Tuesday, April 25, 2017

25/4/17: Couple of Things We Glimpsed from KW Europe 'Deal'


Yesterday, an interesting bit of newsflow came in from Irish markets-related Kennedy Wilson Europe operations: http://www.independent.ie/business/commercial-property/1bn-worth-of-irish-property-assets-in-kennedy-wilson-discounted-takeover-deal-35650134.html. Setting aside the details of the merger between Kennedy Wilson Inc (U.S. based parent) and Kennedy Wilson Europe (UK and Ireland-based subsidiary), the news have several important disclosures relating to the Irish property markets, Nama and the Irish economy.

Consider the following: 

"Kennedy Wilson Europe Real Estate, which is tax resident in Jersey, pays 25pc tax on taxable profits generated in its Spanish subsidiaries, and it pays income tax at 20pc on rental income derived from its UK investment properties. But the qualifying investor alternative investment funds (QIAIFs) it uses in Ireland to hold its assets were until this year entirely exempt from any Irish taxation on income and gains. The group's total tax bill last year was £7.3m (€8.6m) on profits of £73.3m."

Which implies:
  • Kennedy Wilson's Europe operations are running an effective tax rate of 10 percent. Not 12.5 percent, nor higher. Which shows the extent to which Irish operations tax exempt status drives the overall European tax exposures.
  • Kennedy Wilson's merger across the borders is, it appears, at least in part motivated by changes in the QIAIF regime, imposing new "20pc withholding tax on distributions from Irish property funds to overseas investors".  Bringing the, now more heavily taxed, subsidiary under the KW wing most likely create more efficient tax structure, making Irish taxes paid offsettable against global (U.S. parent) income, without the need to formally remit profits from Europe. Beyond that, the merger will facilitate avoidance of dual taxation (of dividends). Finally, running within a single company entity, KW operations in Europe will also be likely to avail of more tax efficient arrangements relating to transfer pricing.
Another bit worth focusing on: "Kennedy Wilson Europe pointed out in its recently-published annual report that in 2014 it acquired a €202.3m Irish loan book for €75.5m". Yes, that's right, the discount on Irish properties purchased by the KWE was in the range of 62.7 percent, almost double the 33.5 percent average haircut on loans purchased by Nama. Assuming EUR 202.3 million number refers to par value of the assets, this implies that Nama has foregone around EUR59 million, if average discount/haircut was used by Nama in buying these assets in the first place. Look no further than the KW own statement: ""The enterprise will benefit from greater scale and improved liquidity, which will enhance our ability to generate attractive risk-adjusted returns for our shareholders. The merger significantly improves our recurring cash flow profile". The improved cash flow profile is, most likely, at least in part will be attributable tot ax structure changes for the merged entity.

Which is exactly how vulture funds' arithmetic works: pay EUR1.00 to buy an asset that Nama purchased for EUR2.68, which was on the banks' books at EUR 3.58. The asset devalued (on average) to EUR1.43-1.79 in the market at the crisis peak, and the fund is in-the-money on this investment from day one to the tune of at least 43 percent. Without a single brick moved or a single can of paint spent...

Of course, there are other reasons for the deal, including steep discounts on asset valuations in the REITs markets for UK properties, but the potential tax gains are hard to ignore too. Whatever the nature of the deal synergies, one thing is clear - vulture-styled investments work magic for deep pockets investment funds, while traditional small scale investors are forced to absorb losses.



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