Friday, April 08, 2005

More on Lease Fleet Valuation (II)

Continuing with the Mobile Mini (MINI) debate . . .

If, as the short-sellers say, the company is capitalizing costs that it really should be expensing, eventually the net book value of the lease fleet will rise higher than market value, resulting in an overvaluation crisis.

In my prior post, I reviewed the company's actual lease fleet sales data for 2003 and 2004 and found that very consistently the containers are being sold at an average price that is 1.5 times net book value. This is an indication that the containers are not overvalued on the books.

We can also extract appraisal information from the 10-Ks, since the company's lenders require periodic third-party appraisals of both fair market value (FMV) and orderly liquidation value (OLV) of the lease fleet. Below I summarize FMV, OLV and total debt as percentages of net book value (NBV):

2002
NBV: $337 mil., or $4,030/unit (Dec. 31, 2002)
FMV: "in excess of 120% of net book value" (Jan. 2002)
OLV: Appraisal completed in Sep. 2002 but value undisclosed
Total Debt: $213 mil. (63% of NBV)

2003
NBV: $383 mil., or $4,280/unit (Dec. 31, 2003)
FMV: Appraisal not updated from Jan. 2002
OLV: 82.4% of NBV, or $314 mil. (Mar. 2003)
Total Debt: $241 mil. (63% of NBV)

2004
NBV: $452 mil., or $4,490/unit (Dec. 31, 2004)
FMV: 110.6% of NBV, or $500 mil. (Mar. 2004)
OLV: 79.0% of NBV, or $357 mil. (Mar 2004)
Total Debt: $277 mil. (61% of NBV)

In absolute terms, with fair market value generally above 110% of net book value and orderly liquidation value around 80% of net book value (well in excess of total debt as a percentage of NBV), the appraised values look healthy enough. However, the above numbers also exhibit a year-to-year trend with a curious shrinkage of the valuation "cushion" above net book value:

1. FMV as a percentage of NBV has fallen from "in excess of 120%" in 2002 to 110.6% in 2004; and

2. OLV as a percentage of NBV has slipped from 82.4% in 2003 to 79.0% in 2004.

Since appraised values are only estimates of value, we should try to avoid reading too much into these numbers, especially since they represent only two or three years of data. Nevertheless, using the appraised values as stated, it IS possible to begin to construct a case for overcapitalization: To achieve "steady state" ratios without shrinkage of the valuation cushion (i.e., to maintain FMV/NBV in excess of 120% and OLV/NBV around 82%), it would be necessary to reduce stated net book value by about 3% to 5% annually, effectively by reclassifying as expenses a portion of the costs that the company has capitalized in its reporting to date. The impact of this hypothetical reclassification would be as follows:

Year: 2003, 2004
Original Net Income: $5.9 mil., $20.7 mil.
Original EPS: $0.41, $1.40

Expense Reclassification (3% of NBV): -$11.5 mil., -$13.6 mil.

Revised Net Income: -$5.6 mil., $7.1 mil.
Revised EPS: -$0.39, $0.48

(The above figures are a "zeroth-order" approximation of the impact of the hypothetical expense reclassification, ignoring first-order effects such as tax savings from having lower taxable income, reduced depreciation from having a lower lease fleet book value, etc.)

Clearly, the hypothetical impact of this type of expense reclassification on reportable earnings would be devastating, with potential for cutting earnings by more than half, crushing the stock price, and forcing the longs to surrender and turn the keys to the party house over to the shorts!

Admittedly, the above analysis is a "back-door" approach to constructing a case for earnings overstatement through overcapitalization, since what really needs to be done is to review each cost item and determine whether it should properly be capitalized or expensed--which, of course, is the job of the CFO, his staff accountants and outside auditors. However, because public information does not give me access to the company's books at this level of detail, I have only simple consistency checks such as this at my disposal.

I must say that the trend exhibited by the appraisals is somewhat disturbing. To examine this matter further, I have requested from Mobile Mini the results of any more recent appraisals that may have been completed. Since appraisals were done in March 2003 and March 2004, it is possible that another appraisal was completed earlier this year (2005). I will post again with any new findings.

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