Valuing S. Kidman & Co's land properties

On 27 January 2016, the Australian Financial Review reported businessman Dick Smith's reaction to news of a possible sale of Australia's largest landholder, S. Kidman & Co, to foreign investors. He was quoted as being totally opposed to the sale and saying "itscomplete madness. Farming land is going to be incredibly valuable - it is going togenerate a lot of wealth into the future so you don't want all that wealth creation to gooverseas."

S.Kidman & Co, which has cattle station1 holdings covering 11 million hectares, was placed on the market for sale in April 2015. The Kidman properties comprise about 2.6% of Australia's agricultural land and 1.3 per cent of the country's entire land mass. The company was expected to sell for more than $325 million2. DomaCom is a "crowdfunding" business that allows investors to make a fractional investment in property assets that are too large for them to purchase in their entirety on their own. Earlier this year, DomaCom set up a fund to allow individual investors to have a "beneficial interest" in the Kidman properties for as little as $2,500. Once a sufficient level of interest in joining the fund has been received from investors, DomaCom will make a bid for the Kidman properties. DomaCom's crowdfunding campaign to acquire the Kidman Station via the Fund is restricted to the land component only.

However, for the purpose of this assignment assume that both the properties and the cattle raising business that is run on the properties are purchased together. See www.domacom.com.au for more details.

Required

(a) Provide your estimate of the maximum value of the Kidman properties that DomaCom should pay. The maximum price is the price at which you think an investment via DomaCom's crowdfunding campaign is not worthwhile. This valuation should be done from the perspective of a potential investor based in Australia who has an existing portfolio of investments consisting of shares in around 30 randomly selected companies that are listed on the ASX.

(b) Assuming the expected cash flows and cost of capital you use in arriving at yourestimate of the maximum value of the Kidman Properties are accurate, do you think aforeign investor should use the same cash flows and cost of capital? Justify youranswer.

Your final estimate of the Kidman Properties' value is largely irrelevant in terms of getting marks. You will be awarded marks for the quality of your reasoning and evidence in justifying your estimated maximum price. Note: the lectures in weeks 7 and 8 will be particularly relevant to this assignment. They will focus on issues in forecasting and in constructing spreadsheets of discounted cash flows. The lecturer will also make references to this particular assignment in class and give further hints.

Here are some hints on how to structure part (a) of the assignment. The hints show the weights awarded to each component of your answer.

The fundamental valuation formula is Price = E[Cashflows]/E(r)

You will need to set out an Excel spreadsheet with forecast cash flows over a period and a terminal value and then discount the cash flows using the expected cost of capital. Keep the Excel spreadsheet in case you are called on to explain a figure but submit only a summary version using either Word or a PDF file. An example will be provided in class.

There is very little publicly available information about the Kidman properties' revenues and expenses (which makes one wonder how Dick Smith can be sure that it is going to be "incredibly valuable"). However, some material is provided in the assignment folder on LMS. You should supplement this material with your own research. You will need to estimate the revenues the Kidman Properties receive from raising cattle and the profit margin on that revenue. The number of cattle on the Kidman Properties and the tonnes of beef it produces each year are publicly available as are estimates of the profit margin from producing beef. You will then need to adjust the figures each year to account for expected growth (or decline) depending on the demand and supply of beef.

A crucial element in the estimate of cash flows is the projected change in the demand and supply of beef in the next few years. If demand goes up, supply doesn't keep up and costs remain the same then profit margins will increase. On the other hand, if supply outpaces demand then profit margins will decrease. You will need to undertake an analysis of the Australian beef industry to develop an idea of the likely change in profit margins. The analysis should address expected changes in supply, demand and costs and how well positioned Kidman Properties is to take advantage of industry trends. There will be a total of 10 marks awarded for your analysis of expected cash flows.

The next important step is estimating and justifying the cost of capital you will use to discount the cash flows. You should use the CAPM. Finally, comment on your confidence about the accuracy of the value of your estimate of the maximum price of the Kidman Properties. You may wish to compare the price against recent similar property transactions in the industry.