Many may have missed last week’s share market debut of Run
Corp Limited. Run Corp is chaired by former NAB CEO, Frank Cicutto, and is
large-scale property manager. Property management has previously been the
exclusive domain of real estate agents who maintain “rent rolls.” Rent rolls are
generally quite lucrative for agents. The agents cream between 5% and 7% of the
landlord’s rental income for managing rental properties (they also earn income
from other fees such as letting and statement fees). Run’s business is to
purchase rent rolls from agents then use its scale to provide a satisfactory
return to shareholders. Seems like a pretty solid idea on paper. Apart from
Cicutto, Run’s board includes very successful Sydney agent, John McGrath and Sam Herszberg (who according
Run’s prospectus, helped establish Melbourne agent, Wilson Pride, which was
recently sold to US-based Century 21).

Through its IPO, Run raised $25 million. Most of the funds
raised are earmarked to acquire rent rolls from agents. Prior to the float Run
acquired Collins Simms’ rent roll and entered into conditional agreements with
other large agents, including Bennison McKinnon Carmichael, Kay & Burton,
McGrath and Mirvac Real Estate.

While Run’s business model seems fairly solid, there are
several aspects of Run’s prospectus which should have raised the ire of
potential investors. First, the costs of the float seemed extremely high
compared with the actual funds raised, and second, Run emphasised its forecast
earnings using the misleading EBITA figure, rather than the more prudent net
profit measure.

Money for

Run’s prospectus indicated that costs associated with its IPO

  • underwriting fees to ABN AMRO Morgans Corporate Limited of
    $1.073 million;
  • preparation of Independent Account’s Report fees to Horwath
    Corporate Advisory (Vic) Pty Ltd of around $1.1 million;
  • fees to IBIS World for research of around $20,000;
  • corporate advisory fees to Investec Wentworth Limited of
    $855,600 plus $596,400 worth of shares (based on the float price of $1.00) for a
    total of $1.452 million;
  • legal fees of $1.674 million (presumably to Phillips

The total costs associated with the float therefore amounted
to more than $5.3 million (or a staggering 21% of the total equity raised). As a
comparison, it cost insurer Promina about $5 million to raise $250 million in a
rights issue in 2004, while Clive Peeters spent $3.5 million to raise $40
million in its recent IPO and merger
with the Rick Hart Group.

Shareholders may question exactly why, given the relatively
small amount of funds being raised ($25 million), the proprietors required an
expensive public offering, rather than the use of private equity or

particularly pernicious EBITA

Another notable issue is the major prominence given by Run
in its prospectus to forecasted earnings for the year ending 30 June 2007 as
being $7.7 million on a pre-amortisation basis. Earnings on a
post-amortisation basis are buried way back in page 62 of the prospectus. When
amortisation (and its tax consequences) are considered, the earnings forecast
drops from $7.7 million to $3.935 million – a decrease of around 50%. While Run
is hardly the only company which has been guilty of using the misleading EBITDA
or EBITA figure, it is worth noting the views of someone far more qualified than
myself on this issue.

In his 2002 letter to shareholders, Warren Buffet was scathing
in his criticism of the make-believe concept of EBITDA. Buffet noted that
“[T]rumpeting EBITDA (earnings before interest, taxes, depreciation and
amortization) is a particularly pernicious practice. Doing so implies that
depreciation [or amortisation] is not truly an expense, given that it is a
“non-cash” charge. That’s nonsense. In truth, depreciation [or amortisation] is
a particularly unattractive expense because the cash outlay it represents is
paid up front, before the asset acquired has delivered any benefits to the
business. Imagine, if you will, that at the beginning of this year a company
paid all of its employees for the next ten years of their service (in the way
they would lay out cash for a fixed asset to be useful for ten years). In the
following nine years, compensation would be a “non-cash” expense – a reduction
of a prepaid compensation asset established this year. Would anyone care to
argue that the recording of the expense in years two through ten would be simply
a bookkeeping formality?

This is precisely what Run will be doing. Shareholders do not
(or should not) care what a business’s EBITA is – all they should be concerned
about the present value of all cash flows which they will receive as owners of
the company. When amortisation is considered, Run’s future earnings look far
less rosy than the headline figure stated in page 3 of the

While Run’s business model in relation to property management
seems sound, some of the disclosures provided in their prospectus seem less
so. Run shares have rebounded back to their listing price of $1.00 on low
volume, after dropping to 91 cents last week.