Lund Financial Corporation

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'Synthetic leasing' leads to authentic success for Lund

Lund Financial Corp. has wrapped up $272 million in financing for two new Novell Inc. campuses using a little-known but powerful credit tool. Lund, a San Jose-based financial advisory services firm, specializes in off-balance-sheet financing, also called "synthetic leasing." Such leasing for Novell's planned 1.5 million-square-foot campus will enable the company to hang on to badly needed cash reserves. The Orem, Utah-based developer of networking software has been plagued by strong competition from Microsoft Corp.'s Windows NT. It experienced significant losses and layoffs during 1997. LFC principal partner Craig Lund said the synthetic leasing structure allows public companies to avoid property depreciation on their balance sheets. Typically, companies must choose between leasing real estate (which costs more than purchasing and offers no long-term control) or buying it and accepting what Mr. Lund calls the "penalty of ownership." LUND "When you buy a facility and put it on your books, you're replacing cash with real estate," he said. "You're increasing assets with nonearning assets." This can force yardstick ratios, such as return on assets or return on equity, to suffer--which, in turn, could lead to Wall Street analysts sourcing on the company's stock. What's more, a purchased facility depreciates over a 30-year span, which can decrease earnings on the balance sheets.

Although real estate likely world be worth more after 30 years, accounting standards adopted for public companies require buildings to be depreciated in value, just as a fleet of trucks or manufacturing equipment. And while leasing a building doesn't affect earnings or assets, it can cost between 10 and 12 percent of the cost of the building each year in rent. Synthetic leasing would cost the corporation roughly 6 percent of the building cost each year. Synthetic leasing works by matching a corporation with the leasing arm of a bank or other financial institution. The contract is structured like an operating lease, with the leasing institution holding the title. Such leases usually are established for five- to seven-year terms. At the end of the term, the corporation may choose to extend the lease, sell to a third party or exercise a lease-purchase option. Another benefit of synthetic leasing is that if the corporation decides to purchase the building at the end of the lease term, it will pay the fair-market value of the building at the time the lease was signed. Internal Revenue Service regulations treat the financing structure as though the company owned the building, thus providing corporate tax breaks. The structure is good for the corporation as well as the bank, said Mary Beth Suhr, vice president of high-technology banking for San Jose-based Comerica Bank California, a provider of synthetic leasing. "It's a fairly widespread practice," Ms. Suhr said. "It's a matter of finding companies to qualify. It's not for everyone; corporations need an excellent track record and a consistent positive financial performance."

Novell Inc's San Jose Campus She said synthetic leasing is gaining popularity, especially among technology companies, which require more control over their facilities because their building requirements are so specialized. That's fine with Comerica. "Historically, high-tech companies have not been larger users of traditional bank debt," said Ms Suhr. "So this is an attractive way for Comerica to provide lending to a company that wouldn't otherwise seek out banks." Instead of bank debt, some companies have used the bear market to make secondary stock offerings to raise needed cash. But Ms. Suhr pointed out that the cost of debt is lower than the cost of equity, and synthetic leasing allows cash reserves to be used for product development and other investments that will help the company grow. "In the future," she noted, "we may see this being done for companies that are below investment grade."

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