Tips on valuing international leasing transactions: due diligence and valuation have taken on even more importance in the wake of Sarbanes-Oxley, and foreign lease deals present specific challenges, says a valuation expert.

The Sarbanes-Oxley Act has changed a lot of the ways that corporations do business, and that's been particularly true of large domestic and cross-border lease transactions.

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In January 2003, the U.S. Securities and Exchange Commission (SEC) adopted the final rules under Sarbanes-Oxley relating to the disclosure of off-balance sheet financial arrangement and contractual obligations. Under these rules, a company may no longer exclude specific financial transactions from its balance sheet by means of a special-purpose entity ("SPE").

Prior to 2003, a company could own up to 97 percent of an SPE without having to include the SPE's liabilities on its balance sheet. Synthetic leases often used an SPE to hold title to a specific asset and lease it back to the company, thereby avoiding the liability while still being allowed to deduct the interest and depreciation from the company tax bill. This provides an attractive investment for major banks and finance companies.

The new rules didn't outlaw off-balance sheet financing, but did eliminate the attractiveness for entering into large domestic and cross-border financial transactions that were going strong prior to 2003. These types of deals were primarily arranged as synthetic leases as a way of providing the necessary financing.

Now that these financings are required to be reported on the balance sheet, the volume of large deals has fallen sharply since 2002. The financing options for U.S. and international municipal transactions--such as wastewater and freshwater systems, roads and rail infrastructure--have since become limited. That's made the need to rely upon precise information even more of a concern for CFOs.

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The information required in performing a financial analysis or appraisal to support an international, as opposed to a domestic, transaction doesn't vary all that much. There is still a need to review the financials and determine the value of the assets.

However, when a country's tax requirements, availability to translate source information and the variance in laws and customs throughout the world are taken into account, international transactions can become more time-intensive. That means a new set of concerns regarding due diligence and the valuation process that a CFO should become familiar with when contemplating an international financial agreement.

Site Visits Important

Site visits are a necessary part of the process for the valuation team and part of the due diligence they need in order to provide a CFO with the most detailed information. Understanding the nature of a business or the condition of specific assets is a critical component of the process and the eventual outcome of any business arrangement. There's no better way to accomplish this than by physically seeing the environment in which the business and/or assets exist--in other words, by "kicking the tires."

The act of physically seeing a business and its assets provides an additional level of insight that can't be captured in documents and ledgers. The ability to observe the day-to-day operations and the functionality of specific assets provides additional information, such as:

* Whether or not the location of a particular business and its assets might impact the overall value as a result of environmental factors, logistics, neighbors etc.

* The actual condition of specific assets and whether or not preventive maintenance is performed.

* Something noticeable as a result of the exposure to the business and its assets that might put into question the accuracy of the financial data provided (such as overall inactivity).

There is no easier or more effective way for a CFO to establish a strong and prosperous business relationship than by making the effort to meet the people closest to the actual investment itself, particularly given the new focus on corporate governance and due diligence. When doing business abroad, risks and concerns can be amplified, as can the trepidation regarding fraud and unethical business practices. Research by the valuation team can help supplement the due diligence done by the CFO in international lease transactions.

Obtaining Translated Information

When conducting foreign transactions, the documentation used in determining the appraisal opinions often has not been translated into English. This makes it beneficial to have an in-house or independent translator look at the original documents to ensure the accuracy of the information used to calculate the appraisals.

A best practice is having an in-house or independent translator interpret all the documents provided from the international company; that way, there can be no confusion later regarding the intended meaning of the information. In addition, this will ensure that all the documents requested and required are accounted for. After a transaction is completed, it's too late.

Due to the ever-present fluctuation of international economies and related currencies, the date at which a currency is converted can be critical; that can have a substantial effect on the value and impact the reliance on the financial results. If the information is dated prior to the establishment of the euro, then it is imperative that the CFO rely upon the capabilities of an appraiser in order to provide an accurate opinion of value.

Political and social conditions can vary substantially among international locations. Back in "the glory days" of U.S. cross-border leasing, the resentment being heard in Germany and other European countries over American companies buying and owning their local infrastructure assets was deafening. In locations that are less stable than the EU, this concern may be muted if the company is working in an area where the local government has the ability to take control of assets or force privatization.

Obtaining Reliable Support

CFOs need to consider garnering reliable support for the appraisal in the form of "secondary market valuations" and "economic useful life information" in order to ensure the lease appraisal will make its way past the appropriate tax council.

After all, the economic useful life for assets of the same age may differ. For example, railroad locomotives and passenger cars that can operate when they are 55 years old doesn't necessarily imply that the useful economic life for similar assets is equally as long, nor can it necessarily be considered a benchmark for similar assets in all instances.

Doing business on an international level is nothing new for American companies, of course. What has emerged as one of the primary areas of concern for multinational business transactions is the accuracy of the information that is provided to and accepted by the CFO.

With increasing regulatory environments, due diligence concerns and the escalating attraction of doing business overseas, CFOs need to be aware of the value and risks involved with conducting international lease transactions. The success of these engagements is increasingly dependent on financial officers' ability to understand the valuation process and the importance of the information garnered from and disseminated to the various parties.

RICK DAUBENSPECK ([e-mail]) is a Senior Vice President at Trenwith Valuation LLC, a provider of corporate valuation services. He has supplied value opinions for a broad variety of machinery and equipment assets for lease finance transactions in the U.S. and many foreign countries.

RELATED ARTICLE: Beware of Currency Conversion Issues

The writer's firm was engaged by an international chemical producer to perform an appraisal of a chemical facility to support an initial appraisal that they were provided. The facility was being constructed in The Netherlands and was nearing completion, and the CFO oversaw all subsequent actions related to the due diligence and valuation process. Though it originally balked at the idea of an on-site visit because of cost concerns, the company's investment in the visit paid dividends in the end.

The facility was inspected, and identical information that was given to the original appraiser was provided, along with unfettered access to the supporting data and the individuals who could translate it. After a review of the construction schedule and construction cost data, it was noted that the time of construction overlapped the European Union's conversion to the euro. As a result, the cost data was in Dutch Gilders, euros and U.S. dollars. With all these currencies being referenced, the information provided was, in a word, confusing.

The costs were re-created in a manner identical to the cost schedule provided, converting the expenses from the indicated currency into U.S. dollars at the time the costs were incurred. Applicable inflation was also applied to the construction costs between when they occurred up to the construction completion date. As a result, the valuation created under the cost approach exceeded the original appraised value by approximately 8 percent. With a total construction cost of almost $150 million, the difference was quite substantial.

The value developed by the original appraisal under the same cost approach methodology was also reviewed in order to determine which appraisal was more reliable. After reviewing the process used in the original appraisal, it was evident that the appraisal was performed under a "desktop" scenario that didn't include a site visit.

It was also determined that the calculation of replacement cost, which is necessary under the cost approach, was made by converting the construction costs in euros to U.S. dollars as of the construction date and applying inflation to represent the construction period.

By making a site visit and having the ability to examine the financial information, the supporting valuation increased the value of the facility by approximately $12 million dollars. Considering that the cost for an on-site visit was less than 0.5 percent of the additional value, the chemical producer considered the approach a wise investment.

RELATED ARTICLE: TAKE AWAYS

** The financing options for U.S. and international lease transactions have become limited, elevating the need for CFOs to obtain precise information.

** While international deals aren't necessarily more difficult, the need to deal with different languages and tax codes can make them more time-intensive.

** Site visits can pay off. The act of physically seeing a business and its assets provides an added level of insight that can't be captured in documents and ledgers.

** Besides translating the documents, companies need to pay close attention to the currency used in the valuation and the date of any currency conversions.