Independent Appraisal Report

Transcription

1 Independent Appraisal Report in relation to the Restricted Transfer Notice given by NorthWest International Healthcare Properties Real Estate Investment Trust to acquire up to an additional 5% of the units in Vital Healthcare Property Trust 19 April 2013 Independent Directors Vital Healthcare Management Limited PO Box 6945 Auckland

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3 Table of contents 1 Introduction Background to the RTN Scope of the Report Independence Other Executive summary Industry analysis New Zealand listed property sector overview LPV performance Management structures Healthcare real estate sector Overview of the Trust Overview and history Structure Manager role and functions Property portfolio Unit holders Unit price performance Financial analysis Financial position Financial performance Assessment of the proposed transactions Valuation analysis Discounted cash flow Broker valuations Valuation analysis summary Other benefits and risks to Non-Associated unit holders Appendix 1: Sources of information Appendix 2: Qualifications and declarations Appendix 3: New Zealand listed property vehicles Appendix 4: Key United States listed property vehicles Appendix 5: Weighted average cost of capital i

4 Glossary of key terms Budget Vital s budget for the year ending 30 June 2013 DCF Discounted cash flow EBIT Earnings before interest and tax FY Financial year GFC Global financial crisis LPVs Listed property vehicles NorthWest NorthWest Value Partners Inc. NorthWest International NorthWest International Healthcare Properties Real Estate Investment Trust NTA Net tangible assets NZX NZX Limited NZX Main Board The market on which Vital s units are traded PIE Portfolio investment entity P/NTA Price to net tangible assets the Report This independent appraisal report RTN Restricted Transfer Notice TERP Theoretical ex rights price TGR Terminal growth rate VHML or the Manager Vital Healthcare Management Limited (the manager of Vital) Vital or the Trust Vital Healthcare Property Trust VWAP Volume weighted average price WACC Weighted average cost of capital WALT Weighted average lease term YTD13 Financial year-to-date for the eight months ended 28 February 2013 ii

5 1 Introduction Vital Healthcare Property Trust ( Vital or the Trust ) is a listed unit trust traded on the NZX Main Board, which invests in health and medical related properties in Australia and New Zealand. Vital Healthcare Management Limited ( VHML or the Manager ) is the manager of the Trust under the terms of a Trust Deed dated 11 February 1994 (which was amended and replaced by a Trust Deed dated 1 September 1999 and which deed was subsequently amended by deeds of amendment dated 10 November 2003, 12 November 2007, 12 December 2007, 5 August 2008 and 27 September 2010 and 1 November 2012) (the Trust Deed ). On 2 April 2013, NorthWest International Healthcare Properties Real Estate Investment Trust ( NorthWest International ) gave Vital a Restricted Transfer Notice ( RTN ) advising of its intention to seek to acquire up to 15,352,830 units (or 5% of the units) in the Trust to take its interest to up to 24.99% of the Trust. NorthWest International is an associated person of NorthWest Value Partners Inc. ( NorthWest ), the sole shareholder of VHML, the manager of the Trust. The RTN has been given under the Notice and Pause provisions in the Trust Deed and NZSX Listing Rules. The Notice and Pause provisions apply in respect of any NZX issuer which is not a code company under the Takeovers Code. The independent directors of VHML (who are not associated with NorthWest or NorthWest International), as manager of the Trust, have appointed KordaMentha to prepare an independent appraisal report as required under NZSX Listing Rules and ( the Report ). Our appointment was approved by NZX Regulation on 3 April Background to the RTN NorthWest International has given notice to VHML and NZX Limited ( NZX ) of its intention to seek to acquire up to 15,352,830 additional units in the Trust (referred to herein as the proposed transactions ). The proposed transactions constitute Restricted Transfers for the purposes of section 4 of the NZSX Listing Rules and clause 16 of the Trust Deed. The relevant part of Rule of the NZSX Listing Rules defines Restricted Transfers of quoted equity securities as follows: Restricted Transfer means: The Transfer which would result in the Votes controlled by any person or group of persons who are Associated Persons of each other, of any Class of Quoted Equity Securities of an Issuer: 1. exceeding 20% of the Votes attached to that Class; or Furthermore, NZSX Listing Rule states: No Restricted Transfer of Quoted Equity Securities shall take place unless notice is given to the Issuer, and to NZX NorthWest International has given a RTN, pursuant to NZSX Listing Rules and clause 16 of the Trust Deed. Key details provided in connection with the proposed transactions referred to in the RTN include: The consideration to be paid for each unit under the proposed transactions will be in the range of $1.15 to $1.38. The completion of the proposed transactions is only conditional upon there being sufficient sellers of units within the price range offered by NorthWest International. The proposed transactions relate to units in Vital. The maximum number of units to which the proposed transactions relate is 15,352,830 (being 5% of all units on issue). Upon completion of the proposed transactions, NorthWest International and associated persons would have a relevant interest in the Trust of 24.99% of all units on issue. Page 1

6 The proposed transactions are intended to occur within and over the period of up to 12 months after 24 April However this period may be extended in accordance with the applicable terms of the Trust Deed and NZSX Listing Rules. The proposed transactions are intended to be effected on-market through the NZX Main Board s order matching market. These details indicate that NorthWest International is reserving the ability to acquire units up to the maximum level indicated over a 12 month period through the NZX Main Board s order matching market at prices within NorthWest International s specified price range. It is not bound to acquire all or any (and may acquire some or none) of the units specified. NorthWest International s purchases via the NZX Main Board s order matching market will, at the time of purchase, be indistinguishable from ordinary/other buying and selling activities. The details (timing, quantity and price) that NorthWest International has notified may be modified by following the notice of change procedure set out in the NZSX Listing Rules. 1.2 Scope of the Report The content requirements for the Report can be summarised as follows: Under NZSX Listing Rule the Report is required to: be addressed to the holders of securities of the class the subject of the RTN (i.e. unit holders); express KordaMentha s opinion as to the consideration and other terms of the proposed transaction; and comply with NZSX Listing Rules 1.7.2(e), (f) and (g) as if the Report is an Appraisal Report. Under Listing Rule (as NorthWest International is an Insider) the Report is to be an Appraisal Report and meet the requirements set out in NZSX Listing Rule (including those identified above). Under NZSX Listing Rule 1.7 key requirements for Appraisal Reports include that the Report shall: be for the benefit of unit holders not associated with NorthWest International (the Non- Associated unit holders ); state whether or not in KordaMentha s opinion the consideration and the terms and conditions of the proposed transactions are fair to the Non-Associated unit holders; and say whether or not in KordaMentha s opinion the information to be provided by Vital to Non- Associated unit holders is sufficient to enable them to understand all relevant factors and make informed decisions. The NZSX Listing Rules require KordaMentha to express an opinion as to the consideration and other terms of the proposed transaction. Therefore, the Report assesses whether the proposed transactions and associated terms and conditions are fair to Non-Associated unit holders. There is no statutory definition of fair in New Zealand law or in the NZSX Listing Rules. Guidance note number 10, issued by the Institute of Chartered Accountants of New Zealand titled Guideline on Independent Chartered Accountants Reporting as Experts to Shareholders states: the expression of an opinion as to fairness will generally involve an assessment as to whether a transaction or proposal is just, impartial and equitable. We note that the Australian Securities and Investment Commission ( ASIC ) Policy Statement 75 and Practice Note 43 defines an offer as fair if the value of the offer consideration is equal to or greater than the value of the securities that are the subject of the offer, in the context of a takeover. Page 2

7 For the purposes of the Report we have assessed whether the consideration set out in the RTN is fair by comparing the value of the consideration to valuation metrics for other entities and cross-checking that against other valuation methodologies. We have also assessed the impact of the proposed transactions on Vital and Non-Associated unit holders in terms of benefits or risks that could result from the proposed transactions. The Report is addressed to, and has been prepared for the benefit of, the Non-Associated unit holders of Vital, to assist them in considering whether the consideration and the terms and conditions of the proposed transactions are fair. We note that each unit holder s circumstances and investment objectives will be unique. It is therefore not possible to prescribe or advise what action an individual unit holder should take in respect to the proposed transactions. Our advice will necessarily be general in nature and is intended to assist each unit holder to form their own opinion as to what action they should take given their specific circumstances. 1.3 Independence We confirm KordaMentha possesses the necessary independence to carry out this role for the independent directors of Vital. We are not aware of any conflicts of interest that would prejudice our ability to provide an unbiased objective and independent opinion on the proposed transactions. KordaMentha has not undertaken any work for Vital or the Manager within the last five years. KordaMentha has not had any role in the formulation of the proposed transactions. 1.4 Other The sources of information, to which we have had access and upon which we have relied, are set out in Appendix 1 of this Report. This Report should be read in conjunction with the statements and declarations set out in Appendix 2 regarding our independence, qualifications, general disclaimer and indemnity and the restrictions upon the use of this Report. References are to New Zealand dollars, unless specified otherwise. References to years, financial years or FY mean Vital s financial year end 30 June unless specified otherwise. Please note tables may not add due to rounding. Page 3

8 2 Executive summary This Executive Summary is a summary only. It should be read in conjunction with the balance of the Report. The proposed transactions specified price range is in line with other valuation analysis undertaken by KordaMentha, as shown in Figure 2.1. Figure 2.1: Valuation summary Proposed transactions specified price range Price to NTA Discounted cash flow Broker valuations Three months trading price range $1.00 $1.10 $1.20 $1.30 $1.40 $1.50 Unit value Source: KordaMentha analysis The proposed transactions have a specified price range of $1.15 to $1.38. Our analysis of comparable valuation metrics using the net tangible assets ( NTA ) valuation method shows that over the past five years, US healthcare listed property vehicles ( LPVs ) have had a median price to NTA ( P/NTA ) approximately 13% higher than all other LPVs (which tend to focus on nonhealthcare properties). If New Zealand healthcare LPVs traded at P/NTA multiples of between 10% and 15% higher than those of all other New Zealand LPVs, this would imply a P/NTA range of 1.16 to 1.37 for New Zealand healthcare LPVs. For Vital this is equivalent to $1.15 to $1.36 per unit, which is broadly comparable to the proposed transactions specified price range. Our discounted cash flow ( DCF ) valuation range of $1.23 to $ is in a range similar to the proposed transactions specified price range. Broker valuations lie within the proposed transactions specified price range. Vital s units have traded in a range similar to the specified price range over the last three months. As at the date of the Report, NorthWest International has a relevant interest in 19.99% of Vital s units. If the proposed transactions are all undertaken, NorthWest International would end up with a relevant interest in 24.99% of Vital s units. NorthWest International need only acquire an additional 910 units in Vital to take its interest in Vital to 20%. Thereafter, NorthWest International will be able to increase its percentage interest in Vital by up to a further 5% in any 12 month period without the need to rely on the current RTN (or any further RTN) under NZSX Listing Rules. Northwest International will be able to acquire the 910 units in Vital it requires to take its interest to 20% irrespective of our views as independent expert. 1 The discounted cash flow valuation is highly sensitive to changes in key assumptions and should be read in conjunction with Section Page 4

9 Potential impacts on Non-Associated unit holders from NorthWest International holding a relevant interest of 24.99% in Vital s units include: Under section 18 of the Unit Trusts Act 1960, there are certain resolutions which, to be passed, require that at least 75% of the units voted support the resolution. This would include a resolution for the removal of VHML as Manager and alterations to the Trust Deed. At its current 19.99% unit holding, NorthWest International has, in practical terms, the ability to block any such resolution. This is because it is rare for substantially all units to be voted on any one particular resolution, and so NorthWest International s 19.99% is a high proportion of the units likely to be voted (if NorthWest votes). Unit holders should, however, note that the Unit Trusts Act does provide for the Manager to be removed in other circumstances that do not require a vote of unit holders. If the proposed transactions result in NorthWest International holding a 20% interest in Vital s units, it will be able to make further purchases of up to 5% of Vital s units in any 12 month period. This could enable NorthWest International, over time, to increase its holding beyond 24.99%. This may impact the ability of Non-Associated unit holders to pass unit holder resolutions. Vital is classified as a portfolio investment entity ( PIE ) for New Zealand tax purposes. This type of fund has favourable tax rules for investors, in comparison to other investment vehicles, and this tends to have a positive impact on the price of the securities of PIE entities. If NorthWest International were to increase its interest in Vital s units above 25%, this would result in the Trust losing its PIE status. This may have a negative impact on the price of Vital s units, which affects both NorthWest International and Non-Associated unit holders. In our opinion, the consideration and terms and conditions of the proposed transactions are fair to Vital s Non-Associated unit holders. We note that each unit holder s circumstances and investment objectives will be unique. It is therefore not possible to prescribe or advise what action an individual unit holder should take in respect to the proposed transactions. Our advice will necessarily be general in nature and is intended to assist each unit holder to form their own opinion as to what action they should take given their specific circumstances. In our opinion, the information to be provided by Vital to the Non-Associated unit holders is sufficient to enable them to understand all relevant factors and make an informed decision in respect of the proposed transactions. Page 5

10 3 Industry analysis 3.1 New Zealand listed property sector overview New Zealand s LPVs enable investors to gain an exposure to a selection of professionally managed investment grade properties. LPVs allow investors, who may otherwise be unable to participate in investment grade properties, to gain the diversification benefits from these investment portfolios. LPVs have traditionally been viewed as a defensive investment, combining a yield from regular distributions with the liquidity achieved from being listed. Table 3.1 summarises the metrics for the nine LPVs which are listed on the NZX Main Board as at 8 April Table 3.1: LPVs listed on the NZX Main Board Entity Type Sector Management P/NTA WALT Market Cap ($ million) Vital 1 Trust Health External Goodman Property Trust Industrial, Commercial External ,299 Kiwi Income Property Trust Retail, Commercial External ,161 Precinct Properties Company Commercial External ,042 Argosy Property Company Retail, Industrial, Commercial Internal DNZ Property Fund Company Retail, Industrial, Commercial Internal Property for Industry Company Industrial External NPT Company Retail, Industrial, Commercial Internal Augusta Capital Company Retail, Industrial, Commercial Internal Source: Capital IQ, NZX i-seach, the entities websites, financial statements and KordaMentha analysis During the global financial crisis ( GFC ), LPVs listed on the NZX Main Board tended to trade at a discount to their NTA, although Vital did not. However, prices as a percentage of NTA ( P/NTA ) have improved, so that the median for the LPVs listed above is The median P/NTA for LPVs, excluding Vital, is The property sector and asset values within the sector are affected by a number of factors, including: General economic conditions; Interest rates; Growth in various sectors of the economy, which affect relative demand for various types of property (retail, commercial, healthcare etc); The supply of new property available for lease; and Government and legislature. The defensive characteristics of property, combined with vacancy levels declining to levels last seen around 2004 and a modest supply outlook have resulted in a significant increase in listed prices of LPVs. To the year-end March 2013, LPVs prices had increased by 18.3% on average. 1 Vital s P/NTA is based on its balance sheet and units outstanding as at 28 February Page 6

11 3.2 LPV performance Figure 3.1 shows the performance of the LPV sector as a whole relative to the NZX 50 Index on a gross basis (i.e. assuming dividends are reinvested). Figure 3.1: Relative gross performance of NZX Property Index and NZX 50 Index Adjusted index Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 NZX Property Index Gross NZX 50 Index Gross Source: Capital IQ and KordaMentha analysis With the exception of the six months ended 30 September 2011, the NZX Property Index and NZX 50 Index have largely tracked in line with each other over the past five years. Table 3.2 compares the performance of Vital to the New Zealand listed property sector, NZX 50 Index and Australian listed property sector over the past ten years. Vital has generally outperformed these indices. Table 3.2: Compound annual return 1 year 3 year 5 year 7 year 10 year Vital 22.0% 11.4% 10.4% 9.1% 12.9% NZX Property Index 20.5% 11.5% 4.2% 5.6% 9.1% NZX 50 Index Gross 24.2% 8.0% 0.1% 2.7% 7.6% S&P/ASX 200 AREIT 27.0% 3.1% -14.4% -9.4% -3.9% Source: Craigs Investment Partners, Bloomberg as at 31 December Management structures The management of LPVs can be broken into two broad categories, externally managed and internally managed LPVs. Externally managed entities generally have no staff of their own and appoint a third party to undertake the management of the portfolio in return for management fees. Internally managed entities have staff, who manage the property portfolio and who perform the management functions. In the period from 2010 to early 2012, there was a strong push in the New Zealand LPV sector for the internalisation of management contracts. In this period management contracts were internalised for: DNZ Property Fund; NPT Limited; Argosy Property Limited; and Augusta Capital Limited. Page 7

12 3.4 Healthcare real estate sector Key drivers of the healthcare real estate sector include: Life expectancy and ageing demographics; Levels of private health insurance; Technology advances; Government expenditure on health; and The population s general healthiness and any outbreak of chronic disease. A key driver of the performance of the healthcare real estate sector is the ageing demographic. Current statistics suggest in New Zealand and Australia, the over-65 age group is expected to more than double to around 30% of the population over the next 40 years. This demographic utilises healthcare services at around three to four times the rest of the adult population. In New Zealand and Australia, healthcare real estate is considered tightly held, with the Government being the largest owner of healthcare real estate, primarily of public hospitals. However, there is a significant and growing number of private owners of healthcare real estate including private health insurance companies, hospital operators, not-for-profit organisations and institutional investors. In healthcare real estate, lease terms are typically long and the landlord is not liable for operational or maintenance expenditure. According to Investment Property Databank ( IPD ) research, healthcare real estate in Australia has tended to outperform traditional property investment over recent years, as set out in Figure 3.2. A key reason for this is the defensive characteristics of healthcare real estate, including that people do not tend to change their healthcare spending patterns according to the performance of the economy. Figure 3.2: Total returns from Australian direct property investments Annualised quarterly return 25% 20% 15% 10% 5% 0% -5% -10% Healthcare Industrial Office Retail Source: IPD Research Page 8

13 4 Overview of the Trust 4.1 Overview and history Vital is an investor in health and medical related properties throughout New Zealand and Australia. Tenants include hospital and healthcare operators who provide a wide range of medical and health services. Vital is the only medical and healthcare property investment fund listed on the NZX Main Board. Vital has its origins back in 1994 when its legacy business was established to take advantage of investment opportunities in the healthcare property sector, which at that time was under-funded and had a significant stock of property that was either outmoded or outdated. Vital was listed on the NZX Main Board on 7 September The Trust has more than 4,500 unitholders and is currently managed by VHML, which has been the Manager of the Trust since its establishment. 4.2 Structure Vital is structured as a unit trust established under the Unit Trusts Act The Trust is overseen by a trustee and managed by VHML. The operations of the unit trust and the powers and functions of the trustee and manager are governed by the Trust Deed. The current structure of the Trust is shown in Figure 4.1. Figure 4.1: Vital s structure * Trustees Executors Limited, the trustee of the Trust, and its wholly owned subsidiary, TEA Custodians Limited, hold all of the shares in these companies for and on behalf of the Trust ** Held through a bare trustee Source: Management information Vital owns its properties through three entities as follows: Vital Healthcare Property Limited: Owns the New Zealand properties. It is taxed at the New Zealand corporate tax rate of 28%; Vital Healthcare Australian Properties Trust: Owns three Australian properties (Epworth Eastern Medical Centre, Epworth Eastern Hospital and Epworth Rehabilitation Brighton). It is taxed at the Australian corporate tax rate of 30%; and Vital Healthcare Investment Trust: Owns the remaining Australian properties. It was established in 2010 and benefits from an income tax rate of 15% by virtue of being a Managed Investment Trust ( MIT ). This MIT status is the result of an Australian initiative to promote infrastructure investment. Vital must meet certain criteria in order to maintain this tax status. Page 9

14 VHML is 100% owned by NorthWest, a private investment firm based in Toronto, Canada. NorthWest is an associated person of NorthWest International, currently the largest unit holder in Vital with a 19.99% unit holding. 4.3 Manager role and functions Essentially VHML is responsible for all the investment decisions in relation to the Trust and for the management of its property portfolio. The scope of this management responsibility extends to setting the overall strategic direction, determination of portfolio mix, property selection, review and negotiation of property acquisitions and disposals, construction management, financial and treasury management, distribution payments and liaison with unit holders and other stakeholders. Under the terms of the Trust Deed VHML is paid a base management fee by Vital based on the value of the Trust s investment property assets and cash. VHML may also receive an incentive fee and is entitled to the reimbursement of certain costs. 4.4 Property portfolio Vital has a property portfolio of 24 properties in New Zealand and Australia. By value the portfolio is split 25:75 between New Zealand and Australia respectively. Portfolio occupancy is 99.5% with a weighted average lease term ( WALT ) of 12.1 years. Both of these measures are sector leading amongst New Zealand LPVs with sector average occupancy of 96.3% and WALT of 5.5 years, based on information available as at the date of the Report. Vital has high levels of occupancy and lease terms that provide comfort around future earnings. The composition of Vital s tenants by income is set out at Figure 4.2. Figure 4.2: Vital s tenant composition by income 4% 5% 9% For-profit hospital 12% 70% Not-for-profit hospital Medical Specialist/Consultant Diagnostic/Radiology Other Source: Management information Private hospital operators make up the majority of Vital s tenants. Page 10

15 Vital s property portfolio is summarised in Table 4.1. Table 4.1: Vital s property portfolio as at 31 December 2012 ($ million unless stated otherwise) 1 Entity Occupancy WALT (years) Net income Book value June 2012 Valuation New Zealand properties: Ascot Hospital 100% Ascot Carpark n/a Hibiscus Coast Community Health Centre 100% Napier Health Centre 100% Kensington Hospital 100% Ascot Central 98% Apollo Health & Wellness Centre 86% Total New Zealand properties Australian properties: Epworth Eastern Medical Centre 100% Epworth Eastern Hospital 100% Epworth Rehabilitation Brighton 100% Allamanda Private Hospital 100% Gold Coast Surgery Centre 99% South Eastern Private Hospital 100% Belmont Private Hospital 100% Dubbo Private Hospital 100% North West Private Hospital 100% Palm Beach Currumbin Clinic 100% Heatherton Road 100% Maitland Private Hospital 100% Lingard Private Hospital 100% Toronto Private Hospital 100% Mayo Private Hospital 100% Hurstville Private Hospital 100% SportsMed SA 2 100% n/a Total Australian properties Total all properties Source: Management information. A description of each property is set out at Vital s website ( Table 4.1 shows: Vital s investment portfolio is independently valued as at 30 June each year. As at 30 June 2012 the portfolio was valued at $562.0 million (excluding Pitman House which was subsequently sold). Since 1 July 2012, Vital has spent approximately $27 million (for the six months to 31 December 2012) in capital improvements and acquired Sportsmed SA in Adelaide, South Australia, for A$31.5 million in December The investment portfolio is well diversified by geographic and demographic spread, and operates within five of the six Australian states. Vital s three largest properties (Ascot, Epworth Eastern and Allamanda) account for 34% of portfolio by value and 37% by income but are geographically and operationally diversified. 1 AUD amounts have been converted to NZD 2 Acquired in December 2012 Page 11

16 Figure 4.3 shows Vital s lease expiry profile. Figure 4.3: Vital s lease expiry profile Lease expiry by income 20% 16% Largest single expiry in year Other expiry in year 12% Allamanda Private 8% Ascot Hospital 4% 0% Vacant FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25 FY26 FY27 FY28 FY29 FY30 FY31 FY32 FY33 Source: Management information Key points to note from the analysis above include: Vital has a very low level of lease renewals over the next 5 years (averaging less than 2% of income per annum over this period); The lease at Allamanda Private in Gold Coast is due for expiry in 2018; and The lease at Ascot Hospital in Auckland is due for expiry in There are two key leases (Allamanda Private Hospital and Ascot Hospital) due for expiry in the medium term. As is typical in the normal course of business early discussions and negotiations with the tenants have commenced, notwithstanding that these leases expire in 2018 and 2019 respectively. Vital s tenant at Allamanda Private Hospital has disclosed it may build a new hospital in the Gold Coast and there is a risk that they may vacate Vital s premises or deliver a different (or scaled down) mix of healthcare services from that location. Relatively high capitalisation rates have tended to apply to the healthcare property sector due to the specialised nature of the properties. This also applies to Vital s properties. Another characteristic of Vital s portfolio is that it has had and will continue to have building improvement and development options, which have been highly remunerative in terms of the rental income generated. A summary of Vital s current development projects is set out at Figure 4.4. Figure 4.4: Vital s development projects as at 31 March 2013 Project Mayo Private Lingard Private Location Cost (A$m) NSW 6.1 NSW 22.0 TOTAL 28.1 Timeline Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Description ~100% 90%-95% New 24 bed ward and one theatre (to three), standalone medical centre, additional car parking. New 40 bed ward and diagnostic imaging areas, two additional theatres (to six), upgrade of patient recovery areas. Current development timeline % practically completed to date Source: Management information Page 12

17 4.5 Unit holders Vital currently has 307,038,608 fully paid ordinary units on issue. NorthWest International and its associated persons have a beneficial interest in 61,406,812 units in Vital (just under 20% of the units on issue). No other unit holder has a beneficial interest in more than 5% of the Trust. Vital s unit holders generally hold their interests through custodial accounts and accordingly, information regarding units held by other individual investors is not readily available. 4.6 Unit price performance Vital s units are traded on the NZX Main Board. Figure 4.5 illustrates the unit price of Vital and the volumes of unit trades since April Figure 4.5: Vital s unit price performance Unit price ($) Maximum purchase price $ February 2013 FY13 interim profit announcement Weekly volume (million) September 2008 Lehman Brothers files for bankruptcy 22 November 2010 Ex. date of renounceable rights issue. 8 April 2011 Announcement of management internalisation proposal 5 December 2011 Announcement that NorthWest is to acquire management contract Minimum purchase price $ August 2011 Difficulty in negotiating price to internalise management Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Source: Capital IQ In early September 2008 and prior to the GFC, Vital units were trading at between $1.06 and $1.15. By 21 November 2008, the unit price had dropped to $1.02. However, throughout 2009 and 2010 the unit price appreciated to a high of $1.35, although that was affected by the announced then upcoming rights issue which resulted in a theoretical ex rights price ( TERP ) at the time of $1.18. The unit price declined on 22 November 2010 as a result of the one-for-one rights issue undertaken at an issue price of $1.05. Following the rights issue, the unit price has continued to drift upward, albeit with some volatility, which in part appears related to announcements made by the Trust affecting investors perceptions of the probability of the management being internalised within the Trust. In December 2011, NorthWest acquired VHML and acquired parcels of units in Vital for $1.20 per unit. Vital s unit price increased to $1.33 in the week following the FY13 interim profit announcement. Immediately prior to the RTN the Trust s units were trading at a price of $1.36. Page 13

18 Table 4.2 shows Vital s unit trading in the three months immediately prior to the RTN. Table 4.2: Unit trading prior to 2 April 2013 Unit Price Period Low High VWAP 1 Cumulative volume % of issued capital 1 Week , % 1 Month ,282, % 3 Months ,702, % Source: Capital IQ Since NorthWest International provided a RTN to Vital, the unit price has tended to trade in a range between $1.35 and $1.38 (up to 8 April 2013). The proposed transactions specified price range of $1.15 to $1.38 per unit represents a discount of 10.8% to the VWAP in the three months prior to the RTN ($1.29) at the low end of the specified price range and a premium of 7.1% at the high end. Prior to the RTN, there was minimal liquidity in Vital s units with only 2.2% of issued capital trading in the previous three months. It appears likely that NorthWest International will acquire some units from the proposed transactions. Therefore, in the longer-term, it is likely that the remaining free float of Vital units will decrease, although this depends on the number of units NorthWest International elects to purchase under the RTN or otherwise. At lower purchase levels, the negative impact on liquidity can be expected to be minimal. This may further limit the liquidity of trading in Vital units. However, in the short-term, the proposed transactions could improve liquidity available to Non-Associated unit holders, with NorthWest International possibly standing as a buyer within its stated price range of $1.15 to $ Volume weighted average price Page 14

19 5 Financial analysis 5.1 Financial position Table 5.1 summarises the balance sheet for Vital at the end of FY10, FY11, FY12 and as at 31 December Table 5.1: Vital s consolidated balance sheet ($ thousand unless stated otherwise) Jun-10 Jun-11 Jun-12 Dec-12 Cash and cash equivalent 1,024 2,671 1, Trade and other receivables 427 1, ,350 Other current assets Derivative financial instruments 1,640 2, Non-current assets held for sale 4,191 12,525 8,236 Total current assets 6,544 18,645 12,760 3,129 Investment properties 291, , , ,041 Derivative financial instruments 719 Other non-current assets 1, Total non-current assets 293, , , ,341 Total assets 299, , , ,470 Borrowings 97, , , ,105 Derivative financial instruments 5,220 5,328 15,386 15,561 Deferred tax 22,478 24,590 23,327 23,749 Other liabilities 3,255 7,137 10,241 9,701 Total liabilities 27, , , ,116 Net tangible assets (NTA) 171, , , ,354 Units on issue (million) NTA/unit Source: Audited Year End Financial Statements and unaudited Interim Financial Statements Vital s balance sheet is a key driver of its financial performance, with asset levels determining property income and management fees and debt levels determining interest costs. Key points to note on Vital s balance sheet include: Vital has relatively low levels of net working capital requirements; All of Vital s investment properties are 100% owned and consolidated for financial reporting purposes; Development projects are included in investment properties based on costs incurred to date. They are not re-valued until complete and operational; Vital s investment properties totalled $623.0 million at 31 December 2012; There was a significant increase in the scale of Vital in FY11. In December 2010, Vital undertook a 1 for 1 rights issue. Using the proceeds of the rights issue as well as additional debt Vital acquired a significant portfolio of Australian healthcare properties for $227 million; Vital has continued to raise capital by issuing further units via its Distribution Reinvestment Plan ( DRP ) and an underwriting of the past three quarterly distributions. Although Vital s FY13 budget envisages that a capital raising will be undertaken, no decision has been made to proceed with an issue, including as to timing, quantum or any other terms. Catalysts are likely to include the approval of future hospital expansion and upgrade projects or the undertaking of any real estate acquisitions; Page 15

20 Vital had borrowings of $278.1 million at 31 December This represents 44% of Vital s total assets. The Trust Deed for Vital has a debt covenant of borrowings not to exceed 50% of total assets; Vital had net debt (including derivative financial instruments) of $292.0 million at 31 December 2012; and Vital had NTA of $300.4 million or $0.99 per unit on issue as at 31 December Capital expenditure Table 5.2 below shows Vital s capital expenditure, including additions and purchases of properties net of sales of properties. Table 5.2: Capital expenditure ($ thousand) FY10 FY11 FY12 Actual Actual Actual Capital additions on properties 1,080 18,052 36,425 Purchase of properties 226,740 34,049 Other 620 1,614 2,297 Less: sale of properties (5,997) (4,000) (14,436) Net capital expenditure (4,297) 242,406 58,335 Source: Audited Year End Financial Statements Vital has invested in existing and new healthcare properties in recent years resulting in the asset base of the Trust growing significantly. One of the main reasons for the high level of capital expenditure in FY11 was the purchase of the portfolio of properties in Australia in December 2010, as discussed. In FY13, significant projects include the acquisition of Sportsmed SA in December 2012 for A$31.5 million (including stamp duty and acquisition costs) and the redevelopment of Lingard Private Hospital for A$22 million as well as a number of other development projects. Vital management considers that, in order to maintain its existing portfolio of properties, it would need to incur long-run maintenance capital expenditure in the order of $2 million to $3 million per annum in excess of its development capital expenditure. Page 16

21 5.2 Financial performance Table 5.3 below shows the financial performance of Vital for the three financial years ended 30 June 2012 and budgeted for the year ending 30 June Table 5.3: Vital s financial performance ($ thousand) FY10 FY11 FY12 FY13 Actual Actual Actual Budget Number of properties (at end of period) Net property income 24,287 36,614 47,962 56,669 Other income 367 2, Total income 24,654 39,247 48,043 56,669 Management fees (2,420) (3,218) (4,100) Trustee fees (166) (198) (230) Registry, audit and other admin fees (538) (468) (573) Other expenses (374) (1,441) (2,232) Total admin & other expenses (3,498) (5,325) (7,135) (6,891) EBIT 21,156 33,922 40,908 49,778 Source: Statutory accounts and Budget. Vital has experienced a significant increase in net property income and Earnings Before Interest and Tax ( EBIT ) between FY10 and FY12. This is mostly related to the acquisition of a portfolio of Australian properties in December 2010, as discussed above, impacting the second half of FY11 and with a full-year impact in FY12. The acquisition of properties in December 2010 also resulted in a significant increase in debt levels and net finance expense. However it should be noted that the net finance expense also includes unrealised marked-to-market movements in interest rate derivatives. Vital s FY12 audited financial statements identify that $731,000 of other expenses incurred in FY12 related to non-recurring costs associated with work involved around the potential internalisation of the Manager. In FY13, EBIT is expected to increase significantly as a result of the continuing increases in net property income from completed property developments, the Sportsmed acquisition and rent reviews and through stable operating expenses. Page 17

22 5.2.1 Year-to-date February 2013 For the eight months year-to-date to 28 February 2013 ( YTD13 ) Vital has performed slightly above Budget. Table 5.4 compares financial performance in YTD13 to Budget. Table 5.4: Vital s YTD13 financial performance ($ thousand) Actual Budget Variance Number of properties (as at 28 February 2013) Net property income 37,954 37, Other income Total income 38,020 37, Total admin & other expenses (4,504) (4,216) (288) EBIT 33,516 32, Source: Management accounts and budget. Management undertook a re-forecast for FY13 at December 2012, which confirmed that Vital is ontrack to achieve Budget. Furthermore, as at the date of the Report, Vital management continue to expect that income and profit in the final four months of FY13 will be broadly similar to Budget Financial projections KordaMentha s valuation analysis is based on Vital s board approved Budget for FY13 and three years of management indicative financial projections from FY14 to FY16 (not board approved). FY13 Budget Principal assumptions underpinning the FY13 Budget (as set out above) are: In accordance with lease agreements, CPI adjustments have been assumed across most tenancies that have rent reviews; and Capital expenditure (including acquisitions of new properties), as discussed above. FY14 to FY16 Indicative Financial Projections Over the three years ending FY16, Vital management expects growth in profits as a result of continuing increases in lease income and constrained expenses. Principal assumptions underlying the FY14 to FY16 indicative financial projections are: In accordance with lease agreements, CPI adjustments have been assumed across most tenancies that have rent reviews; Capital expenditure projections are based on identified development opportunities; Income is driven by leases and renewals of existing properties and development properties; Interest rates are based on current rates; No specific new property acquisitions; Property disposals of approximately $19 million over the three year period; and No major tenant vacancies. Page 18

23 6 Assessment of the proposed transactions To assess the proposed transactions we have considered: The proposed transactions specified price range relative to valuation metrics for other LPVs and against other valuation methodologies, where appropriate; and Other benefits and risks to Non-Associated unit holders as a result of the proposed transactions. 6.1 Valuation analysis Valuation methodologies There are four methodologies commonly used for valuing businesses: DCF analysis; Capitalisation of earnings; Estimate of proceeds from an orderly realisation of assets; and Industry rules of thumb. Each of these valuation methodologies is appropriate in different circumstances. A key factor in determining which methodology is appropriate is the actual practice commonly adopted by purchasers of the type of businesses involved. Discounted cash flow It is a fundamental principle that the value of an asset or business is represented by its expected future cash flows, discounted to present value at a rate which reflects the risk inherent in those cash flows. This approach, referred to as the DCF methodology, is particularly suited to situations where a business is in a growth phase or requires significant additional investment to achieve its projected earnings. The DCF methodology requires considerable judgement in estimating future cash flows and the valuer generally places significant reliance on medium to long term projections prepared by management. The DCF valuation methodology can also be very sensitive to changes in underlying assumptions. Notwithstanding these limitations, DCF valuations are appropriate where current earnings are not representative of reasonable expectations of future earnings. Capitalisation of earnings The capitalisation of earnings methodology requires an assessment of the maintainable earnings of the business and the selection of an appropriate capitalisation rate, or earnings multiple. This methodology is most appropriate where there is a long history of relatively stable returns and capital expenditure requirements are neither large nor irregular. In practice, it is often difficult to obtain accurate forecasts of future cash flows and therefore the capitalisation of earnings methodology is often used as a surrogate for the DCF methodology. Realisation of assets The realisation of assets approach is based on an estimate of the proceeds from an orderly sale of assets. For LPVs the realisation of assets is often assessed by reference to the NTA of the entity (the NTA method ). Industry rules of thumb In some industries, businesses are valued using well established rules of thumb. Generally these rules of thumb are used as a cross-check for other valuation methodologies. Page 19

24 Our valuation approach KordaMentha has compared the proposed transactions specified price range to valuation metrics implied by the NTA method for broadly comparable entities. We have also considered the DCF methodology. Any valuation by its very nature must attribute a current value that reflects the expected future financial performance of the subject business. Consequently, information regarding the expected future performance such as financial projections is important to the valuation exercise. We have relied on indicative financial projections that have been prepared by Vital management but have not been reviewed or approved by the board NTA method Vital has a high level of fixed assets (healthcare properties), which are required to generate its earnings. At 31 December 2012, Vital s NTA per unit was $0.99. We have undertaken an analysis, set out at Appendices 3 and 4, of the P/NTA multiples of New Zealand LPVs and US healthcare LPVs. New Zealand LPVs are currently trading at a premium to NTA. The median premium of the LPVs listed in New Zealand is 18% (excluding Vital). Figure 6.1 shows that all New Zealand LPVs are currently trading at a premium to their NTA, between 5% and 38%. Figure 6.1: Current price per share/unit as a percentage of NTA per share/unit as at 8 April 2013 Price to NTA Median NPT GMT DNZ AUG ARG KIP PFI PCT VHP Source: KordaMentha analysis At 8 April 2013, Vital s unit price was $1.37 and it was trading at a 38% premium to its NTA per unit. We note that on the basis of P/NTA, Vital has traditionally traded at a premium to its New Zealand listed peers which are focused on non-healthcare property assets. We have undertaken an analysis of whether healthcare LPVs in other parts of the world also trade at a premium to LPVs focused on non-healthcare property assets. The best data for this comparison is available in the United States. Summary profiles of United States LPVs are set out at Appendix 4. The analysis shows that over the past five years, US healthcare LPVs have had a median P/NTA ratio of 1.13, compared to 1.00 for all LPVs (representing a 13% premium for healthcare LPVs). Page 20

25 This analysis provides some broad support for healthcare LPVs trading at a premium of approximately 10% to 15% above LPVs focused on non-healthcare property assets. If we apply that premium of 10% to 15% to New Zealand s non-healthcare LPVs, this would imply P/NTA multiples of 1.16 to 1.37, as set out at Table 6.1. Table 6.1: Implied P/NTA multiples for a New Zealand healthcare LPV Low High NZ LPVs P/NTA multiples (excl. Vital) Premium for healthcare LPVs 10% 15% Implied P/NTA multiple Source: KordaMentha analysis and Capital IQ 6.2 Discounted cash flow Key valuation parameters that we have used in our DCF valuation are set out below. Forecast period: The DCF valuation is based on Vital management s indicative financial projections to FY16 (the principal assumptions underpinning the indicative projections are discussed above). The indicative projections are based on expected earnings from Vital s existing portfolio of properties and identified development opportunities. Terminal value assumptions: Terminal value is calculated by assuming terminal year unlevered free cash flows grow in perpetuity at the terminal growth rate ( TGR ). We have adopted a terminal growth rate of 2.0%, which is in line with current inflation forecasts. Valuation date: 31 March Weighted Average Cost of Capital: We have estimated Vital s post-tax, nominal Weighted Average Cost of Capital ( WACC ) between 7.0% and 7.4%. Our calculation of WACC is set out at Appendix DCF valuation summary Table 6.2 summarises our DCF based valuation of Vital, which results in a valuation range of $1.23 to $1.41 per unit. Table 6.2: Summary of DCF based valuation ($ million, unless specified otherwise) Low High Enterprise value Net debt (including derivatives) (292.0) (292.0) Equity value Units on issue (million) Unit value ($) Source: KordaMentha analysis As noted, the DCF valuation is based on cashflow forecasts for existing and identified development opportunities. It is possible that an acquirer would be willing to pay more for Vital than the amount assessed here if the acquirer considered it likely that Vital would continue to add value-enhancing development opportunities and acquisitions not yet identified. Page 21