
at Greece, or at US President Barack Obama’s healthcare bill to explain why
equities have risen over the past six weeks. I look at underlying valuations,
knowing that the past has taught me increasing expectations tend to trigger
and stimulate buying support.
That’s exactly what has happened over the past month.
The good news is that this process is far from over. The offset is that the
psychologically important 5000 level is approaching, and approaching fast.
Will we get through it? Probably not this week, I’d say. But if the monthly
rhythm of equity market weakness into the new month repeats itself next
week, I’d be inclined to say go, jump on board, because April is likely to see
the ASX 200 climbing above 5000.
By then we will be another month closer to the start of 2010-11 and
who knows how many additional expert upgrades further. It is difficult to
argue with apparent valuation support.
This is also why I believe that any stockmarket weakness will remain
limited in the short term. There’s simply too much valuation support for too
many blue-chip stocks.
Here’s another way to illustrate this point: if the Australian stockmarket
is trading on 13.7 times the average P/E for 2010-11, then how many stocks
are actually trading above or below this average multiple?
My calculations show 97 of the top 200 companies are currently on a
lower multiple. Upmarket retailer David Jones (DJS) is the last one to make
the cut, trading on a 2010-11 P/E of 13.66.
If we take into account that nine of the 200 companies cannot be
included because of the simple fact there is no consensus data available
(yes, it’s a small market in Australia) then this equals more than half the
index.
The good news is that the half with below-average P/E multiples
includes all the banks, Big Four and the others, both BHP Billiton (BHP) and
Rio Tinto (RIO), plus the likes of Harvey Norman (HVN), QBE Insurance (QBE),
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Fortescue (FMG) – yes, you read that right – Incitec Pivot (IPL), Foster’s (FGL)
and Orica (ORI).
This is a rough measure to assess the market because it doesn’t take
into account that some stocks deserve a premium while others should
trade at a discount, but surely it must be a relief to see so many blue-chips,
including the banks and the two diversified resources giants, still on the
cheaper side of the market?!
And those two resources giants, plus Fortescue, are about to become a
deal cheaper if the latest news from Brazil about this year’s iron ore pricing
proves accurate.
To avoid all misinterpretations: further upgrades to corporate earnings
forecasts are not solely a result of increasing pricing expectations for bulk
commodities, or for commodities and energy in general.
Macquarie strategists have just finished redoing their numbers and
projections for US corporate earnings and they too have responded with
material upgrades. “The US is undergoing a strong production-led recovery,”
they say, “underpinned by a very large inventory cycle, together with a still
cheap currency and strong productivity growth of over 4%.”
The key factor in Macquarie’s outlook is that the US consumer will not
contribute materially to the jump in corporate profits. Nevertheless, earnings
per share for US companies are expected to advance by 30% on average in
calendar 2010 and by 20% next year. And that’s just one such example.
Just for comparative reasons: earnings per share for Australian
companies are currently forecast to improve by some 5%-plus in the
year to June 30 and by more than 20% in 2010-11 (these are consensus
calculations done by FNArena). No doubt, this difference explains why experts
believe the US market will outperform Australia.
Sceptics will wonder whether this sudden boost of optimism doesn’t
smack of the good old “investor exuberance” that regularly creeps into
financial markets, usually as a precursor to major disappointments later.
I note, for instance, resources analysts at Barclays issued a report today
in which they proclaim we are about to witness the “biggest-ever recovery
in global base metals demand” (click here). Even if this prediction proves
accurate, one wonders how many investors will genuinely take this as a given
and act accordingly this time around?
Just the fact that all risk assets continue to trade in close correlation
with each other, centred on that elusive “risk appetite”, should indicate to
everyone that just as financial markets are now caught in a self-feeding
positive spiral, things could still get ugly if the global winds change direction.
But, as I have indicated previously, these are not considerations on Mr
Market’s present mind.  u

Rudi Filapek-Vandyck is editor of FN Arena, an online news and analysis

service.

Back to Contents
Published in Eureka Report on March 29
How to prepare
for inflation
By Doug Turek
PORTFOLIO POINT: Looming inflation means you might need to adjust your
portfolio in terms of shares, property, bonds … even debt.
“The Greeks gave us democracy, but their greatest contribution to
government was watered-down money,” according to The Bear Book author
John Rothchild. He and other financial historians tell a disturbing history of
indebted governments debasing their currency and printing money to avoid
raising taxes or cutting spending.
So it is interesting here we are again with Greek finances in the news
and concern about inflation on the horizon.
If you believe that history repeats itself after each generation forgets the
past then we have lived long enough to be surprised by the next outbreak of
inflation. Alternatively, if you look for conspiracy behind every accident you
will note that a favourable outcome of 1970s inflation was the halving of
bloated Vietnam War debt relative to GDP.
Despite perhaps there being only a one in three chance high inflation
is around the corner, it may pay to know the answer to the question: Which
investments work best in inflation? Here I’ll try to answer that question.
Shares
While it is mythically held that shares are good inflation hedge, this is the
case only over the medium and long term. This is only because a diversified
portfolio makes enough money in the good non-inflationary times to more
than cover for poor performance during inflationary periods, which is not the
case for other asset classes such as cash and traditional bonds.
In the short term, however, companies can struggle to raise prices (or
shrink package sizes) fast enough to keep up with rising wages and factory
supplies. The tax system doesn’t adjust for inflation so company profits and
capital gains are taxed more and depreciation and other allowances are
worth less. Rising interest rates add to company costs and also cut consumer
budgets, resulting in lower sales volumes.
Most importantly, the prices investors are willing to pay for shares can
fall alongside overall optimism and as bond yields become more attractive.
Looking back to the 1970s, the modest real performance of shares was
driven more by falling price/earnings multiples than corporate earnings,
which eventually caught up with inflation.
That said, not all companies perform similarly.
Better performers include energy and resource companies, because
commodity prices rise while costs of their extraction remain unchanged. BHP,
Woodside and Rio Tinto are just a few of the companies that will benefit,
or are likely to. Gold and gold miners are also obvious inflation hedges.
Soft commodities such as timber and agriculture should also perform, but
unfortunately not if accessed via failed MIS investments.
Utilities and other infrastructure are also sought out for inflation
protection because they enjoy CPI-linked revenue streams. However, one
18
must select investments carefully: a developed toll road or water utility would
be expected to perform better, clipping bigger tickets compared to a utility
forced to buy coal or oil to fuel their generators at higher prices.
The bid for Transurban by Canadian pension funds is a sign some are
taking the threat of inflation seriously (see Robert Gottliebsen’s feature, Why
I like Transurban). Unfortunately you can’t consider Telstra a reliable inflation
hedge given uncertainty over its infrastructure assets.
Retailers with pricing power selling things we need to buy (consumer
staples) should perform better than companies trying to tempt us to buy
things we might be able to postpone when personal budgets tighten
(consumer discretionary). In this regard you would select companies like
Woolworths and Wesfarmers over Myer and David Jones.
Banks are expected to be losers in an inflationary environment
because loans are repaid with money that is worth less and less each
year. The collapse of the US savings and loan institutions in the late
1980s can be traced to American borrowers having locked in low
interest rates prior to inflation breaking out. Of course in Australia it is
impossible to get a 30-year loan and most borrowers take out variable-
rate mortgages. That, along with the big four banks having demonstrated
pricing power, means the situation may not be that bleak. Don’t expect
manufacturers to perform well because their costs often rise faster than
their prices do, and sales can fall.
Property
Commercial property tenants pay rent contractually linked to CPI, which
means property trusts should enjoy inflation-adjusting revenue. A bout of
inflation might be very welcome for those distressed investors in frozen
property trusts because it should shore up falling commercial property prices
and eroding high levels of indebtedness. This might accelerate the beginnings
of a recovery in listed property trusts.
Residential property prices generally keep up with inflation. However,
after several years of property price increases well in excess of the 120 year
trend of prices rising by inflation plus 2%, further price growth and rental
income may be constrained by stretched affordability.
Bonds
If you were a US investor you wouldn’t want to be lending your money
to your government at 4.6% fixed for 30 years, despite that being
4.45% higher than the recent at-call rate of 0.15%. While an extreme
comparison, this is the dilemma facing Australian savers choosing
between high-yield at-call rates and locking up their money for five years
to earn an additional 1%.
During the surprise run-up in inflation to the peak rate in 1975,
traditional medium-duration and long-term bonds underperformed. However,
once the inflation cycle peaked and interest rates came down, these locked in
investments outperformed.
So the general rule of thumb is:
n In a rising inflationary and interest-rate environment, avoid bonds and
deposits with maturities of more than three to five years and favour cash,
floating rate investments or inflation linked bonds.
n After inflation is broken and as interest rates fall, lock in longer-term
fixed-term bonds.
A few things also to note:
n The bond market is professionally neurotic about rising interest rates
and inflation, which means the greater return you get on a five-year, 10-year
or longer-term bonds or deposit reflects their anxieties. What you need to be
worried about is the market being wrong or central banks having another
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agenda, such as promoting financial system stability. Locally, the opposite
may be occurring, where the RBA is using higher interest rates to slow
property prices from bubbling over and banks are being forced to seek more
local finance.
n Floating rate bonds, which yield a margin over a benchmark interest
rate, offer some protection against rising inflation. However, as in the US and
Europe today, and Australia only a year ago, benchmark rates can be held
down while inflation continues on. In the 1970s, CPI outpaced interest rates
for several years.
n The capital value of hybrid income securities fluctuate a lot more than
any extra premium they offer. If your invested company doesn’t perform well
in an inflationary environment, then you might suffer greater capital loss than
any extra yield you get.
n Inflation-linked bonds are a nice complement to interest rate-linked
bonds. Aside from short-term repricing by bond traders, your investment is
not linked to interest rates. They are generally structured so that your capital
appreciates with CPI and your ongoing interest is paid as a fixed percentage
of that adjusting amount. At the moment bonds from NSW Treasury are
paying about 3.2% return above inflation, which is a total return of 6.2% if
CPI is 3%.
INFLATION ETF™
Exchange Traded Funds (ETFs) are all the rage now, so why don’t we
translate this portfolio thinking into a fictitious inflation fighting fund.
We’ll even trademark the attractive name “INFLATION” to describe it.
Like most ETFs this will need to be constructed from various indicies so
market makers can do their job to keep asset and security prices aligned.
However, you may be able to implement this using the example securities
or funds noted. Since investing in indices may be too broad, there may
be an argument to carefully filter investments by their inflation-fighting
characteristics, suggesting the need for a managed fund instead. In the
interests of simplicity, we’ll leave out more complex methods such as
gearing and shorting poor inflation hedges.
Time will tell if inflation proves a big problem and whether our attempt
at building a benchmark inflation fighting portfolio does an adequate job
protecting the value of your assets from its ravaging. It’s important to note
that if commodity prices are actually overcooked then this approach may do
exactly the opposite.
However, having had so many outbreaks of inflation to study in the
past, we can assume that many of the successful techniques that prevented
wealth erosion in the past will continue to be useful in the future.  u

More debt anyone?
If you are quite certain that paper money will be worth much less in the future,
then you should borrow it from others now. Your real liability will decline as
inflation erodes your debt. Provided you invest in inflation-fighting assets and
lock in your interest rate then you could
be well ahead. American Dan Amerman,
who spent years keeping failed S&L
institutions on life support, is a proponent
of this strategy.
However, this works better in the US
where you can borrow for less, fix your
interest rate for up to 30 years and even
refinance if you’re wrong and rates fall. All
these strategies are difficult to implement
locally, but can be done if you are keen
on buying property in the US (or for that
matter the many other places in the world
where you can borrow at a 2–3% interest
rate and earn rental income of 4–6%).
Currency
Inflation and currency crisis go hand in
hand. This suggests one needs to a have
a firm view whether the Australian dollar
will strengthen further or weaken relative
to other countries. On balance one might
expect the Australian dollar to stay strong
or strengthen further in a high inflationary
environment for three reasons: demand
for Australian commodities, higher
interest rates and concerns about the
strength of US, UK and Euro currencies.
If correct then your investments offshore
should be currency hedged and maybe
you should buy more of them while the
dollar is strong.
Constructing our INFLATION ETF™
Component
Australian equities
Metals and Mining
Energy
Consumer staples
Gold
International equities (currency hedged)
Infrastructure
Natural Resources (energy,
metals & mining, agribusi-
ness)
Property
Australia Listed Property
International property
Australian bonds and cash (combined 30% level to be rebalanced twice annually)
Australian Inflation Linked
Bonds
Australian High Yield Cash
Doug Turek is the managing director and principal adviser of independent
money management and wealth advisory firm Professional Wealth. The range
of investments cited here is for illustrative purposes only and should not be
considered recommendations by the author.
Benchmark Index % Examples or alternatives
S&P/ASX 300 Metals and Mining 10% BHP, Rio Tinto
(XMM)
S&P/ASX 200 Energy (XEJ) 10% Woodside, Santos, Origin
S&P/ASX 200 Consumer Staples 10% Woolworths, Wesfarmers
(XSJ)
S&P/ASX All Ordinaries Gold (XGD) 5% Newcrest, Lihir; GOLD ETF;
gold bought direct from the
Perth mint
UBS Global Infrastructure & Utilities 10% Vanguard Global Infrastructure
Fund; Transurban, Connect
East ; Spark Infrastructure, SP
AusNet
S&P Global Natural Resources 10% Energy and metal companies
above plus local agribusi-
nesses AACo, Incitec Pivot
S&P/ASX 200 A-REIT (XPJ) 10% SSGA ETF SLF; or Westfield,
Stockland, GPT AREITs
UBS Global REIT ex-Australia 5% Dimensional Fund Advisors
Global REIT
UBSA Government Inflation Index 20% Aberdeen Inflation Linked Bond
Fund; direct inflation linked
bonds
RBA 180 day term deposit rate 10% 6 month TDs ½ rolled every
90 days; high yield savings
account or short-term fixed
interest
 20
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Published in Eureka Report on March 29

Investment Road
“downpayment” seems to be an amazing feat of financial engineering.
But it isn’t, really: all that the investor has bought is a simple zero
coupon bond, plus a call option “spread” over the ASX 20, which doesn’t

Test: CBA OzAsia

By Tony Rumble
PORTFOLIO POINT: This new product from the CBA seems like a lot of hard
work for very little gain.
It’s been a consistent theme of this column that investors should beware of
financial products that promise a guaranteed or fixed return, and/or where
the investment can only be purchased with money borrowed from the issuer.
Like the Yellow Brick Road, the benefits of these types of products are illusory.
It’s hard to fathom why a mainstream institution like CBA could find
itself issuing this type of product, but that is exactly what has happened with
the latest offering in its “Capital Series.” The latest version is called OzAsia;
and with the offer in Strategy One of that product of a fixed, unconditional
“coupon” of 4% pa for each of its past four years (as well as another
“coupon” at the same rate payable at maturity), CBA has joined the ranks of
other product providers that issue high cost, high risk investments.
This fixed “coupon” is window-dressing for what is a return of the
investor’s initial capital (with the implication that the investor can obtain a tax
deduction for the interest involved if they use the optional investment loan to
fund the investment).
At first glance OzAsia looks very interesting. Strategy One is a five-
and-a-half year investment that is 100% capital protected at maturity and
which, in addition to the 4% “coupon”, gives a return at maturity linked to the
performance of the ASX 20 stocks over that period. The final contingent return
is capped at 70% of any gain above the starting price of the ASX 20 stocks at
issue date, minus the 20% paid already as “coupon”.
No dividends are payable during the investment term; and at maturity
the investor can choose to take delivery of ASX-listed shares equal to the
maturity value of the product, or they can elect for those stocks to be sold and
receive cash instead.
The OzAsia product is hedged synthetically by deploying the investor’s
initial purchase price into buying a discounted zero coupon bond, with the
balance being used to buy a structured call option over the ASX 20 shares,
as well as allowing enough money to be set aside to pay the “coupon.” The
zero coupon bond matures in five-and-a-half years time at 100% of the initial
investment price – hence there is no rocket science in the method used for
the capital protection.
The structured call option is worth very little, because essentially it
does not give an investor much real or valuable exposure to the underlying
ASX 20 index. The marketing bumph surrounding the investment makes this
product look like much more than it is – the online videos and brochures
depict an amazingly powerful product that somehow “knows” how much has
already been paid by the product, and states that the investor receives up
to 70% of the growth in the underlying shares – less any amounts already
paid by the investment. This suggests that the “coupons” could be thought
of as a downpayment of a portion of the growth in those shares; but since
that growth is entirely contingent on the market, this fixed and unconditional
start paying a return until the ASX 20 shares have risen by 20% – and which
is then capped at a total return of 70%. What if the market goes up over the
term of the product, but by not much more than 20%? Seems like a lot of
hard work for very little gain.
This option is so cheap to create that instead of spending a lot of the
investor’s capital to buy a simple, more effective call option, the very low
option cost allows for enough of the investor’s capital to be set aside to return
as a fixed “coupon” over time. And to make the option even cheaper, its
reference price is set in respect of each component share in the ASX 20 – so
that even if the top 20 stocks as a whole are up in value, this is ignored and
the final payoff looks to the return on each individual share.
The tax opinion included in the PDS isn’t helpful, either. It states
generically that investors that borrow may not be entitled to a tax deduction,
and that investors should take their own advice. It doesn’t comment
specifically on the character of the fixed “coupon” payment and if it did, it’s
hard to see how it could avoid making the absolute statement that there is
very likely to be no tax deduction available at all.
Or it could be looked at that CBA is really just lending the client nearly
50% of their future interest cost – since if you borrow $100 and receive
4% pa from years 1.5 onwards, this is like a subsidy from CBA for ongoing
interest expenses. Other than that, and the obvious layers of fees involved for
the over–engineering involved in this product, there doesn’t seem to be much
merit in buying this product instead of buying simple long-dated call warrant
over the same stocks.  u
The score: 1 star
0.0 Ease of understanding/transparency
0.0 Fees
1.0 Performance/durability/volatility/relevance of underlying
asset
0.0 Regulatory profile/risks
0.0 Innovation
Tony Rumble is the founder of the ASX-listed products course LPAC Online, a
provider of investment training to financial services professionals.
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Published in Eureka Report on March 31

Retail’s best buys

The Reject Shop is justified by their superior returns on equity (profitability).
One of the key drivers of the value of a business over the long term is
sustainable high profitability.
Interestingly, Kathmandu falls behind in this criterion. Its return on
equity suffers from the high level of intangibles on its balance sheet. These
intangibles have arisen from the sale of the business from its private equity
owners to the public market. Thus, the market paid a high equity multiple to
By Guy Carson the private equity owners. To justify this sale price the company will have to
substantially lift its return on equity. Investors in Kathmandu have paid for a
PORTFOLIO POINT: Beyond the fanfare of the big names, several smaller higher level of profitability than what is justified.
listed companies are performing strongly and giving investors good long-term So let’s return back to the two businesses that have a high return on
opportunities. a equity. The Reject Shop has been a great success story in recent years. It
opened its first store in South Yarra, Victoria, in 1981 with five staff selling
When investors think about retail stocks, they are invariably drawn to the factory seconds and discontinued lines. Since then, it has grown to 192
security of such big names as David Jones and Harvey Norman. Those who stores located within shopping centres and shopping precincts throughout
participated in the recent float of Myer – which is still well below its offer Australia. Today it no longer sell just seconds and discontinued lines. They
price – would be aware that this strategy isn’t necessarily infallible. have adopted a new formula of targeting low prices and bargains on the
Those who are prepared to dig a little deeper though through the market everyday items.
will find that there are several retail companies valued at less than $1 billion If we look at
that are performing well, growing and providing investors with good long- The Reject Shop’s
term opportunities. historical return
Some of the great success stories of the Australian stockmarket in on equity, the
recent years have come through well-managed retail rollouts. One of the best trend is positive.
examples of this is JB Hi-Fi Limited. Management has
JB Hi-Fi was established in 1975 to provide specialist hi-fi and recorded been able to generate
music at low prices. Its product range now includes televisions, computers, profits, pay growing
games and consoles. dividends and retain
Through its rollout program it now operates 123 stores and the company some profits, which
plans to open an additional 18 new stores in the current financial year. This have been reinvested
successful rollout has seen the company’s share price go from $1.55 at its into the business at
float in 2003 to over $20 today and has launched the company into the ASX higher and higher
100. rates of return.
With this in mind we have decided to cast our eye over a number of the This is has been done through its continuing roll out program and
emerging retail players in the sector to see how are they are progressing and through increasing brand awareness. So what does this mean for our
what the future may hold for them. valuation?
We have
assumed the
company will achieve
a return on equity of
60.9% for the next
By comparing these companies on the basis of a “revenue to market three years. This
capitalisation multiple” we can see that two distinct groups emerge: the represents a fall from
speciality retailers such as Oroton Group and Kathmandu, who trade at a its 2009-10 figure
premium; and the rest. Oroton and Kathmandu are so far ahead because of of 73.2%. When we
the huge profit margins they can carve out of their exclusive lines. combine this with
our required return of
13.2%, we derive a
valuation of $14.72
and unfortunately
the share price has raced away from this for the time being. Investors should
If we then turn our attention to return on equity we get a slightly different be watching carefully for an opportunity to acquire shares in this excellent
perspective on events. By considering profitability we can see that retail business for about $14.
companies trade in a wide range of ratios of market capitalisation to On the other hand, we have Oroton, a retailer of luxury fashion brands
shareholders equity. in Australia and New Zealand. Apart from the Oroton brand it also has the
On this measure, two companies stand out: Oroton (again) and The Australian distribution rights for Polo Ralph Lauren.
Reject Shop. Both trade at equity multiples of more than nine times and well Oroton underwent a significant restructure in 2006 with a newly
in excess of the other four companies. The high market rating for Oroton and appointed chief executive Sally MacDonald, who had experience with the
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hugely successful US retailer Gap and Boston Consulting Group. One of

MacDonald’s first orders of business was to divest the underperforming
Aldo, Marcs and Morrissey brands. From that point Oroton focused on “high
margin” and “upmarket” products.
The main focus is the design and retailing a wide range of Oroton
products, including bags and small leather accessories, jewellery, ties,
umbrellas, knitwear, lingerie, men’s underwear and shoes. Products are sold
through 38 of its own retail stores, two David Jones concession stores and six
factory outlets. Products are also sold online.
Oroton has been the Polo Ralph Lauren licence owner for Australasia
for more than 20 years and earlier this year renewed that exclusive licence
for another three years. Merchandise is sold through eight standalone retail
stores, nine Myer stores, five David Jones stores and five factory outlets.
Similar to The
Reject Shop, we see
a history of sustained
profit and return
on equity growth
from 2006-07 to
forecast 2009-10,
characteristic of a
strongly performing
business. This
coincides with the
change in chief
executive in 2006.
The growth
in profit from 2007, prior to the economic downturn, through to 2009-10
is impressive. More impressive is that this was achieved without new
capital being raised from shareholders. Capital increased solely from
retained earnings of about $8 million. Over this period earnings growth
was approximately $7 million, which shows a high capital retained to profit
conversion ratio. Stated simply, Oroton is a highly profitable business.
We have
adopted a forecast
profitability level of
112%, which we
regard as achievable
over the next few
years given how the
Oroton business has
demonstrated strong
like-for-like sales
growth and excellent
margins. However,
we note that the
maintenance of this
level of profitability
will be a challenge for management in coming years.
We believe the stock presents value at current market levels but investors
should note that the current share price and the StockVal valuation represent a
high multiple of equity. Thus, investors should seek to acquire the shares with a
significant margin of safety or a discount to the valuation of at least 10%.  u

Guy Carson is an analyst with Clime Asset Management, which uses StockVal.
For Eureka Report subscribers, StockVal is offering a free two-week test drive.
Click here.

Back to Contents
Published in Eureka Report on March 26
Research Watch
By Luke McKenna
PORTFOLIO POINT: This is a sampling of the week’s best research notes. In
a world of too much information, we hope our selection helps you spot the
market’s key signals.
Just when you thought the sovereign debt crisis was under control, Fitch
cuts Portugal’s credit rating and the whole issue blows up again. Research
Watch takes a look at what this twist will mean for stocks as ominous
“death crosses” form in key troubled markets; we also examine revelations
that the biggest holder of Hellenic CDS was actually a state-owned Greek
bank. So much for the evil international speculators demonised by the Greek
government. Meanwhile, North Korea shows the rest of the world how to
deal with underperforming finance officials, while corporate raider Carl Icahn
makes some big bets on a rebound in casinos. Research shows that adding
“China” to a company’s name can dramatically improve its prospects and
that investors now trust blogs more than their own brokers. Liberia aims
to modernise on the back of property investment – with mortgage-backed
securities and REITs – as a jenga-style financial crisis game is released as a
reminder, for the whole family, of where Liberia might end up. On video, the
head of global economics at Fitch Ratings explains Portugal’s downgrade.
A death-cross in Portugal signals market trouble … “Technical death
crosses – when key short-term moving averages move below longer-term
moving averages – have occurred in several of Europe’s troubled markets.
Most will agree that the stockmarket looks forward to events expected to
occur perhaps nine months down the road. It is one way we can explain why
stocks rallied a year ago when the financial world was in danger of collapse. If
we apply that same logic to the stocks of European countries with the greatest
economic difficulties, we will see … their markets are falling and have been
doing so for many months. Portugal’s PSI-20 index peaked in October of last
year and, unlike many of its healthier European neighbours such as Germany,
it was unable to move to new highs in December. As the chart shows, when
global markets including the US and China had their pullbacks in January,
Portugal suffered a 19% decline to its worst levels in February.
Spain’s IBEX-35 index also formed a death cross last week … Looking at the
other troubled markets in Europe, the so-called PIIGS, Italy and Ireland have
23
not had death crosses but Italy is close. Greece crossed in January … For
investors, all of these bad technical items from around the world do indeed
weigh on the bull market.” (Barron’s, March 24)
The Greeks bet against themselves … “After nearly a month-long
scapegoating campaign by Greek PM G-Pap … [against] all those who dared
to buy Greek CDS, with the stupidity reaching as far and wide as the Spanish
and German secret services, which said they would spy on CDS traders
in London and New York, Greek daily Kathimerini has just uncovered the
biggest speculator. Holding 15%, or $1.2 billion of the total $8 billion in Greek
notional CDS, has been a firm that operates about two blocks away from
the parliament building in Athens – the state-owned Hellenic Post Bank …
While there had been speculation that Greek banks were selling Greek CDS to
hedge funds, it had never crossed anyone’s mind that a Greek bank could be
betting on the collapse of its own sovereign host (especially one which does
not own Bernanke’s printing press), and that in such size! Frankly this beats
even the AIG fiasco by orders of magnitude in stupidity. Kathimerini reports
that Post Bank bought $1.2 billion of Greek CDS at 135 bps in August 2009
and sold them at 235 bps in December at 235 bps, making a profit of €35
million.” (Zero Hedge, March 22)
And a warning for controversial financial figures … “North Korea has
executed a senior official blamed for currency reforms that damaged the
already ailing economy and potentially affected the succession, according
to a news agency in South Korea. Pak Nam-gi was killed by firing squad
last week, said Yonhap, citing multiple sources. The Workers Party chief for
planning and the economy had not been seen in public since January. The
77-year-old was put to death as “a son of a bourgeois conspiring to infiltrate
the ranks of revolutionaries to destroy the national economy,” the agency said
… November’s abrupt redenomination of the won led to public discontent
and was having a negative impact on plans for the succession, another
source said.” (The Guardian, March 19)
Carl Icahn wagers big on casinos … “The billionaire investor has taken
control of 10 casino properties in the past three months and is currently vying
for three more. He grabbed control of nine Tropicana Entertainment casinos,
including the Tropicana in Atlantic City, acquired the partly built Fontainebleau
megacasino in Las Vegas and is currently in a contentious bidding war with
Donald Trump for control of three Trump-branded casinos in Atlantic City. It all
comes down to price, valuation and long-term potential returns … ‘I like to
wait and buy things when nobody wants them – that’s when you get the best
values,’ says Icahn, who made his investments through bankruptcy-court
proceedings. But he cautions that the sector still holds considerable risk and
that a rebound could be many months or even years away … Some wonder
if his move into the sector is a sign to start putting investment chips back on
the table and roll the dice on companies with big exposure to the US gaming
market. ‘It definitely could be a sign that valuations are at or near record low
levels,’ says Janet Brashear, a senior analyst at Sanford C Bernstein & Co …
This isn’t Icahn’s first foray into the casino sector. Between 2000 and 2006,
he purchased four casinos – the Stratosphere, Arizona’s Charlie’s Boulder,
Arizona Charlie’s Decatur and Aquarius Casinos – for $300 million, and sold
them for $1.2 billion in 2008 … ‘That’s a pretty good reward for waiting,
right?’ says Icahn. ‘Hopefully history will repeat itself’.” (Time, March 23)
The lure of ‘China’ lifts share prices … “Dozens of tiny companies have
gotten big stock-market boosts simply by adding the word ‘China’ to their
names. While the total dollars at stake are small, the trend is reminiscent of
 24
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the internet bubble’s heyday, when a company could launch its stock price to And gather the family, it’s time to relive the financial crisis … “Did Bear
the moon merely by tacking ‘.com’ to its official name … I asked Wei Wang, a Stearns cause the crisis or was it Lehman Brothers? Was it CDS, CDOs or
finance professor at Queen’s School of Business in Kingston, Ontario, to study CEOs? Was it Bush, Obama, Congress, or Madoff? Find out with Collapse! –
the returns of the 82 companies that have adopted new names containing the The Commemorative
word ‘China’ since late 2006. The list includes 18 last year and four so far in Game of the Financial
2010. Wang looked at returns from 20 trading days before the announcement Crisis … In the game of
through 20 days after. He found that the average stock that added ‘China’ Collapse! each of the
to its name outperformed the overall market by 31 percentage points over 54 blocks represents
that period. The results held up over shorter and longer periods … Consider one of the factors
Apogee Robotics, a company with no revenues or assets. It merged into a firm or events that helped
called Advanced Swine Genetics last September 30, immediately renaming create the crisis or hasten
itself China Swine Genetics Inc. The company didn’t announce the name its escalation. After stacking the blocks (the included instructions provide a
change until October 13, however. The next day, the stock went from $8.40 useful frame), players take turns pulling them out one by one until the entire
to $15.60, an 86% gain. Then it collapsed. Last week, a mere 100 shares structure collapses! Read the phrase on the block that caused the Collapse!
changed hands at $4.50.” (Jason Zweig in the Wall Street Journal, March 20) and reminisce about the ‘bad old days.’” (Bespoke Investment Group)

While investors trust blogs more than their brokers … Video of the week: Fitch on Portugal’s credit rating … The head of global
economics at Fitch doesn’t expect irrational contagion after cutting Portugal’s
rating, but expresses concern about the UK’s fiscal outlook. (YouTube)  u

(Clusterstock, March 23)

Modern Liberia seeks property investment … “Liberia will soon be 200

years old and, perhaps, the biggest village on the planet earth. As gloomy
this may sound, there is still hope for Liberia to transform into a modern
nation with abound opportunities for all … The modernisation of Liberia
through a community-based development can begin at an alarming rate
if the government of Liberia can provide end loans … If the government
can grab the bull by the horn and provide mortgage-backed securities, the
Liberian market would be flooded with a new pool of money from real estate
developers and investors looking to make a buck or two in this newly created
housing industry … The realisation of the dream can begin by the issuance
of T-bonds or Treasury bonds, a Liberian government debt issued in order to
underwrite mortgage loans on an affordable housing … How can a person
of non-negro descent take advantage of becoming a real estate developer in
Liberia, when Article 22 of the Liberian constitution forbids him from doing
so? … This can be accomplished through the creation of REITs [which] would
allow anyone to own shares in any commercial real estate as an investor. A
person of non-negro descent can own any number of shares, not the land, in
a real estate company that specialises in the development of commercial real
estate … I am sure Liberians in the diasporas and here at home along with
other foreign nationals would see this as an opportunity to own a developed
piece of the green coast.” (Armaso Bawn, professor of accounting at the AME
University, in The Liberian Observer, March 21)

Back to Contents
Published in Eureka Report on March 29
Collected Wisdom
By Alex Liddington-Cox
PORTFOLIO POINT: This is an edited summary of Australia’s best-known
investment newsletters and major daily newspapers. The recommendations
offered represent the views published in other publications and may not
represent those of Eureka Report.
Premier Investments (PMV). This retail conglomerate has become difficult
to analyse since it acquired Just Group. First-half net profit declined 14% to
$42.2 million, but Premier paid cash for Just so the diminished interest return
skewed the results. EPS dipped 31% to 28.5¢, revenue increased 9% to $473
million and EBIT swelled 8% to $58.5 million, leaving many investors more
than a little puzzled by the numbers. News that the global retail powerhouse
Gap plans to open 10 stores in Australia contributed to the weaker sentiment
surrounding Premier and knocked 5% off its share price.
The newsletters are well aware of the perils associated with retail
investment but they also think the share price punishment was a bit
overblown – major shareholder Solomon Lew has an excellent track record
and the newsletters respect that. The company’s Portmans brand performed
sluggishly, which Premier put down to opening too many stores without
adequate management. A new team has been installed and the newsletters
are content with Lew’s confidence that a turnaround is not far away.
Premier is facing the same challenges as the others in the retail space:
customers are forcing tighter margins on them by holding out for sales, when
prices are cheaper. In terms of its result, the newsletters are comfortable
with the assessment by Premier chief Jason Murray. “It was a tight result in
a competitive environment,” he said. “There were many highlights and one
major negative: Portmans.”
But while other retailers are on the nose, Premier still has $325 million
on hand to make more acquisitions. Lew expects to update the market in the
current half and the newsletters suspect it will involve a new market entrant
from the US or Europe. One publication says this is what sets Premier apart
from its rivals: while other retailers are trying to keep their own operations
in order, pumping money in to secure sales and margins, Premier is moving
along reasonably well with enough cash to expand. Lew has a formidable
record of picking up companies at a good price and making a handy profit by
the time he sells it, which should be taken into account with Just Group and
whatever he picks up next.
• Investors are advised to hold Premier shares at current levels.
WorleyParsons (WOR). The mining support services company was hit in
January when a market update about its first-half results demonstrated it
was not infallible. Worley managed to gather record earnings during 2009 as
the rest of the market back-pedalled. But the downturn finally bit in the latest
set of results, with a 30% contraction in first-half profit. Worley shares fell
from $32 before the trading update to below $23 by the start of February, and
they have since more or less tracked the benchmark index. With the company
still trading with the market update discount, the newsletters think there’s a
potentially attractive opportunity.
The newsletters point out that the company maintained its full-year
25
guidance of a $280–320 million profit, a firm illustration of their belief
that conditions will improve. But more broadly the newsletters encourage
investors to look at Worley for what it really is: a truly internationally
diversified company; its Australasian operations make up just 17% of its total
assets. The domestic operations that it does have are well established, with
an impressive order book. Worley secured a four-year extension to its 15-year
contract to the Woodside-Transfield joint venture. One publication says higher
oil demand and the feverish appetite for LNG will continue to drive revenue.
Another publication argues that investors who were concerned that
the company’s exposure to North America in the latest set of numbers have
overestimated the severity of the situation and downplayed the significance of
Worley’s exposure to emerging Asian economies. There’s substantial demand
building for minerals and metals in Asia and Worley has been shaping itself
accordingly for quite some time.
Worley’s dividend slipped from 38¢ to 35.5¢, but the franking credits
jumped from 76% to 100%, which evens things out. The newsletters argue
that Worley is sheltered from competition by providing niche services, but
sets itself apart from rivals through its diversity and focus on emerging Asia.
With a solid balance sheet, Worley stands to benefit handsomely from its
mining customers, which are increasingly strengthened by the emerging
demand of Asia.
• Investors are advised to buy WorleyParsons shares at current levels.
Oil Search (OSH). Front and centre of this oil company’s future is LNG. Oil
Search recently completed the sales and purchase agreement for its LNG
project in Papua New Guinea, promting one newsletter to heave a big sigh
of relief. Thanks to that milestone, the company will be reimbursed $US270
million from its lenders for some initial costs it has already shouldered.
Oil Search is pursuing LNG aggressively, mainly because of the feverish
interest in the commodity, but also because production from its existing
fields is declining. The latest numbers show that decline was somewhat
overshadowed by the weaker oil price, which hit the figures hard. Adjusted
full-year profit plunged 58% to $US100 million, revenue fell 37% to $US512.2
million and EBIT slid 52% to $US228.2 million.
One newsletter says investors, bullish about the oil price, are happy to
back the company’s efforts and have pushed its share price back into an
upward trend. However, the PNG won’t be producing until 2014, which the
newsletters agree is a long time for investors to wait.
Oil Search did express some concern that the oil price might remain
subdued in the short term if developed nations’ economic recovery continues
to falter. The newsletters disagreed, on two grounds: that chairman Brian
Horwood, who made the remarks, would not define “subdued”; and that
investors are looking at the oil price between now and 2014. Short-term
weakness isn’t ideal but it’s not a big problem. With a healthy balance sheet
featuring $1.3 billion in net cash, thanks largely to an $895 million capital
raising, investors appear happy to stay put and the newsletters are backing
them up.
• Investors are advised to hold Oil Search shares at current levels.
Insurance Australia Group (IAG). After many years of disappointing
shareholders this insurance company finally appeared to be gaining ground
on market leader QBE. The latest set of profit results show IAG posted
improvement in the margins while its chief rival missed guidance, although
this is up for debate. The fresh momentum among the smaller players led to
a burst of optimism that change was in the air and there was money to be
made. One publication described IAG and Suncorp as the “new darlings” of
the sector and saw IAG’s margin of 13.4% as a sign of more upside to come.
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Then the heavens opened in March. Victoria and Queensland were
savaged by storms, reminding investors that insurance is a game of risk.
Melbourne’s damage bill is heading towards $500 million; in Queensland
the figure could be more than twice that. By March 12, the afterglow of IAG’s
results was gone as it announced that claim costs were expected to reach its
maximum event retention level of $135 million and the company cut its full-
year insurance margin from 11.5–13% to 10.5–12%. The insurer added that
natural disaster costs were expected to exceed the budgeted $184 million for
the second half by $105 million, or 43%. Chief executive Michael Wilkins said
he was confident the company could achieve the revised margin target.
Two weeks later, on March 22, that target was history as Perth was hit
by storms, which could leave a clean-up bill of $300 million. IAG now expects
its margins to come in at 9.5–11%, after the insurer was flooded with 13,500
claims, pushing natural peril costs $180 million over budget. IAG added that
the targets are subject to their estimates being accurate, to foreign exchange
rates and investment markets. One newsletter couldn’t help but muse that
this margin is just a fraction off what IAG was expecting before the half-yearly
results.
The newsletters argue that investors got ahead of themselves with
the latest set of numbers. One suggested investors were looking for cyclical
upside after bunkering down with established players during the recovery.
But the newsletters added that investors need to understand that insurers
must be judged on their ability to minimise and diversify risk, which is not
only difficult to evaluate but is often not reflected in a single set of half-
yearly figures. Another newsletter pointed to IAG’s escalating price/earnings
multiple, which is sitting at a healthy 15.6, compared to QBE’s 10.7. Climatic
events like those earlier this month mean the newsletters are often wary of
insurers and IAG is no exception.
• Investors are advised to sell IAG shares at current levels.
Iluka Resources (ILU). This mineral sands company has frustrated many
investors looking to capitalise on the resources boom. Iluka produces zircon
and titanium minerals but has reaped somewhat limited benefits from
swelling prices due to the strong Australian dollar. Many investors will be
relieved to hear that Iluka’s management has moved to protect the company’s
earnings through medium-term currency hedging.
Iluka really struggled in 2008-09, booking an adjusted full-year loss of
$21.3 million, down from a $42 million profit a year earlier. The unadjusted
loss of $108.6 million included $110.7 million in non-recurring expenses,
write-offs and restructuring costs on the downside, and a $23.3 million profit
from a sale on the upside. Sales revenue dropped 41% to $624.7 million
and free cash flow was negative due to the high capital expenditure. One
newsletter says it was just bad timing that commodity prices tumbled as Iluka
was concentrating on getting its house in order. Iluka also looks unattractive
because its main commodities tend to recover more slowly than minerals
such as iron ore, which get all the attention.
But the newsletters argue that capital expenditure has peaked and the
fruits of the restructure will begin to flow through. Although Iluka’s results
were far from attractive they beat market expectations and one publication
could not help but notice that the share price had risen more than 20% since
the results, while the benchmark index has added 5%. It seems there’s more
to this mineral sands producer than meets the eye.
Part of the explanation comes from the iron ore price. Iluka doesn’t
produce any of it but it does collect royalties from specific parts of BHP
Billiton’s Mining Area C province in Western Australia. With the big iron ore
players moving towards massive increases in contract prices, iron ore is
shaping up as a serious secondary revenue stream for Iluka, which will help
bridge the gap.
• Investors are advised to hold Iluka shares at current levels.
Watching the directors
n Leighton Holdings boss Wal King has executed a series of trades over the
past two weeks that have left him in good stead. The latest were announced
late on Friday, the best time to avoid media scrutiny. After exercising rights
granted in 2006, King paid $5.9 million to convert 300,000 options to shares
on March 18 and almost immediately began selling down his holding by
70,000 shares for a cool $2.8 million. King sold more shares over the next
week, eventually offloading another 16,660 shares for $652,931, which
was announced last week. The net result of these transactions is King has
pocketed $3.4 million over the past two weeks while still retaining Leighton
valued at more than $13 million.
n Macarthur Coal chairman Keith De Lacy sold 100,000 shares, about
31% of his stake, for $1.2 million through his superannuation fund as part
of a personal financial restructuring by him and his wife. In a statement to
the ASX, Macarthur Coal said De Lacy and his wife were mainly closing out
a mortgage on an investment property and they had no intention of selling
down any further.
n Macmahon Holdings chief executive Nick Bowen disposed of 1.5 million
shares for $1.13 million at an average price of 75.4¢. The company said
Bowen offloaded the shares to meet tax obligations associated with shares
he had received for meeting performance targets. His remaining stake in the
company is worth around $4.6 million.
n Wotif.com Holdings managing director Robbie Cooke has pcoketed$3.8
million for a parcel of 500,000 shares. The company’s share price has rallied
hard from its bear market lows below $3 to be trading around $7.50. The
online accommodation booking company posted a 34% jump in first-half
profit on February 17 and expects conditions to continue improving in the
second half.  u

Recent directors’ trades worth more than $200,000

Date Company ASX Director Volume Price Value Action
24/03/10 Conquest Mining CQT Paul Marks 1,000,000 0.384 $384,450 Buy
18/03/10 Industrial Minerals Corp IDM Philip Garratl 2,500,000 0.116 $289,872 Buy
15/03/10 Rocklands Richfield RCI Benny Wu 1,118,396 0.244 $272,995 Buy
12/03/10 Nexbis Limited NBS Peter Dykes 2,000,000 0.15 $300,000 Buy
10/03/10 Nexbis Limited NBS Peter Dykes 4,210,000 0.144 $605,483 Buy
09/03/10 Nexbis Limited NBS Dato Sri Johann Yonng 2,000,000 0.148 $295,218 Buy
09/03/10 Charter Hall Group CHC Glenn Fraser 336,495 0.65 $218,722 Buy
08/03/10 K2 Energy KTE Robert Gaunt 2,000,000 0.11 $220,000 Buy
04/03/10 QBE Insurance QBE Francis O’Halloran 25,000 20.33 $508,149 Buy
04/03/10 Jupiter Mines JMS Priyank Thapilyal 2,442,195 0.24 $584,905 Buy
 27
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Published in Eureka Report on March 31

ValueLine: Directors
You may hear something along the lines of, “We will maintain our stated
policy of paying 50% of earnings out to shareholders as a dividend”, but not
a single word as to why this is the appropriate course for the company or the

behaving badly
By Roger Montgomery
PORTFOLIO POINT: They might be able to run a business, but many managers
are incompetent at allocating capital.
Warren Buffett is famous for his ability to select good investments, but the
way he runs his business interests is rarely discussed. It’s a shame really
because there is much that could be learned from his approach.
When Buffett makes an acquisition for Berkshire Hathaway, he asks
the vendor or their family to continue to run the business and retain a small
stake. Most people are aware of that. What many don’t appreciate is why he
asks that all the cash be sent to him for the purposes of allocation.
Running a business and allocating capital are two very different things
and it is common to find managers adept at one but incompetent at the other.
The most obvious example of this is the frequency with which Australian
company directors happily report their dividend payment policy but rarely
explain why or how they have reached the decision.
shareholders.
My previous column about dividends (click here) discussed the
importance of retaining profits when returns on equity where high; and
returning them in the form of dividends and buybacks when returns on equity
were low, declining or had plateaued.
Overlay on this non-disclosure of dividend policy the habit of raising
money from shareholders in the same year that dividends are paid and – the
most galling event – the emergence of the unfranked dividend, and you have
billions and billions of dollars being destroyed constantly.
There are exceptions to the rule and good managers who generate
modest returns on equity will elect to increase their payout ratios. This was
evident when Mark McInnes joined David Jones in 2003 after the retailer
had posted a prolonged period of single-digit returns on equity. Of course he
promptly set about increasing returns significantly.
But executives able to manage both the business and capital allocation
decisions are rare. Channel Ten is a company with a mixed track record
on return on equity. Between 2000 and 2002, and again in 2006, Ten paid
dividends that exceeded profits by running up increasing amounts of debt.
In 2009 dividends also exceeded profits but strong cash flows
enabled management to seize an opportunity and conduct a cash-boosting
equity capital raising that reversed the legacy of previous debt binges. Not
surprisingly, the ultimate outcome of all this capital allocating activity is
diluted shareholder wealth.
There’s no course, seminar or workshop in Australia for managers to

The ValueLine portfolio, as at March 30, 2010

Company Buy price Price Est Margin of Shares Invested Capital Divs Total Total
today value** safety bought value rec return return
JB Hi-Fi 14.8 20.3 19.65 -3.3% 845 $12,500 $17,145 0.62 $5,169 41.35%
Cochlear 56.36 72.84 56.3 -29.4% 102 $5,744 $7,424 1.9 $1,873 32.61%
CSL 31.81 36.43 32.87 -10.8% 163 $5,197 $5,952 0.75 $877 16.88%
Woolworths 26.16 28 26.85 -4.3% 206 $5,377 $5,756 1.09 $602 11.20%
Reece 17.8 25.75 17.78 -44.8% 236 $4,209 $6,089 0.53 $2,005 47.64%
Platinum Asset Mgt 4.06 5.2 4.45 -16.9% 854 $3,467 $4,440 0.2 $1,144 33.00%
CommBank 46.51 56.29 47.37 -18.8% 215 $10,000 $12,102 2.35 $2,608 26.08%
Since July 1, 2009
Security Value $58,909
Cash Value $57,268
Total Value $116,177
Total Return ($) $16,176.62
Return Invested (%) 34.61%
Total Return (%) 16.18%
XAO Change 23.90%
Negative Watch
Company July 1 Price Est Margin of Divs Total
price today value safety* rec return
ISOFT 0.635 0.565 0.19 -197.4% 11.02%
Amcor 4.79 6.39 3.63 -76.0% -33.40%

* Outperformance of invested portion 10.71%

* Outperformance of total portfolio -7.72%

**Last Intrinsic Value update 3/3/2010

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attend specifically about capital allocation and, unfortunately, it is particularly

evident in the business of takeovers.
You may have heard my views about corporate Australia being full of
toads that no amount of kissing will turn into princes. But poor decisions
are also made on the other side of the bargaining table, where boards fail to
negotiate the best possible prices for their businesses more often than you
could imagine.

•••••

Take Forge Group, a company that I really like and am assessing for inclusion
in the ValueLine portfolio.
Here is a business that ticks many of my criteria. It has virtually no debt,
profits have grown from $2.7 million in 2007 to an anticipated $40 million in
2010, generates high rates of return, has great cash flow and, perhaps most
importantly, its intrinsic value has risen at an impressive rate from just 50¢ in
2007 to over $3 today.
Further, based on my estimates for the demand of our resources and
the services of the companies servicing the sector, Forge’s value could rise to
over $4.60 and close to $5 in the next couple of years. My 2012 valuation and
the current one are both substantially above the current price of $2.93.
So if management knew something about allocating capital, why would
they recommend the placement of 15% of the company to Clough at $1.90
– a full dollar less than the current price and much less than the company’s
2012 intrinsic value?
And with the share price at $2.93, how can they in good conscience
continue with an agreement to recommend to shareholders the sale of
50% of the company to Clough at $2.10, even if there is a genuine strategic
alliance?
Dilutionary issues and placements of shares at prices below their
intrinsic value, destroy wealth and suggest that management would have
difficulty passing any course set on capital allocation (for more on this, see
GFC-hardened blue chips, page 4).
Now it may be that Forge reached some agreement with Clough in
the past when the share price was indeed lower, but to recommend it today
indicates directors’ lack confidence in themselves. Indeed, Clough might also
like to consider whether trading away Forge’s shareholders’ intrinsic value for
a strategic benefit is the best way to begin a partnership.
Unfortunately, this is not an isolated example and Australian corporate
history is littered with the written-down shells of acquisitions and the fleeced
bank accounts associated with poor investment decisions.
Capital allocation is about investing, about assessing alternate
proposals: to pay dividends or to reinvest in one’s self; to put the money in the
bank; make an acquisition; or even to buy back shares and acquire oneself.
But capital allocation is a field of expertise that business operation experience
does not automatically qualify you for.
As an investor it is important to assess not only management
operational expertise but their investing capability as well. The very best
businesses can be undone by the poor investment decisions of those charged
to be stewards of shareholders’ ownership stakes in the business.  u

Roger Montgomery is an independent analyst and managing director at

rogermontgomery.com.
 29
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Published in Eureka Report on March 31

The Speculator
By David Haselhurst
PORTFOLIO POINT: A host of small companies have been restoring capital
through share placements and issues, among them cancer-cure hopeful
Viralytics and several of our other portfolio “specs”.
Listed bio-technology company Viralytics Ltd (VLA) has cleverly locked in
sufficient funding to cover its planned research programs for as much as two
years.
This will underpin the company’s planned Phase II trials on melanoma
sufferers due to begin in coming months under the rules of the US Food and
Drug Administration rules.
Last week Viralytics shares traded up to 7.9¢ before closing the week at
5.6¢ after the company announced a placement of 28,650,000 new shares
at 5.3¢ a share to professional investors, to raise a gross $1,518,500. The
placement, to clients of HC Securities, was made at a 20% discount to the
10-day weighted average price of the stock between March 9 and March 22.
It is believed the surprise placement is the result of an unexpected
telephone call from HC Securities to Viralytics managing director Bryan
Dulhunty, after the financial services company had followed up on a positive
research report produced by a Sydney tipsheet on March 14.
The new funds will top up current cash of about $850,000 held by
Viralytics plus an available convertible loan facility worth $US4 million. (In
June, 2009, the company entered into a convertible loan facility with La Jolla
Cove Investors Inc of California for a total of $US6 million, broken into four
tranches of $US1.5 million. One tranche has been used up already and $US1
million has been drawn down from the second tranche.)
Better, Viralytics has also secured HC Securities to underwrite the
exercise of 28.65 million options at 4¢ a share due by June 30, 2010, to raise
a further $1.146 million. That has been done through granting Viralytics a
“put” option to enable the company at its own election to place any of the
28.65 million shares not taken up by option holders.
The latest placement of 28.65 million shares takes issued capital
to 404.61 million shares, which at 5.3¢ gives the company a market
capitalisation of $21.4 million. Viralytics’ shares have traded as high as 12¢
this year.
Among positive conclusions reached in Wise-owl.com’s research paper,
is the suggestion that success by any one of at least seven companies
worldwide investigating oncolytic viruses could re-rate Viralytics as it would
validate the field.
Queensland prospector’s turnover soars
The outlook for Queensland Mining Corporation (QMN) reviewed in this
column last week saw shares in the copper-gold prospector surge from a
week’s low of 12¢ to a high of 16.5¢ with 55.5 million traded during the
week, down to a closing price of 13.5¢.
That’s more than six times the volume of the previous week when
turnover totalled 8.18 million in a high-low range of 15¢ to 13¢.
The surge in turnover must have taken a lot of stale bulls out of the

The Speculator portfolio, as at March 30, 2010

Company ASX No of shares Bought Purchase price Current price Current value
Cortona Resources options ex. 20¢ by 31/01/2012 CRCO 25,000 31/12/2009 $0.042 avge $0.061 $1,525
A1 Minerals AAM 20,000 31/12/2009* $0.370 $0.230 $4,600
Image Resources IMA 8,000 31/12/2009* $0.830 $0.745 $5,960
Golden Gate Petroleum op ex. 8¢ by 31/8/2012 GGPO 6,665 31/12/2009* $0.017 $0.017 $113
Viralytics VLA 50,000 31/12/2009* $0.037 $0.056 $2,800
Trafford Resources TRF 20,000 31/12/2009* $0.760 $0.650 $13,000
OBJ Limited OBJ 100,000 31/12/2009* $0.029 $0.045 $4,500
OBJ options ex. 1¢ by 31/12/2010 OBJO 11,111 21/01/2010 Free $0.034 $378
Beacon Minerals BCN 200,000 13/01/2010 $0.024 $0.029 $5,800
Quickstep Holdings QHL 20,000 14/01/2010 $0.520 $0.350 $7,000
Golden Gate Petroleum GGP 100,000 25/01/2010 $0.040 $0.038 $3,800
Robust Resources ROL 3,000 9/02/2010 $1.15 avge $2.130 $6,390
Scotgold Resources SGZ 20,000 16/02/2010 $0.105 $0.097 $1,940
Coalworks CWK 10,000 9/03/2010 $0.275 $0.340 $3,400
Queensland Mining Group QMN 50,000 23/03/2010 $0.125 $0.130 $6,500

Total value of portfolio $67,706

Owe the bank -$28,507
Total $39,199

Portfolio change since January 4, 2010 (started with $40,000) -2.00%

All Ordinaries change since January 4, 2010 (then 4889.8) 0.76%

*Shares held from last year. They are carried at their December 31, 2009 closing price.
 30
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market and, coincidentally, it almost matches the size of the 60 million share
placement the company made earlier in March at 13.5¢ a share to raise a
gross $8.1 million.
Briefly, last week’s report concerned Queensland Mining’s $5 million
purchase of the White Range project from the receivers of Matrix Metals, with
a claimed JORC-compliant resource of 163,000 tonnes of copper in material
grading 1.1% copper. White Range, together with Queensland Mining’s other
seven or eight projects, are all clustered in the Cloncurry region of northwest
Queensland.
Late last week, Queensland Mining released another report to the ASX
on its 100%-owned Flamingo project, announcing a maiden inferred resource
estimate at a shallow depth below surface (a maximum depth of 60 metres)
of 117,000 tonnes of material grading 6% copper and 1.8 grams per tonne
(g/t) gold.
That’s not a lot yet, but it is comparatively rich. The company also
announced an additional at Flamingo target based on previous drilling of
100,000–150,000 tonnes of 2–4% copper and 1–2 g/t gold, plus a further
“conceptual target” outside the current range of drilling of between 200,000
and 300,0000 tonnes at similar grades.
Following its recent placement, the company is cashed-up. So it was
also able to announce that a 2500-metre drilling program would start in
April to increase both the size of the resource and the company’s level of
confidence.
Yesterday, the company announced a further 5000-metre diamond
drilling program to begin in late April on its 100%-owned Jessie Vale project.
It is 30 kilometres northwest of Xstrata’s Ernest Henry mine (based on a
resource of 167 million tonnes of 1.1% copper and 0.54 g/t gold) and claimed
to be within the same structural corridor bounded by northwest trending
faults.
The new drill targets will be testing “large, untested geophysical
anomalies” preceded by follow-up electro-magnetic surveys to be carried out
in the next two weeks. That should keep all the new shareholders on their
toes.  u

David Haselhurst writes a monthly column for Money magazine. Please note
that he is not able to provide personal replies to emails.

Back to Contents
Published in Eureka Report on March 31
How far can
property rise?
By Monique Wakelin
PORTFOLIO POINT: Market observers suggest property prices will rise by 10%
or more this year. Where do you see prices going?
There was no doubting the determination of Reserve Bank governor Glenn
Stevens this week when he appeared on breakfast television to hose
down property speculation. “It is a mistake to assume that a riskless, easy
guaranteed way to prosperity is just to be leveraged up into property,” he
said. “It isn’t going to be that easy.”
It was an unprecedented move, and some in the media were quick
to make bold predictions that a bubble was about to burst. I thought his
message was much more a sober warning: Don’t borrow too much and don’t
expect every residential property to be an investment winner.
So, we know what Stevens thinks, but what do you think will happen to
property prices this year? I believe they may rise as much as 15% in parts of
major capitals, and 5–10% more broadly before the year is out.
In Melbourne, heightened activity is continuing to attract headlines, as
are predictions that the city’s population will reach seven million by 2050.
This is the year smart investors, who have done their homework and chosen
their location and property types well, should find compelling returns on their
investments.
I see investment-grade houses and apartments in Melbourne’s inner
ring rising by 12–15%, while middle-ring property should go up 8–10%.
Outer-ring areas should see a moderate rise of 5–7%. Underlying these
predictions is the fact that 1700 people are migrating to Melbourne each
week, many of them attracted by a strong economy and job market. This is
occurring on top of the pent-up housing demand, which has been building
since before the financial crisis.
I spoke to experts across the country this week to see how my forecast
was reflected in other cities. All agreed investment-grade property in inner-
ring suburbs should rise by more than 10%. Again, this is where wise choices
by smart investors will be well rewarded.
In Sydney, Property Buyer director Rich Harvey concurs that the biggest
rises are expected in the inner ring, where he is predicting rises of 10–12%.
Proximity to the CBD, demand for limited stock in established areas with good
infrastructure and a general undersupply of stock are the key factors at play
here, he says.
“Properties in the 5–15 kilometre ring of Sydney should experience rises
of 8–10% this year, driven by access to schools and a reasonable commuting
distance from the CBD,” he says. “The market in the outer ring of Sydney
is still reasonably strong but it is coming off a low base, yet Sydney’s outer
ring could still see up to a 7–9% price rise this year.” Harvey has an overall
qualifier though: the pace and severity of interest rate rises will certainly help
to determine the trajectory of price increases this year in Sydney.
In Brisbane, Meighan Hetherington, managing director of Property
Pursuit, says investment-grade properties may experience an 11% price
31
rise over the year but with a clear distinction that those in flood-prone inner
areas could see values lowered by as much as 10–15%. “Middle-ring homes
– those in the $550,000–600,000 range – are in demand and may also see
an 11% rise,” she says. “I can’t comment on outer-ring prices because we
concentrate on inner-ring investment-grade property but it is apparent that
investors have returned to the outer ring just to get into the market.” (Whether
this is a wise move for them remains to be seen.)
In Adelaide, Anthony Toop, of Toop & Toop, expects an overall rise of 10%
in 2010. He says the top end is driving the market: prestige properties are in
short supply and all good properties are selling at a premium with 10–12%
price rises anticipated. “The middle ring, $500,000–700,000 market, is
strong but not hectic for owner occupiers and investors and we should see
about an 8% rise here,” he says. He predicts a 7–8% rise for the bottom end
of the market despite some predictions that this market might have stalled
after the end of first-home owner’s grant boost.
In Perth, Gavin Hegney, of Hegney Property Group, says prices for
properties in the city’s inner and middle suburbs are expected to increase by
10% by the end of 2010. “The excess stock is off the market and we are now
seeing some buying pressure and price rises,” he says. The wild card for the
outer ring is significant lack of land supply.” In Perth, the downside of interest
rates is counterbalanced by risks to the upside: namely land supply.
In Darwin, Todd Petersen of Peterson’s Property Search, says there is a
growing undersupply of properties for a city whose population is growing by
4000 a year. “Price pressures are being felt at nearly all levels and we still
have major employers about to arrive on the doorstep,” he says. Properties in
the most popular $450,000–600,000 range, are likely to achieve a 15% rise
over the year but higher-priced units at the $830,000 mark in inner Darwin
should only see a 10% rise. Property under $400,000 should also experience
a 15% rise. Darwin’s prices are certainly on the move.
Compare these views with those of the controversial economist Steve
Keen, who famously predicted house price drops of up to 40% in Australia
and still believes we are heading for a property bust. Keen has stuck to his
guns, saying recently that we still have a house price bubble while Japanese
and US bubbles have already burst because of “the same old same old:
debt”. (A message that is perhaps not entirely unconnected to Glenn Stevens’
breakfast address.)
Keen says Australia’s aggregate level of private debt to GDP over the
past 150 years is the biggest debt bubble in our history and we will see the
“long overdue bursting of the Australian property bubble – along with the
unwinding of excessive housing leverage and the slowdown in the rate of
growth of mortgage debt”.
Yet despite this prediction, we have clear signs of solid price growth in
each capital city.
n Property is always a hot topic of conversation and I’m very interested
to know what Eureka Report subscribers think will be happen to prices
this year and which factors they believe will be the most influential. Do
you believe this is the year wise investment choices will be rewarded or
do you fall into the Steve Keen camp and think house prices are set to
fall? I’d love to hear from you. In the meantime, there’s plenty of fat to
chew!
What do you think will happen to house prices this year? If you
would like to have your say, click here and tell us in 150 words or
less by Monday April 5 what you think will happen to house prices
in your market in 2010 and why. Remember to include your name
and region and we’ll publish a selection of the best answers in a few
weeks’ time.

Back to Contents
Property Q&A
This week:
n I’m thinking of buying a property with my sister.
n Is US property really that cheap?
n Should I buy in Guildford, in Sydney’s west?
n Estimates seem out of line with selling prices.
All in the family
I was really interested to read your column last week (see Property
investment buddies) as my sister and I are looking to buy a house
together. We have about $550,000 between us and the idea is to live in
the house for two years, then move out and let it for five years then sell
it. Is this a good plan?
There are a couple of things you should consider you finish planning and
start purchasing. First, you need to determine why you are buying: is it for
investment or as house to live in? As your plan assumes you will live in
the property for only for two of the seven years you intend to own it, I will
assume the purchase is primarily for investment purposes. If that’s the case,
you should make sure the house you buy meets all of the investment-grade
property benchmarks, and don’t assume it will achieve good capital growth
just because you and your sister like it.
You should start by going through the checklist I provided in last week’s
column, a checklist designed to start you thinking about what you will each
need to do and to help you understand that while your interests may be the
same now, they may be quite different in five or seven years’ time. So before
you buy anything, make sure you have a plan and a written comprehensive
agreement and you have each consulted a solicitor about your arrangements.
Also, I am wondering why you would sell it after only seven years rather
than use the equity to begin building a portfolio? Holding investment property
for the long term is by far the better way to go.
US property
I am getting emails about buying US property, and to me they appear
dirt-cheap. What are drawbacks of investing in US properties? What is
your time frame for US property market recovery?
Why do you think these people are spam emailing you? That’s right, because
they can’t sell these properties to anyone else in the US. They might look
cheap from an Australian perspective, but the US market is telling these
vendors their properties are not worth the asking price.
In answer to a similar question in February (click here) I outlined the
main reasons why property in most US cities, if it is selling at all, is cheaper
than it was three years ago. Essentially it boils down to America’s economic
plight, its high unemployment rate, its booming federal debt and the fact
there is an enormous supply of foreclosed properties hanging around the
market unsold following an out-of-control construction boom from 2001 to
2006.
But what I really want to impress on you is that there is no iron law of
physics that says US property prices have to go up. Americans have to find
a way to revive their economy before prices will rebound. Without a revival
property prices could stagnate for a long time. It has happened elsewhere.
If that sounds a little fanciful, just remember that it was only two or three
years ago that financial experts routinely described US mortgages as “safe as
32
houses”, not the bundled up parcels of dubious assets some of them turned
out to be.
Until we have very clear indications that the US economy and property
market have become the beneficiaries of astute and coordinated actions
between American governments, foreign investors who buy into most US
property markets are not investing, they’re gambling.
Buying in Sydney’s west
I have been looking for an investment property in Sydney’s west but
prices are forcing me to push out from where I originally intended to
buy. What do you think of the Guildford area?
Your goal as an investor is to find the best possible property in the best
possible location for the budget you have. Start with the location first and aim
for a high-growth, high land value area. The next step is to find a property
type that ticks as many of the “good for investment” boxes as possible so
that you get the best capital growth outcomes and resilience, whether the
market is rising, slowing or falling.
You haven’t told me which location you started with, just that you’ve
headed further out as your budget would not allow you to purchase in another
area. It’s possible that you have put the cart before the horse and will only
buy a certain property type and you’re prepared to move areas to get it.
As a home buyer that’s fine but as an investor that’s the wrong approach.
A one-bedroom apartment in a great location will deliver better growth to
an investor than a three-bedroom house in a compromised location. Why?
Because the many different buyer types in a high-demand location will push
prices higher, more consistently over the cycle.
Guildford certainly has some factors going for it, namely that it is
affordable, has a train station and some relatively consistent streetscapes
with Edwardian houses. But its location in Sydney’s outer west is not ideal.
This area saw prices actually go backwards between 2003 and 2007, and
though it has recovered now, it would not be the first place I would buy an
investment property.
If you are looking at a house in the Guildford area then you should be
able to afford top-notch one-bedroom apartments further towards Sydney’s
centre. That’s where I would be heading.
Quoted prices and reality
I went to bid at an auction on the weekend for a house in Melbourne’s
outer east I thought was just perfect for investment. It was advertised at
$330,000–360,000 but sold for $457,000.
In Victoria, a real estate agent doesn’t have to use a price in their advertising
for a property going to auction, but if they do, the advertised price should
appear in the form of an estimated selling range (ESR). The agent should
ensure that the upper figure of this range is no more than 10% higher than
the lowest figure of the range; for example, a range of $500,000–550,000.
The agent’s quoting range is merely an early indication of what the
vendor might accept as an opening offer, which may be negotiated upwards.
The ESR is generally lower than the correct market value and designed by
the agent to generate enquiry and interest. If an offer is received or the profile
of interested buyers suggests that the market will pay more than the original
quoting range, the ESR should be adjusted upwards to reflect the market’s
level of interest.
Investors should only ever interpret the ESR as a minimum indication
of the price range, not the true market value of the property. It’s legal but not
transparent or reliable.
 33
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The best way for investors to manage what is often referred to as

underquoting is to forget what the agent tells you about the price and
understand the conditions driving the market, in particular what prices
are being achieved by comparable properties in the area. A thorough
understanding of your local market and actual sales prices will better equip
you to estimate the price a property will fetch so that you shouldn’t find
yourself surprised too often.  u

Monique Wakelin is co-founder of Wakelin Property Advisory, a Melbourne-

based independent property acquisition and advisory company, and co-author
of Streets Ahead: How to Make Money from Residential Property.

Note: We make every attempt to provide answers to readers’ questions,

however, answers are of a general nature only. Subscribers should seek
independent professional advice for more in-depth information that is specific
to their situation.

Do you have a question for Monique Wakelin? Send an email to monique@

eurekareport.com.au.
 34
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Published in Eureka Report on March 31

Letters of the Week

By Eureka Report subscribers

Telstra is doomed
I have great respect for Alan Kohler’s opinions, but I think that his latest piece
on Telstra is way off the mark (see Don’t discount Telstra).
I cannot understand why anyone would think the NBN would want
Telstra’s infrastructure. The only thing of value that Telstra has is its
underground pipes and the NBN could lease access to them on quite
favourable terms. Telstra will never be able to compete with the NBN simply
because its copper lines carry internet traffic too slowly. Supposedly, once
a line is more than four kilometres from an exchange, even apparently
superfast ADSL2+ (speeds up to 27mbps) only reaches a maximum of
3–4mpbs. Forget being further away than that: the further from the exchange,
the slower the speeds. Anyone who says speed doesn’t matter is crazy.
Telstra’s 3G is testimony to that, as is ADSL2+. Telstra is a dinosaur and will
become extinct.
– M Raiteri

At the NBN forefront

I happen to live in Tasmania near one of the towns that are about to trial
optic fibre provided by the NBN. It is noticeable that the fibre is high above
the ground, attached to power poles. It appears vulnerable to damage from
storms, wind (common in this area) and road accidents as the poles run
along the main highway. Perhaps Telstra should wait and see how the NBN
operates. Fundamentally, can the NBN provide a reliable service and how
much will it charge its customers? At a recent local meeting with NBN and
potential clients, no pricing was available.
– C Bishop

Misdirected thinking
I was amazed to read that Telstra thinks it will regain print share with its
directories. It is almost unbelievable it could think that. Just in our family we
now have four iPhones and do almost everything on them or on my computer.
I am over 70 and haven’t used a phone book for years – why should I? Of
course what they lose on print they will gain on mobiles.
It could be naivety, but I am amazed that Telstra isn’t doing the NBN.
If they did, the Telstra shares in the Future Fund would become even more
valuable, and all Telstra shareholders would be rewarded for their patience.
Maybe I’m missing something here, but it just seems to make sense.
– C Stewart

Back to Contents
Published as an email to Eureka Report subscribers on March 27
Week in View
By Alan Kohler
Last night’s close:
n Dow Jones, up 0.08%
n S&P 500, up 0.07%
n Nasdaq, down 0.1%
Greece grease
Add a few more to the “too big to fail” list: Greece, Dubai, every American
homeowner, Australia’s banks.
Europe’s leaders were last night weeing with pleasure and self-approval,
after Germany and France finally agreed to a Greece bailout. Wall Street
rallied as a result.
US stocks then gave up the gains at lunchtime when news came
through that a South Korean naval ship had been sunk by an explosion,
possibly caused by the arrival of a North Korean torpedo. It was dark, a
second South Korean ship arrived on the scene and saw sailors floating in the
water, and started firing at an unidentified target. Not good.
Anyway, back to the Greecey pole. It presumably won’t be long before
it all goes avocado-shaped again, or rather that markets realise that it hasn’t
stopped being pear-shaped. Europe’s leaders have been flip-flopping so
much on the subject of Greece that they don’t know which way is up or which
day it is. As the FT’s Lex column remarked this morning: “Yes, no, yes, no,
said the politicians. Up, down, up, down, went the markets.”
It’s an inadequate loan facility (rumoured to be E20 billion when,
according to The Economist, E75 billion is needed); every EC member has
a veto, which is itself a guarantee of failure; the amount of the facility and
the interest rate is undisclosed; and it’s decidedly unclear whether Greece
can reach fiscal sustainability anyway. But it presumably gets Greece past
the e11.5 billion in bonds that need to be refinanced at the end of April. And
at least Germany’s hard-working citizens will not be underwriting Greece’s
shorter working week, longer holidays and younger retirement age, which is
the main thing.
Meanwhile, the government of Dubai announced that it would
recapitalise Dubai World so none of its bondholders would lose any money. It
had previously been felt that Abu Dahbi would do all the bailing out, but the
neighbouring emirate has melted into the shadows having given Dubai $US10
billion last year.
Why it’s taken so long for the Emir of Dubai to cough that money up to
Dubai World’s investors is unclear, but it finally happened yesterday. Maybe
they wanted to wait until everyone forgot that the money came from Abu
Dhabi, so Dubai could say, as it did yesterday, that it is standing on its own
feet now. Yeah, right.
So count Dubai World as too big to fail, with Greece.
Count, also, America’s beleaguered homeowners. With up to 13
million foreclosures anticipated over the next five years in the US, the
Obama administration last night announced a $US50 billion expansion to its
mortgage assistance program, to help people stay in their homes without
paying.
The trouble is, it’s not enough. What’s more, the mortgage assistance
35
programs inside the $700 billion TARP uber-program have never been enough
and have never prevented a material number of foreclosures, because the
lenders won’t go along.
This is the long tail of America’s mortgage madness, 2003–2007,
which caused the GFC. Millions of people borrowed too much and then paid
too much for houses with money they shouldn’t have been lent. Lenders –
mostly mortgage brokers on commission, working for investment bankers on
commission – didn’t check whether the borrowers could repay the loans.
Now a lot of those people are out of a job and on the dole, and obviously
can’t keep up repayments, especially if they’re on “reset” mortgages, where
the interest rate was low for a couple of years and then resets higher (round
about now).
The new Obama plan means some jobless homeowners will be
subsidised so their loan repayments will be 31% of the dole, or defer
repayments for six months. However, the investors who own the loans have to
agree to take a haircut, which so far they’ve been reluctant to do.
And finally, also on the too big to fail register … Australia’s banks? Well,
APRA put out some data during the week that show the four majors account
for 84% of net interest income, 78% of fees and commissions, and 73% of
all bank profits. The big four’s average profit margin is 21.6%, compared to
8.6% for the rest.
THEY’RE CLEANING UP. And each of them is certainly too big to be
allowed to fail, not that there’s any danger whatsoever of that, but it’s
worth bearing in mind as they eventually and inevitably respond to their
extraordinary profitability by believing their own bulldust and going mad.
Murdoch paywalls
Rupert Murdoch’s News International announced last night that the Times and
Sunday Times in London would start charging for their content in June: £1 per
day, or £2 per week: the same as the newspaper.
It’s the culmination of Murdoch’s campaign against Google and the
giving away of News Corp’s journalism. Rebekah Brooks of News said last
night it’s a defining moment: “We are proud of our journalism and unashamed
to say that we believe it has value”. As one blogger put it, the 10-year free
trial is coming to an end.
What it really means, it seems to me, is that the Murdoch group
is simply giving up on making money from websites: this is all about a
desperate attempt to protect print revenues. Other perfectly good websites,
such as the BBC and The Guardian will remain free, so no one will pay £1
a day for the Times or the Sunday Times online, but they might refrain from
cancelling their subscription to the paper … maybe. Anyway, the strategy will
be a success if newspaper profits stop declining.
Alan Rusbridger, editor of The Guardian, says it’s a “hunch”, and I think
he’s right. Murdoch has always been a big risk-taker, and putting paywalls
around his newspapers’ websites is perhaps his greatest punt of all.
Gotty and me
Robert Gottliebsen and I entertained a crowd of CPAs at lunchtime on
Thursday with tall but true tales from our combined 90 years in journalism.
We had a lot of fun, although I didn’t get to tell the story of how we met. So I’ll
tell you now.
It was 1978, and I had just returned from England, newly married to
Deb, and got a job on The Age as a finance reporter. I looked around for who
I might emulate to improve my skills and I thought the Chanticleer column in
the Financial Review was pretty good, so I started trying to copy the way it
was written. It was not by-lined in those days, so I had no idea who wrote it.
About a year later this bald bloke sidled up to me at a Ford Australia
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press conference and said: “Hello, I’m Bob Gottliebsen and I write the Bond investors will demand higher premiums to offset the rising risk,
Chanticleer column. Would you like to come and work with me?” and shares will start getting some serious competition from bonds. In the
After five years Bob needed a successor on Chanticleer, and he quite past, when shares were fully valued, a bond market correction also brought
liked the way I wrote, for some reason. What I never told him, until this week on a sharemarket correction. Shares are certainly fully priced now after the
(to his astonishment), is that it was because I had been copying his style. And 10% rally from the February lows, so fasten your seat belt.
thus began a beautiful, life-long friendship based on the sincerest form of My Weekend Briefing email won’t arrive next Saturday because of
flattery: imitation. Easter, so I’ll be back with Steve on my lap and Sam at my feet as dawn
breaks in a fortnight. Have a great Easter.  u
Jeff Beck
My son Chris and I went to his concert in Melbourne last night and the Palais
seemed to be full of middle-aged men taking puzzled sons, to show them
what it was like in the sixties when The Yardbirds and Led Zeppelin ruled the
world.
It was better than I’d hoped in my wildest nostalgia. Chris was agog.
The man is a genius, even better than he was 40 years ago – a peerless
master of the Fender Stratocaster, ranging brilliantly from loud, driving blues/
rock to an astounding version of the Beatles’ Day In The Life and a beautiful
cover of Somewhere Over the Rainbow. His encore, to a roaring Palais crowd,
was Nessun Dorma, one of my most loved songs. It was an incredible, eye-
watering end to the night: if anything the Fender was more heart wrenching
than Pavarotti’s voice, more powerful than Aretha Franklin’s.
Is Beck the greatest living rock guitarist? After last night, I think he is.
I saw Clapton two years ago and, before that, Santana. Neither was up to
Beck’s level. Hendrix might have been better, but he’s dead. (Rolling Stone put
Hendrix at No.1 rock guitarist of all time and Beck at 14 – a travesty, in my
view). Beck out-Gilmoured Dave Gilmour with beautiful lyrical harmonics; he’s
better at finger picking than Mark Knopfler; he drove the driving rock better
than Clapton; and he’s a superior technician to Jimmy Page, Keith Richards or
Duane Allman.
And, by the way, bass guitarist Tal Wilkenfeld almost stole the show
last night. She’s an Australian-born New Yorker in her early 20s and an
unbelievable virtuoso on the bass. I have never heard this instrument played
like that.
If I’m sounding a bit overwhelmed, it’s because I still am. It was an
incredible concert.

Matisyahu
This 31-year old Hasidic Jew from Pennsylvania has been serenading my
commuting to and from work this week with his remarkable blend of reggae
and hip-hop.
Matisyahu is a Hebrew version of his birth name, Matthew (Miller). He
joined the Lubavitch Hasidic sect in 2001 and started producing records
a few years later. His latest album, Smash Lies, is a big hit and the single
from it, One Day, was the official anthem, would you believe, for the Winter
Olympics in Vancouver, as well as being a huge hit.
The music is a wonderful surprise: joyous, complex and very modern.

Next week
The main problem for sharemarkets in the weeks ahead is that bonds are
starting to crack. Yields have been rising and prices are falling. Shares can
never hold out for long against a bond correction.
Maybe last night’s news on Greece and Dubai will turn the bond market
around in the short term, but fundamentally the outlook for investing in
government securities is very poor. At some point this year cash rates will
start to rise in the west (apart from in Australia, Israel and Norway) as the
supply of bonds relentlessly increases with governments trying to fund their
deficits.