Opinion & Analysis
There are people who believe local councils should own businesses because they generate returns and ease the burden on ratepayers.
Chalkie is not one of them.
Your humble correspondent thinks councils should stick to their knitting. The reasons are many and varied. Taking a couple of examples at random:
a) Councils can start to think they are there to make money instead of, say, distribute water; and
b) Councils are not commercially savvy shareholders.
Poppycock, you say. Show me a single case of a council's emptyheaded pursuit of unprofitable goals.
In response, Chalkie invites you to consider Dunedin.
In that southern city the council is the proud owner of Dunedin City Holdings, whose job, according to its report, is "to manage the commercial investments of the Dunedin City Council to maximise returns".
The businesses under DCH's umbrella include electricity network company Aurora, forestry company City Forests, the Taieri Gorge Railway Company and an engineering business called Delta Utility Services.
DCH's 2012 numbers are not yet available, but last year it trumpeted an improvement in revenue and profit and a total cash return to the council of $23.2 million.
If you thought that was a good result, you'd be wrong.
When you look at several years of DCH numbers a disturbing pattern emerges of ever-increasing millions being borrowed and pumped into underperforming assets.
The cashflow statements tell the story.
In 2007 DCH made $42.7m from its operations and invested a net $50.6m in new assets. After paying a $12.5m dividend it was looking at a cash shortfall for the year of $20.4m, so it borrowed an extra $20.8m.
Subsequently, each year DCH invested more money in various assets - $61m in 2008, $90m in 2009, $106m in 2010 and $125m in 2011.
However, despite investing more than $430m over those five years, DCH's profits actually shrank. And each year it had to borrow more to fund those investments: $58m in 2008, $70m in 2009, $124m in 2010 and $66m in 2011.
As a result, DCH's external debt ballooned from $245m to $534m over the period. That, by the way, does not include the amount it owes the council, which was $112m at last balance date, up from $103m in 2007.
A picture therefore emerges of a group prioritising asset growth over profit growth, and staying cashflow positive, just, through heavy borrowing.
Chalkie suggests another term for this behaviour is empire building.
Of course, it could be justifiable if the asset build-up is value enhancing in the long term, but is it?
Going by some of the deals involving one DCH subsidiary, Chalkie doubts it.
Delta Utility Services styles itself as a "multi-utility service contractor that provides a range of civil, electrical and other services to local authority and private sector clients" - ie, drainlaying, installing cabling and the like.
Fair enough, you could say. Councils often have in-house contractors and Delta has simply been given freedom to take on other work and make money for the council.
Among the work Delta took on was servicing a subdivision at Jack's Point, near Queenstown. DCH accounts show Jack's Point was a good customer: Delta and sister company Aurora sold services to Jacks Point Ltd worth $3m in 2007, $4m in 2008 and $3m in 2009.
On June 6, 2009, Delta announced a new long-term contract to provide services to Jacks Point Ltd, saying it was "a genuine and timely good news story, especially for Delta's employees".
As well as estate management services, Delta was appointed preferred contractor for all future development work at Jack's Point.
Oddly, the next year's accounts, till June 2010, show Delta sold no services to Jacks Point Ltd.
The transactions were specifically disclosed because Delta director Mike Coburn - also, until last October, a director of DCH - was a director of Jacks Point Ltd until December 2008.
He also had a 15 per cent interest in Jacks Point Ltd between 2004 and 2006.
Chalkie would be interested to know what may have encouraged Delta to do more than provide services.
In May 2009, Delta bought 9.4 hectares of land at Jack's Point from Jacks Point Ltd. The terms were not revealed at the time, but property records show the price paid was $8.82m, with settlement deferred until April 2010.
Chalkie reckons this investment matches an $8.82m "development property" asset carried on DCH's books as "current assets held for sale".
Three years on from the acquisition, Chalkie sees little sign of the land turning into good money for Delta - there's no shortage of sections already for sale at Jack's Point, and for what it's worth, the council's rating valuation in July last year was $4.25m.
A similar picture can be discerned from another DCH land investment in the Queenstown Lakes area, this time in the blink-and-you-miss-it settlement of Luggate, 13km from Wanaka.
In early 2008 Delta went into business with South Island investor Jim Boult, forming a joint venture to develop property in Luggate. DCH accounts show the council invested $5.3m in the Luggate joint venture; property records show the investment took place in July 2008.
Delta's report for 2009 shows in July 2008 it also "became party to an agreement that provided it with preferred-contractor rights to a substantial development in Luggate", although it didn't mention it was half-owner of a substantial development in Luggate.
Chalkie reckons it must be a lot easier to win service contracts if you part-own your customer - but perhaps Delta just liked the project so much it bought into the company.
At balance date last year the project was still on DCH's books valued at $5.8m.
Chalkie, having a passing acquaintance with Luggate, reckons the council shouldn't hold its breath for a return on that investment.
Anyway, returning to Jack's Point. In April this year Queenstown Lakes District Council declined a resource consent application to develop a contractor's depot at the entrance to Jack's Point. The applicant was Henley Downs Farm, a company associated with Jack's Point developer John Darby, and the depot was to be used by Delta Utilities.
The land concerned was owned, not by Delta, but by Henley Downs Farm. So although Delta had bought substantial land within the development, it aimed to lease further property from the developer to house its operations.
This appears to contradict a statement in DCH's 2009 annual report saying "land purchased at Jack's Point will be used to consolidate and expand [Delta's] Queenstown/Frankton operations".
To Chalkie's eye, this sequence of events adds up to a woeful deployment of council capital and supports his view that councils should be kept away from businesses in the same way you keep children away from matches.
Failure to do so can turn assets into ash.
- Chalkie is written by Fairfax Business Bureau deputy editor Tim Hunter.
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