October
19, 2018
Robert
F. Telewicz, Jr.
Branch
Chief
Office
of Real Estate and Commodities
Securities
and Exchange Commission
Division
of Corporation Finance
100 F
Street, NE
Washington,
D.C. 20549
Re:
IRSA Propiedades Comerciales Sociedad
Anónima
Form 20-F for the fiscal year ended June 30, 2017
Filed October 10,
2017
File No. 000-30982
Dear
Mr. Telewicz:
On
behalf of our client IRSA Propiedades
Comerciales Sociedad Anónima (the
“Company”), we are writing to respond to comments
raised in the Staff’s comment letter dated September 21, 2018
(the “Comment Letter”) relating to the above-referenced
annual report (the “Annual Report”) of the Company
filed on October 10,
2017, pursuant to the
Securities Exchange Act of 1934, as amended.
We are
providing the following responses to the comments communicated by
the Staff in the Comment Letter. For convenient reference, we have
reproduced below in bold the text of the comments from the Staff.
The responses and information described below are based upon
information provided to us by the Company.
Form 20-F for the fiscal year ended June 30, 2017
Item 5. Operating and Financial Review and Prospects
Results of operations for the fiscal years ended June 30, 2017 and
2016
Changes in fair value of investment property, page 122
1.
We
have reviewed your response to comment 2. Please tell us the
underlying market or economic factors that caused the significant
increases in the values of your shopping mall properties relative
to your other property types. Please note that while changes in
methodologies or assumptions for internal calculations utilizing
unobservable inputs may impact your estimate of fair value, fair
value, in accordance with IFRS 13, is the actual price that would
be received to sell an asset in an orderly transaction between
market participants at a given measurement date. To the extent you
believe that market and/or economic changes uniquely impacted the
value which market participants would be willing to pay for
shopping mall properties versus other property types, please
specify those factors and explain why they have impacted the price
of shopping mall properties relative to other property
types.
The
Company acknowledges the Staff’s comment and respectfully
advises the Staff that, as set forth in the response letter to the
Staff‘s prior comments, the market for sales of shopping
malls in Argentina is highly illiquid and there have been no
relevant transactions in recent years to use as a reliable
comparable transaction. Since the fair market value of our assets
may not be determined based on comparable transactions as detailed
in our prior response to the Staff’s comments, we have
developed a valuation model based on discounted cash flows that we
believe reflects the fair market value of our shopping mall
properties. Note that this valuation methodology has been generally
accepted by market participants in Argentina (in which we are
leaders) and it is the methodology we (and other market
participants) use to determine the acquisition, sale or development
of a shopping mall in Argentina. In addition, the value of the
shopping malls is determined based on the stream of cash flow that
such asset may generate. As discussed in the Company’s annual
report for the fiscal year ended June 30, 2017, shopping mall
revenue is directly related to consumer spending since a
significant component of the rent payment received from tenants is
tied to the sales realized by such tenants (i.e is a percentage of
the sales of our tenants). Therefore, our approach is to estimate
those cash flows based on the available reliable data in the market
and discount them to arrive at the fair market value of each
shopping mall property as of the calculation date.
Since
the cash flows generated by the shopping malls are closely related
to the spending by our tenants’ customers, the fair market
value of a shopping mall is especially sensitive to economic
activity (or the expectations regarding future economic activity,
mainly GDP growth and inflation) in as much as such activity
affects consumer spending as contrasted to the methodology used to
calculate the fair market value of our office properties, whose
rental payments are mainly denominated in U.S. dollars and are more
stable over time (when measured in U.S. dollars). In this sense, in
order to reflect such correlation with economic activity, we
believe that the valuation model we use for our shopping mall
properties takes into consideration the necessary factors and key
components to fairly represent the impact that Argentine economic
activity has on the fair market value of our shopping malls
assets.
Set
forth below is a brief explanation of the market or economic
factors that the Company believes caused the significant increases
in the fair market values of the Company’s shopping mall
properties followed by a summary of the main factors that affect
valuation of our office properties.
a)
Value
of shopping malls measured in U.S. dollars
We note
that the Argentine economy has experienced considerable volatility
in the last few years. As of June 30, 2018, the Argentine economy
has registered inflation of more than 100% in the last three fiscal
years and the peso had depreciated more than 200% since June 30,
2015. This volatility, especially inflation, has had an impact in
the fair market value of our shopping malls as measured in
Argentine pesos. Specifically, the value of our shopping malls has
been significantly impacted by inflation since, as retail products
(the products sold by our tenants) have been adjusted (increased)
to account for inflation of the Argentine peso, our expected cash
flows from our shopping malls have similarly increased in nominal
terms since it is mainly calculated as a percentage of sales of our
tenants in pesos.
In
addition, the fair market value of real estate assets in Argentina
is usually set and transacted in U.S. dollars, so any depreciation
of the peso generates a significant nominal increase in our
Investment Properties measured in pesos as reflected in our
Financial Statements as of the end of each Fiscal
Year.
As
reflected in the chart below, the nominal fair market value of the
Company’s shopping mall properties as calculated in pesos has
increased significantly mainly due to the increasing inflation in
Argentina and the depreciation of the peso but, consequently, the
value of such properties, as measured in U.S. dollars, has
reflected a lower increase in fiscal year 2016 compared to 2015
(and a decrease as measured in U.S. dollars in fiscal years 2017
and 2018 although there was a nominal increase in such value as
measured in Pesos).
|
(*)
Offer exchange rate at the end of the period (Banco de la Nación
Argentina).
|
Note
that we have determined that, as of July 1, 2018, the Argentine
economy qualifies as a hyperinflationary economy according to the
guidelines contained in International Accounting Standard 29,
Financial Reporting in Hyperinflationary Economies (“IAS
29”) since total cumulative inflation in the 36 months prior
to July 1, 2018 exceeded 100%. IAS 29 requires that the financial
information recorded in a hyperinflationary currency be adjusted by
applying a general price index and expressed in the measuring unit
(the hyperinflationary currency) current at the end of the
reporting period.
b)
Economic
Activity (GDP)
As
discussed above, our valuation model is based upon the cash flow
that we expect to receive as rent from each shopping mall
(i.e., a percentage of the
sales of our tenants which, in turn is closely aligned to GDP
growth). Therefore, the evolution of GDP in nominal terms is
considered a significant variable to explain the evolution of
shopping mall sales and revenue growth. Based on the analysis of
information from 2006 to date, historical shopping mall revenue
shows a high correlation of 0.9x with the evolution of nominal GDP
growth. This reflects the significant impact generated by the
Argentine macroeconomic environment on the behavior of the shopping
malls business.
Source:
INDEC/Company’s information (Form 20-F).
In
December 2015, a new president was inaugurated in Argentina and the
new administration introduced several economic reforms that had a
positive impact on Argentina’s economic outlook. During the
first months after the new administration was inaugurated, many
international and local financial institutions had a positive
perception of Argentina’s economic outlook, which had a
corollary positive effect on Argentina’s GDP growth
estimates. The new outlook, in turn, had a positive effect on the
fair market value of our shopping mall properties since our
estimated cash flows from our shopping malls were similarly
positively affected. Note that such outlook and GDP growth
estimates have since been adjusted to reflect the revised market
perception of Argentina’s future economic growth, the effects
of higher interest rates by the U.S. Federal Reserve, the increase
in estimated rates of inflation and the effects of the depreciation
of the peso against the U.S. dollar that occurred in the last few
months.
c)
Inflation
and Exchange Rate
During
the first semester of 2016, the Macri administration implemented a
series of economic measures intended to produce an important change
in the direction of the country in political, economic and social
terms.
Among
those measures, the administration authorized several tariff
adjustments and subsidy reductions in relation to certain public
services such as transportation, gas and energy prices. Such
measures caused an increase in inflation since several businesses
increased their prices to cover the increase in their costs. An
increase in inflation caused, in turn, a nominal increase in
revenue from our shopping malls. According to the INDEC, the
increase in the Consumer Price Index was 26.9% in 2015 and 41% in
2016. As mentioned before, inflation generates an increased
revenues from our shopping malls in nominal terms (and, therefore,
an increase in our estimated cash flows as measured in Argentine
pesos).
In
addition, the Argentine government removed certain exchange
controls that restricted access to the exchange market which
resulted in a significant depreciation of the local currency
exchange rate in late 2015. The Peso to U.S. dollar exchange rate
increased from AR$9.03 per US$1 as of June 30, 2015 to AR$14.99 per
US$1 as of June 30, 2016. Note that this caused a higher market
value in Argentine Pesos of our properties for investment and
offices since those assets are, generally, valued and transacted in
U.S. dollars. Note that, during fiscal year 2016 there was a
greater inflow of U.S. dollar financing into Argentina, which
prevented a further depreciation of the Argentine peso against the
U.S. dollar. The following chart shows the evolution of flows to
the country reported by the Argentine Central Bank:
Source:
Central Bank of Argentina.
Therefore, the
difference in the fair market value of our shopping malls was
affected by inflation registered during fiscal year 2016 and
projected high rates of inflation for the following years, which
caused an increase in value measured in Argentine pesos while the
value of our investment properties measured in USD was affected by
the exchange variation which was, in nominal terms, lower than the
rate of inflation. In addition, exchange projections in June 2016
did not predict further significant depreciation of the peso due to
capital inflows context in Argentina for fiscal year
2016.
d)
Cost
of capital and discount rate
The
cost of capital and, thus, the discount rate that was used in our
valuation model was (and still is) subject to the economic
conditions in Argentina since the sovereign cost of capital has
been subject to volatility in the last few years.
At the
international level, in 2016 the government reached an agreement
with certain holdouts of the its restructured sovereign debt (For
further information, see Risk factor “The Argentine
government’s ability to obtain financing in the international
markets is limited, which may impair its ability to implement
reforms and foster economic growth, which may negatively impact our
financial condition and results of operations.” in our 2017
annual report in Form 20-F) which meant that Argentina had access
to the international capital markets. Consequently, the country
risk decreased significantly during calendar year 2016, as well as
the performance of sovereign and other Argentine corporate bonds,
evidencing a decrease in cost of capital of companies in Argentina
(including us). Therefore, these new market conditions also
affected the fair market valuation of our shopping mall properties
since the rate we use for discounting the estimated cash flows from
our shopping malls decreased under such circumstances.
The
following chart describes the decline in sovereign bond yields
registered during 2016/2017, as well as the decrease in the
performance of the corporate bonds issued by us in March 2016
(prior to the agreement with the holdouts).
Sovereign Bonds (US$) – Yield (%)
Source:
Bloomberg.
IRCP bond 2023 (US$)-Yield (%)
Source:
Bloomberg.
e)
Evolution
in the Fair Market Value of Offices in AR$ and in US$
|
(*) Bid
exchange rate at end of period (Banco de la Nación
Argentina).
(**) FY
2015: Exchange Rate: Contado con
Liquidacion –implicit exchange rate given by the price
is Pesos of a stock listed in Buenos Aires and ADRs traded in New
York. Sales offices: 95.005 GLA (fy15) vs 79.048 GLA
(fy16).
|
As
discussed above, we calculate the fair market value of our office
properties based on comparable sales transactions since the value
of the class A offices in Buenos Aires is set by observable market
operations (as opposed to the value of the shopping malls that is
set by projecting the related future cash flows). In connection
with the offer of class A offices in Buenos Aires, the segment
(approximately 1.4 Million m2) is a small market in relation to the
population due to the lack of financing in this market. Therefore,
the stock of offices has been historically limited and the vacancy
rate is generally low (less than 9% on average). Consequently, the
fair market value of offices generally responds to a genuine demand
for space. The vast majority of companies that demand office space
do so through rentals rather than buying.
On the
demand side, new projects are developed mostly with equity rather
than debt, with developers of office properties raising capital
from multiple investors. In Buenos Aires, real estate investors are
more likely driven by medium/long term return because they see
their real estate investments as a refuge of value. For these
reasons, it is a small consolidated market in which variations in
value are limited. In general, prices rise with income and
inflation in the United States since these assets and rents are
usually valued and marketed in U.S. dollars. Since this is an
equity market rather than debt, investors tend to hold their
investments in slow market cycles and wait to sell in better market
conditions.
The
value of our office measured in U.S. dollars slightly decreased
during the fiscal year 2016 versus the fiscal year 2015. However,
these same assets recorded an increase in value as measured in
Pesos at year end exchange rate due to the depreciation of the
Argentine peso against the U.S. dollar.
In
conclusion, as explained in the previous paragraphs,
Argentina’s macro-economic conditions (such as GDP growth,
inflation and exchange rate) have a different impact on our
shopping mall’s fair market value than on the fair market
value of our office properties since the fair market value of our
shopping malls is based upon the estimated cash flows generated by
such assets, which are closely related to the expected spending by
our tenants’ customers and are more sensitive to variations
in overall macro-economic conditions, while the fair market value
of our office properties is based on observable market transactions
which are usually valued and marketed in U.S. dollars.
2.
We note from your June 11, 2018 response that you translate the
peso-denominated projected cash flows of your shopping mall
properties into US dollars using projected US dollar-peso exchange
rates for the periods involved. Please tell us what periods were
included in your projections, the forward US dollar-peso exchange
rates you used for each of those periods, and how you determined
those forward exchange rates. In your response, please compare the
forward US dollar-peso exchange rates to the spot rates at the
respective balance sheet dates and, in addition, please confirm you
are able to obtain forward exchange rates for periods greater than
12 months into the future.
The
Company acknowledges the Staff’s comment and respectfully
advises the Staff that the length of the projections of the
estimated cash flows from each of the shopping malls is bases upon
the expected useful life of such asset which is determined
according to the conditions of each one of the properties, which is
generally set between 9 and 28 years. The useful life is the
projection and/or forecast of total life in months or years during
which such shopping mall can be expected to contribute to the
Company’s operations, which takes into account the passage of
time, the use and deterioration, technological advances, as well as
other aspects that influence and affect the ability to use such
asset. The expected useful life is determined by an external
appraiser.
The
Company also advises the Staff that it is able to estimate forward
exchange rates for periods greater than 12 months into the future.
However, it should be noted that the local market in which foreign
exchange future contracts are commonly traded in Argentina (ROFEX)
offers future exchange contracts for a period of up to 12 months.
Accordingly, exchange rate projections and other macroeconomic
information used by the appraiser, such as projected inflation and
GDP growth, used by the external appraiser to estimate the fair
market value of our shopping malls are obtained from an external
consultant. Our external consultant is Miguel Angel Broda, a
well-known macroeconomic consultant in Argentina, who is
independent from the Company.
In
addition, and in order to reinforce our process and diligence, we
validate such projections and results we receive from our external
consultant with the “Reporte de Expectativas de
Mercado” (Report of Market Expectations “REM”)
prepared by the Central Bank of Argentina. This report summarizes
the main macroeconomic projections for the short and medium term of
the Argentine economy (up to 2 years) provided by a survey of local
and foreign specialized analysts. The survey is conducted during
the last three business days of each calendar month and includes
each analysts’ projections of consumer prices, the Peso-U.S.
dollar exchange rate, level of economic activity and the result of
operations of the non-financial domestic private sector. This is
one of the most reliable sources of projections related to the main
economic variables and it is commonly used by market
participants.
The
information detailed bellow is provided by the external consultant
and it is used to estimate a short and a medium term exchange rate
curve. However, in order to project the long-term exchange rate,
the following depreciation rate is used: [(1+ CPI Argentina) / (1+
CPI USA)-1], assuming that exchange rate in the long term follows
the difference between Argentine inflation and US
inflation.
Projection of Exchange Rate
(1)
Real
data.
(2)
Average exchange
rate for fiscal year 2016: considers the last six months of the
administration of President Cristina Fernández de Kirchner and
the first six months of the administration of President Mauricio
Macri.
3.
We
note from your response to comment 2 that there is no observable
data available to estimate a long-term peso-denominated interest
rate with which to discount the projected future cash flows of your
assets. Please clarify how you determined that reliable forward US
dollar-peso exchange rates can be estimated and what factors cause
you to be unable to estimate a long-term peso-denominated discount
rate.
The
Company acknowledges the Staff’s comment and respectfully
advises the Staff that, as mentioned in our response to comment 2,
in order to determine the fair market value of our properties we
engage an external appraiser, who calculates the fair market value
of our shopping malls using the macroeconomic information compiled
and provided by Miguel Angel Broda, a well-known macroeconomic
consultant in Argentina. Among other items, our external consultant
estimates forward U.S. dollar-peso exchange rates that are used to
convert the peso-denominated cash flows generated by each shopping
mall property into U.S. dollars.
To
support this process and reinforce the reliability of the inputs
used in this methodology, we validate such projections by comparing
them to the REM prepared by the Central Bank of Argentina. As noted
above, the REM contains the main macroeconomic projections for the
short and medium term of the Argentine economy (including the
peso-U.S. dollar exchange rate), which are based on a survey of
local and foreign specialized analysts.
There
are a number of challenges to estimating a discount rate in pesos
mainly due to the characteristics of an emerging market such as
Argentina, including: economic volatility, illiquid capital
markets, and institutional instability, among others. The Company
believes that the challenges related to estimating a long-term
peso-denominated discount rate are primarily the
following:
1)
Difficulty in determining a long-term risk
free rate:
a.
In developed
economies, the long-term rate that is considered risk-free are
those of the assets that have default risk equal to zero, which, in
general are calculated using the sovereign’s long term bond
rates. However, in emerging economies, sovereign bonds do not
reflect a risk free rate, because default risk probability is not
zero.
b.
In Argentina, the
interest rate for financing in pesos is based on a Reference Index
(generally the BADLAR rate which is the interest rate for deposits
greater than AR$ 1.0 million) plus a spread. Both variables (the
rate and the spread) are highly volatile and therefore are not a
reliable reference for periods longer than a year. Applying a peso
rate to our valuation model would imply developing a dynamic
discount rate over time, which means adding a greater number of
assumptions to the calculation that would make such rate
unreliable.
|
Source:
Argentine Central Bank.
|
2)
Problems with the estimation of the beta
coefficient and return on equity.
a.
The market’s
illiquidity has a considerable impact on the returns of local
assets, which means that the Reference Index (MERVAL) is not always
representative of the economy.
b.
The low
representation of the Reference Index means that the beta
coefficient obtained does not reflect the market risk, but rather
the risk between the analyzed asset and a limited basket of assets.
For this reason, analysts use betas estimated against broader and
more trustworthy indices, especially if the emerging markets has a
foreign listing.
3)
Impossibility of calculating the cost of debt
in local currency: in particular, the Company does not have
long-term bonds outstanding denominated in pesos. As a general
rule, most local companies issue debt securities in foreign
currency (primarily US dollars) for periods that exceed one year or
up to two years.
* *
*
Please
do not hesitate to contact me (212 455-3066) with any questions you
may have regarding the above responses.
Very
truly yours,
By: /s/ Jaime
Mercado
Jaime
Mercado
cc: Matias
Gaivironsky
Leonardo
Magliocco
Eduardo
Loiacono
Mariano
Tomatis
David
L. Williams