Part 2 Questions to Council on Kings Square October 2014

The other day I posted an email sent to the cof, here is the questions in the attachment.

These are questions being asked to the City of Fremantle on their Kings  Square business plan.

These are the questions that the City of Fremantle are not answering on the kings sq business plan.

They real question is why?


City of Fremantle

8 William St


To: Brad Pettitt [Mayor]



Jon Strachan [Cr]

Bill Massie [Cr]

12 Oct 2014

Dear Mr Pettitt

Having read through your November 2012 Business plan for the redevelopment of Kings Square, I find the Financial section addressing Net Present Value and Rates of Return so puzzling that I feel the need to bring these concerns to your attention. The NPV and IRR numbers you have presented to justify this development defy logic. I suspect there may be a fundamental error in the evaluation methodology, which I will explain below. If I am correct, you have overstated the NPV of the Kings Square development by more than A$30 million. If so, this project will significantly destroy value rather than add to the value of the City of Fremantle’s property portfolio. As a rate payer, I find this deeply concerning.

I will lay out my reasoning below and give you an opportunity to respond. I am more than happy for you to demonstrate that in fact the financial evaluation you have completed is correct. However, should I not be satisfied with your response, I will take this further along alternative channels.

There are a few tell-tail signs that indicate that something does not make sense here:

1. The redevelopment of the Council Chamber site costs approximately A$45 million, but that redeveloped site generates minimal additional income in the order of just A$0.2 – 0.3 million per year from retail, café and office lease income (I cannot see the exact total lease income, but it is in that order of magnitude). This cannot generate a positive NPV.

2. Your choice of discount rate for the NPV calculation is arbitrary and flawed, and does not respect the Council’s own investment policy benchmarks

3. Comparing Scenario C with the Base Case rings alarm bells, because the NPV increases when you do not sell the Spicer site

4. While the current value of the 4 properties has been documented (A$37.84m), there is no reference to what the retained property would be worth after the development. Considering the retained building will be primarily a Council Chambers facility, its fair market value will not be equivalent to the A$45 million invested as it will not have alternative uses. Your Business Plan makes no mention as to whether this process increased or decreased the value of the City of Fremantle asset / property portfolio?

5. Your funding structure was written by Sirona, it relies on the sale of properties to Sirona, and does not consider alternative funding structures. If the development of the Kings Square Council Chambers area was truly a great investment opportunity for the City of Fremantle, then it would also be robust under funding structures that did not rely on the sale of other properties, and your Business Plan would discuss this. Your Business Plan does not properly consider other funding structures.

6. There is no proper discussion of the impact of this project on consolidated City of Fremantle cash flows

7. The report states that it is not applicable to include Long Term Capital Maintenance. You are including lease income but I cannot see any maintenance costs associated with the management of the new A$45 million building over its life. 

I can only conclude that you must be including the proceeds of the sale of the Queensgate Centre, the Spicer site and the Queensgate Carpark in the cash flows for the NPV / IRR calculation. This is only valid if you then reflect that the Council asset portfolio is also reduced by the value of these three divested properties. By inspection, you cannot have done this when you present the financial assessment in your executive summary. 

I suspect that this evaluation has been incorrectly framed, and misrepresents to ratepayers the net benefit of this Project to the City of Fremantle to the tune of more than A$30 million.

Getting back to basics, once you have properly framed the project evaluation you must separate the evaluation into its component parts:

• Understand the underlying value and returns from the Project

• Identify the most effective financing structure for the Project

• Understand the impact of this project on Council consolidated cash flows

Your Business Plan and analysis muddles the three together and does not correctly evaluate any of them. Being blunt, the financial analysis in the Business Plan is poorly structured, and smacks of “goal seeking” rather than being an impartial evaluation.


Firstly, you must properly frame the scope of the Project. The “Project” is what you are investing in. The “Kings Square Project” is the redevelopment of the Council Chamber site. The Project being evaluated is not the divestment of other Council properties, as these are separate business decisions. 

I suspect that this may be the fundamental flaw in your analysis. In 20 years of evaluating project development opportunities in the energy sector, I have found that the incorrect framing of the investment opportunity is the single main source of value destruction. This is usually caused by deciding what the answer needs to look like and then back solving an analysis to support this, which is a common and often unintentional trap to fall in. I am not suggesting this has been done intentionally in this case, but if you have not framed this analysis correctly, you cannot expect to get the correct insights, and you will be misrepresenting the true impact that this project would have on the City of Fremantle finances.

The correctly defined Project generates negligible income stream as a return on it’s A$45 million investment, and I cannot possibly see any scenario where it can generate a positive NPV or IRR. 

The sale of the Queensgate Centre, Queensgate Carpark and Spice site are not part of the Project being developed, but they simply represent some possible financing structures for the Project. Project value and project financing, while related, are separate evaluations. The discount rate used in the value / NPV calculation already takes into account the cost of capital for the Project. It is however important to consider the sale of these properties from a consolidated Council cash flow perspective, but this discussion is absent in the Business Plan.

To use the proceeds from the sale of these three properties in the evaluation of whether the A$45 million Project is value accretive or value destructive to the City of Fremantle is the equivalent of someone boasting to have earned say A$100,000 in a year, but neglecting to explain that they did so by selling A$100,000 worth of shares that they already owned, and that they inherited those shares from a relative – that would be delusional!

Furthermore, even your own analysis shows that this is not the optimal financing structure. If we accept your own assumptions about costs of capital (which is questionable), Scenario C (No Sale of surplus property – Spicer site) has a NPV of A$7.27 million versus the Base Case NPV of A$4.47 million. The Council would be better off retaining the Spicer site. This is your analysis, not mine! 

I suggest you run another scenario where the higher rental yielding Queensgate Centre (approx. 11%) is not divested, as I would expect that this would have a similar directional impact on NPV.


Secondly, I question the choice of discount rate. You have stated on page 38 of the 2012 Business Plan that the Council’s investment policy benchmarks a 10% rate of return, yet this is not used in the NPV calculation, not even as a sensitivity. This is not your WACC, but a hurdle rate against which City of Fremantle investments should be tested. The NPV of this Project should be tested against this 10% hurdle rate first if you intend to honour Council’s investment policies, and this will have a significant negative impact on your stated Project NPV.

It may then also be appropriate to test the NPV against your WACC, which in this case is based on the City of Fremantle’s cost of debt (which you have stated to be 4%). However, while a WACC may be appropriate for evaluating the acquisition of a de-risked completed project, it is totally inappropriate to use it for a project development. This is why you have a City of Fremantle investment policy benchmark discount rate, and you should be using it!

The application of a 1.5% nominal risk premium to your cost of debt is nonsense. The discount rate should either reflect your hurdle rate or your WACC, and should not be a “fudge” for representing risk. The use of a 5.5% discount rate cannot be supported. This is either a schoolboy error, or a deliberate attempt to “goal seek” a positive NPV. 

As part of your risk analysis, you should test the sensitivity of your NPV to your cost of debt assumptions by discussing the uncertainty relating to the Council’s cost of debt over the 20 years life cycle of the NPV analysis. This has not been done. We are currently at historically low interest rates, the likes of which we have not seen in our lifetimes. I very much doubt that your analysis of interest rate risk will conclude that the cost of Council debt is unlikely to ever exceed 5.5% over the life of this project. 

The fact that you have stated “investment policy benchmarks” strongly suggests that the 10% discount rate should be used in the Base Case NPV calculation, not an arbitrary 5.5% discount rate. At the very least a 10% discount rate should be used to test the investment against your policy guidelines, which you clearly have not done. Your choice of discount rate methodology looks suspiciously like goal-seeking to get a positive NPV, and this should be great concern to rate payers. 


I am not against the redevelopment of this area in central Fremantle, but the financial analysis in the 2012 Business Plan for Kings Square simply does not stack up. The NPVs and IRRs cannot correctly reflect the City of Fremantle’s A$45 million investment in the redevelopment of the Kings Square site. This was obvious from a first fleeting glance at your Business Plan, and it looks even worse when I dig deeper.

I am happy for you to demonstrate otherwise, as a financially sound redevelopment of this site (assuming you include parking) would truly be fantastic for Fremantle. However, should I be correct, you will be responsible for burning a A$30+ million hole in the value of the City of Fremantle’s finances. I would expect that this should concern you sufficiently to give this the attention it deserves. 

I would appreciate a satisfactory response to this query within 14 days, after which I will follow alternative routes to ensure it does get the attention it deserves.


Good questions

But no answers at all, why is that?

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