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In February 1991, Mr. Rafael Nelson, Investment Officer of the PERA Foundation,
received a copy of the prospectus for the Cebu Equity Bond Unit (CEBU) from Ms.
Reyes, a manager of an investment bank that regularly informs the Foundation of new
offerings in the money market. CEBU was being described in the business dailies as an
innovative long-term instrument - promising a tax-free interest income and a stock-for-
principal exchange which offered the holder appreciation potential. Mr. Nelson and his
Executive Director thought that CEBU might provide both higher yields and
diversification benefits to the Foundation's portfolio which was largely in short-term,
default-free treasury bills. Mr. Nelson was tasked to make a recommendation to the
Investment Committee for a P 1 million investment in CEBU.
The PERA Foundation is a non-profit institution established to support the PERA School
of Business through funds generation and investment programs. Over the years, the
Foundation had built up a P 20.7 million portfolio which was invested in treasury bills,
corporate promissory notes (PNs), stocks, and a trust placement which was mainly
invested in a mix of corporate and government debt instruments. The breakdown (at book
value) of this portfolio as of year-end 1990 was as follows:
Amount %
P 20,769,166 100.0 %
Although there were no formal investment guidelines, Mr. Nelson was fully aware that
the Investment Committee and the Board of Trustees traditionally maintained a generally
conservative investment philosophy. This was evident in the disproportionate share of T-
1
Case written by Roy Ybaez, Associate Professor of the UP
College of Business Administration, for the FINEX Foundation-
PACSB-UPBRF Case Development Project, March 1993. All rights
reserved by the casewriter.
Bills in the portfolio and the practice of limiting purchases of corporate PNs only to those
of large, reputable corporate borrowers.
The Foundation's expenses are fairly stable and predictable. These are for various forms
of support to the School, e.g., research and professorial chairs. The Foundation's
investment philosophy ensured that there would always be ample liquidity to meet these
expenses. Hence, the assessment of investments in equities is expected to center on the
issues of expected yield on the one hand, and the risk of capital losses on the other.
Historically, the Foundation had settled on a practice of limiting equity investments to at
most 30% of the portfolio and limiting stocks to the commercial-industrial issues and
eschewing what it views as more speculative mining and oil issues.
The Cebu Equity Bond Unit constitutes a direct unconditional and general obligation of
the Province of Cebu. CEBU will have the distinction of being the first municipal bond to
be publicly offered in the country. It is a component of a P 1 billion financing program
of the province to fund various infrastructure projects estimated at P 1.6 billion. The
overall financing program involves the formation of a subsidiary corporation in
partnership with Ayala Land, Inc. (ALI) to undertake property development projects in
key commercial areas of Cebu City. The Cebu government contributed "patrimonial
properties," all located in prime areas and valued at P 748 million as of June 1990, as its
equity in the subsidiary corporation named Cebu Property Ventures Development
Corporation (CPVD). In exchange, the provincial government received 748 million
shares of CPVD with a par value of P1 per share. ALI contributed P 252 million in cash
and received an equivalent number of CPVD shares.
The flotation of P 300 million of CEBU is the first tranche of this financing program. The
principal payments of CEBU will be in the form of Class "A" shares in CPVD at the pre-
determined formula below. The rest of the financing requirements of Cebu would be met
by the gradual sale of the remaining CPVD shares of the provincial government to the
investing public.
In short, the Cebu government plan is to use its land as equity and enhance the value of
its equity through a partnership in property development with ALI. It would then raise
the needed cash for its infrastructure program by liquidating its CPVD shares via CEBU
and the sale of its other CPVD shares through a series of secondary offerings over the
2
next three years. CEBU provided a mechanism for the province to realize cash up front at
a value which hopefully already incorporated a premium for Cebu's original properties.
MPA
No. of Shares =
RV + (AMP RV) x 0.50
If CPVD prices fall below par value, i.e., AMP < 1.00, the following formula is
applicable:
However, the foregoing formula is applicable only to the extent of the number of shares,
i.e., 1.25 shares, pledged per unit.
If the AMP cannot be determined (if say the stock is not yet listed when a principal
payment becomes due), then CPVD's Net Asset Value (NAV) as determined by two
independent appraisers will serve as AMP.
Since the transfer of the CPVD shares to unitholders would be coursed through the stock
exchanges, the unitholder would have to pay the broker's fee upon such transfers (the
maximum fee currently being charged is 1.5% of the value of the stock transaction).
Security : Pledge of 1.25 Class "A" shares of CPVD for every unit of CEBU
Default : Failure of the Cebu government to pay interest or deliver the CPVD shares
would allow unitholders to declare a default, demand payment of the
outstanding balance in terms of its equivalent number of CPVD shares or
foreclose on the pledged shares.
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The prospectus offered the information that the tax exemption on the interest income and
other legal matters had been cleared with the concerned government agencies.
Mr. Nelson decided to check further with Ms. Reyes, the investment banker. According
to her, "There is strong interest in CEBU. Many of my clients are attracted by the 16%
interest income, especially since it's tax exempt. And because you receive CPVD stocks
in exchange for the principal, you have the potential for capital gains. Sir, with a partner
like Ayala and a boom town like Cebu, how can you go wrong?" Ms. Reyes also quoted a
business daily which reported one of the co-issue managers as saying, "It's almost certain
that investors purchasing the CEBUs would be enjoying a higher yield from capital
appreciation than CPVD shareholders would be getting from market appreciation over
the same period."
Nelson relayed these to his Executive Director, who promptly reacted, "Nelson, you have
to take these sales talks with a grain of salt. It's not obvious to me why we're going to
earn more than an outright buyer of CPVD stocks if the CEBU formula forces us to share
the capital appreciation with the Cebu government. You'd better look at that formula
carefully. What if CPVD stocks don't fare too well - we could end up with lots of
certificates that's only good for wallpaper. And you know our Board, they're going to ask
you about the liquidity of CEBU."
Nelson got back to Ms. Reyes on the matter of liquidity. "Well, we have it from the issue
managers that they are prepared to buy back CEBU from any unitholder who would want
to liquefy his CEBU holdings. Also, according to the prospectus, they might list CEBU in
the stock exchange. And if you're concerned about the CPVD stock itself, the plan is to
list it in the exchanges six months from now," said Ms. Reyes.
The partnership between the Cebu provincial government and Ayala Land, Inc. (ALI)
involved cash equity from ALI, made ALI the exclusive developer of CPVD, and
involved the transfer of three parcels of land from the Cebu government to CPVD as
Cebu's equity. These three parcels are as follows:
4
Property Appraised Value
Total P 747,992,000
According to a report prepared by the investment bank, these properties were recently
appraised and found to have a current market value of P 1.063 billion, with the Lahug
property experiencing the highest appreciation to P 4,000 per square meter.
The same report estimated the Net Asset Value of CPVD as follows:
P 1,315,223,000
CPVD's real estate operations would be in three major areas: a) land banking for future
development by ALI; b) property development and rental; and c) buy and sell of
properties for capital appreciation and eventual sale for a profit.
Ayala Land, Inc. was both 25.2% owner of CPVD and exclusive developer. ALI is a
wholly-owned subsidiary of Ayala Corporation. The choice of ALI as partner was clearly
dictated by Ayala's vast experience in real estate development. When Ayala Corporation
was restructured into a holding company, ALI acquired all its real properties and equity
in real estate related subsidiaries.
The robust economic growth of Cebu was in direct contrast to the slow recovery of the
rest of the economy. The province, with its highly successful export zone and major
infrastructure projects, was attracting substantial investments in industrial and
commercial projects. Among these are the hotel projects of the Kuok group and the
shopping complex project of the Shoemart group.
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Perhaps the single biggest property development in Cebu, and responsible for much of
the high rates of appreciation in land values, was the 44.6 hectare Cebu Business Park
(CBP) envisioned to be a mixed development of commercial, office and residential uses.
The CBP is a project of Cebu Holdings, Inc., an affiliate of ALI, Santiago Land
Development Corporation, A. Soriano Corp., the Kuok group, and the Philippine Long-
Term Equity Fund. The Lahug airport property of CPVD is about 1.5 kilometers from the
Cebu Business Park.
One investment bank had estimated that average real estate prices in Cebu City, Mandaue
City and Lapu-lapu City (the latter two forming part of metropolitan Cebu) have grown at
an average high of 52.75 % annually and an average low of 31.23 % annually for the last
three years.
Mr. Nelson realized his problem would be establishing the likely prices of CPVD when it
is finally listed in the stock exchange. His experience with the Foundation's stock
portfolio had taught him that property stocks were typically priced in terms of their net
asset values. Recent data on listed property stocks gathered by Mr. Nelson is summarized
below.
Another lesson he had learned was the volatility of stock prices in the Philippines. In fact,
the market was still in the midst of a strong price rebound in the aftermath of the recently
resolved Gulf crisis (Chart 1).
Ayala Property
Ventures Corp. 1.64 1.68 2.4 % 914.0
6
There were hardly any comparable bond instruments in the Philippine capital market.
This added to the difficulty in evaluating the relative attractiveness of CEBU. The closest
to CEBU were long-term commercial papers or LTCPs issued by corporations with at
least "A" credit ratings. These LTCPs had maturities of three to five years, and offered
adjustable interest rates at a fixed premium over either the 91-day or 182-day treasury bill
rates. Three-year long-term commercial papers of San Miguel Corporation were due to be
offered in February with gross yields of 1.5 % over the 91-day treasury bill rate. Chart 1
shows the historical and current treasury bill rates. Treasury bills offered a maximum
tenor of one year.
Mr. Nelson wondered whether the innovative features of CEBU might in fact be a
disadvantage if investors fail to appreciate its features and sources of both profitability
and risk. With the CEBU offering period barely three weeks away, Mr. Nelson needed to
submit his recommendation on the purchase of CEBU soon. Given the features of CEBU,
Mr. Nelson was concerned about preparing a report that would allow the Board to make
an informed decision.