AWA: Academic Writing at Auckland

Question 1

The firm that Robert Huang represents is HRL Morrison &Co. a specialist investment management firm, that invests in private equity and infrastructure. Projects include Wellington Airport, Trust power and Metro bus. The strategy employed for their decision making is a risk and return strategy. The risk is spread over a spectrum and increases along the spectrum. Core infrastructure is generally considered low risk and risks increases with private equity as there is operational risk, which means there is uncertainty around rental revenue and costs.

The firm also employs a strategy of megatrends and modern technology trends such as personal mobility, urbanisation and environmental consciousness. Their core infrastructure is operational public infrastructure partnerships. A more recent project is the purchase of data centres in Australia and this is a private equity deal.

Question 2

The overall constraints in achieving their chosen strategy is operational risk which is spread across a spectrum and varies from different projects, uncertainty with revenues and costs. Development risk and the ability of not being able to sell the properties. Operational risks (uncertainty with revenue and costs) increase as increases along a spectrum. However, the Australian government is steady rental income stream and is one of their biggest clients. Re contracting is a big risk as technology continually changes. As the firm’s strategy involves megatrends and modern technology there is a significant risk involved as data centres technological change.

Question 3

The property discussed was the Canberra Data Centres (CDC) it fits in to the strategy as it is attractive entry point with growth opportunities and has an established reputation as high quality operator over a period of 9 years. CDC aims to provide reliable green data solutions which aligns with the firm’s strategy of environmental consciousness and the data centre is growing modern technology industry and is used by many organizations such as the Australian government.

Data centres they have operational risk costs may increase as overtime facilities get stronger and consume more power usage, development risk as facilities need to be highly reliable and if you can’t sell a facility it is a big loss of capital as each facility has $200 million invested in it approximately.

Question 4

The target IRR for HRL Morrison and Co. is 18-20% which is determined through the company’s management strategy from prior and existing investment returns. If management is able to achieve a target of around 18-20% then it is an indicator that management is performing well.

Canberra Data Centres are worth A$1.1 billion and have strong projections of medium term growth CDC. Overtime the facility is expected to grow to A$1.75 billion.

Question 5

1. Rents : Guaranteed rental stream once contracts are finalized, typically from a quasi-governmental organisations. Rentals are usually ratcheted, 4% increments for CPI adjustments.
2. Vacancy Risk: Relatively low, as clients are long term tenants e.g. Australian government. However, re contracting presents a risk as technical obsolescence may mean clients look elsewhere.

1. Possible non-recoverable outgoings: Potential non recoverable outgoings can be passed on to tenants through higher rents. Examples of non-recoverable outgoings include legal and accounting fees for advice regarding potential sites for development. The expenditure spent on research and development for potential sites cannot be recovered regardless of whether the venture is profitable or not. Other non recoverables can be LIM, council reports, etc. for the property.

1. Obsolescence / Depreciation: Technical and functional obsolescence is present data centres. Materials change in the design of data centres moves away from adopted methodology. This issue is cured by continually building new data centres approximately one a year. Once a wide variety portfolio of data centres are established, it is easy to circulate tenants around newer upgraded facilities while upgrading the older facilities.

1. Going-in and Going-out Capitalisation Rates (reversion value):

The reversion value is higher as facilities can sell for then they are purchased for it is the net of all existing debt payments.

1. Capital Expenditure: Capex assumed to be 100% debt funded. Cap ex is important to upkeep and reliability of facilities in order to avoid failure. The facility is upgraded from
2. Debt / Gearing: Re-gearing is done 2 or 3 times over the life of the facility. Old data centre can be upgraded though the equity from a newly developed data centre.

 Question 6

For HRL Morrison and Co. Apart from equity cash flows the other cash flows assessed in detail include operating expenses which ranges from 4 to 12 years, it is the day to day expenses incurred in running the property e.g. electricity is recoverable and is a pass through cost. Other cash flows include EBITDA (earnings before interest, taxes, depreciation and amortization) and increases as facilities are filled in years two and four. The net rental is important and is received from POD rental revenues are guaranteed it is finalized once the contracts have been finalized,

 Significant cap ex in costs are incurred in setting up building as sufficient capital is required for constructing facility, this includes building the base building, systems used for power cooling, networking. Pipes are also placed throughout the facility in order to maintain optimal temperature. Repairs and maintain capital expenditure is incurred in subsequent years.

The capital expenditure is an investment in infrastructure, and is financed through cash reserves, grants and loans. The debt drawdowns capex assumed to be 100% debt funded. High gearing is not viable, cash is used to decrease debt levels and each facility isn’t financed by a specific security which allows to optimize debt profile further.

Free cash flows to equity is what is paid out to shareholder’s or what the investor receives after interest, taxes, net working capital, capex, debt drawdowns (repayments), etc. is paid.

Question 7

The presentation incorporated obsolescence as an overarching driver of cash flow analysis this is because obsolescence is detrimental to HRL Morrison &Co.’s business model (Construct a facility, Sell capacity Customer management, Expansion planning). When building a facility, the design has to be very modular, convertible and reconfigurable easily in order to avoid depreciation and obsolescence and have a high class facility for clients. Brownfield development means more capacity is added to an existing facility.  In order for the facility to be Brownfield development is adding more software to existing software systems.

Each facility is refreshed every four to seven years. In a ten-year period, the chillers and coolers are replaced and the diesel tank is replaced every seven years despite it’s useful life being 15 years. These features are replaced as chillers and coolers are important to maintain optimal temperature in the facility to prevent overheating and malfunction of servers. Certainty is required because if these components fail then valuable data is lost and contracts among clients emphasize reliability.

Obsolescence is taken care of by building new facilities constantly approximately one a year. This because material and designs of building change and there is a shift for the adopted methodology. Obsolescence is also mitigated by moving clients who have data storage serves at existing facilities to newly furnished facilities. At the end of a facilities life (which is approximately 25 years) redevelopment (knocking down the facility and starting again) is considered.