Thursday, February 6, 2014


OUE C-REIT, which comprises OUE Bayfront and Lippo Plaza, IPO at a price of $0.80. It offers investor a yield of 6.8% which is considered rather high for a non-industrial REIT. The price-to-book ratio is 0.77x which offers investor a 'discount' to the book value that is one of the largest among all the S-REITs. As always, the devil is in the detail.

Office properties are typically sold at a capitalization rate of 3.5% as compared to 5% for retail properties and 6.5% for industrial properties. However, the average dividend yield for office REIT is around 6.5% as compared to 6% for retail REIT and 7.5% for industrial REIT. Capitalisation rate is similar to PE in that it is Net Property Income (NPI) / Property Value. Obviously, something has to been done to pump up the NPI yield by 3%.

Same Old Tricks Again

Income Support is the favourite trick of all office REITs. It guarantees a minimum level of income and yield for the initial few years that will satisfy the need of the investor. The principle is that rental rate signed at the moment is much lower and is likely to grow in the future. The seller provides income support for the first few years until the positive rental reversion takes place which will render the income support useless. Income support is almost always needed whenever office REITs are looking to acquire new asset. Since 2007, most office properties acquired by REITs have income support in place. Let's examine the track record.

Figure 1 - Office Properties where income support expires

 Figure 2 - Office Properties where income support has yet to expire

From figure 1, all 3 properties fail to meet the Income Supported NPI level at the time of acquisition. The final yields were all around 3.5%. Figure 2 refers to properties with income support provision that has yet to expire. Currently, none of them achieves organic NPI yield of more than 4% after exclusion of income support. This brings into question whether income support has merely been a gimmick all these while. Notice the difference in the NPI(With Income Support) and the acquisition price for MBFC (1/3 interest) acquired separately by Suntec REIT and K-REIT (since rebranded as Keppel REIT). The difference in acquisition price is likely due to the difference in net present value of the total amount of income support (difference of 17.6 million yearly) provided. At the end of the day, does not it seem like investors are the one paying for the income support to create the illusion of a higher yield?

The way I view income support is that growth is being purchased upfront. If the forecast growth is achieved, DPU does not increase as the growth in NPI compensates for lost of income support. If the forecast growth is not achieved, investor will suffer a drop in DPU after expiry of income support. Growth in DPU is achieved only if growth in NPI exceeds that of the forecast which is already likely to be aggressive in its assumption.

Figure 3 - Implication of Income Support

Lets get back to OUE Bayfront, the property that's provided with income support to guarantee minimum Gross Rental Income (GRI) of $57 million annually for 5 years. Total amount of income support is subjected to the limit of $12 million a year and $50 million in total for the 5 years. Based on the total NLA of 37,381.8 sq m and forecast GRI of $47.3 million in 2014, this works out to be average rent of $9.84 psf. To achieve the level of $57 million, average rent of $11.81 psf is needed. Current passing rent is only $10.4 as of September 2013. With Bank of America occupying 28.7% of OUE Bayfront's GRI with a long-dated lease term till 2021 (though there will be step-up clause) and that top 10 tenants account for 76.4% of total GRI (less bargaining power), there is likely to be no growth in DPU for next 5 years and a small possible downside after 2018. Figure 4 provides a comparison of how much of the distributable comes from Income Support or Capital Return, which is a sign of how sustainable the dividend is.

Figure 4 - Income Support/Capital Return as % of Distributable Income

Management Fees payable in Units or cash can affect the amount of income distributable to unitholders. It is equivalent to paying staff using share options instead of cash and has been mentioned in an earlier post on SPH REIT. The impact can be significant as seen from the 0.69% increase in distributable income by having 100% of Management Fees Payable in Unit in Figure 5. I have also done a comparison against other office REITs in Figure 6. The key importance here is that when distributable income drops during bad time, it is those who have been paying management fee in cash that can convert them into units and hence reducing the drop in DPU.

Figure 5 - Management Fees payable in Units

Figure 6 - % of Management Fee Paid in Unit

High Gearing is used to lever up the income for distribution. The low capitalisation rate for office building is why all the office REITs are much more geared as compared to other S-REITs. A 35% gearing ratio allows income for distribution to be levered by 1.54x (100%/65%) minus the finance cost (interest rate multiplied by 35%) In the case of OUE C-REIT, the 42.3% gearing ratio provides a leverage of 1.73x minus finance cost of 1.06% (Interest Rate of 2.5% x 42.3%). Therefore, the unlevered income for distribution will be 4.5%. ( [6.8%+1.06%] / 1.73) and leverage increases dividend yield by 2.3%.

Figure 7 - Gearing Ratio of Office REITs

Something Different

However, gearing ratio ( Debt/Investment Properties ) can be manipulated by the denominator. By valuing the investment properties higher than its fair value, REIT can actually artificially depress the gearing ratio to make the balance sheet appears more healthy. In fact, this point is linked to why OUE C-REIT is trading at a 23% discount to book value. The main reason why OUE C-REIT trades at a discount to book is due to the discount over fair value that OUE and Lippo China Resources offer to sell to OUE C-REIT.

Figure 8 - Valuation of Investment Properties

Figure 9 - Unitholders' Funds

The difference in purchase consideration and value on balance sheet is the revaluation surplus and this is how unitholders get a huge discount on book value in an IPO. For OUE Bayfront, the difference in purchase consideration and value is only 100 million or 10% of the value. At a NPI yield of 3.3%, maybe the valuation on OUE Bayfront is slightly aggressive based on the value on balance sheet. We do not have conclusive evidence for this. However, does not there seem to be a huge gap between the purchase consideration of Lippo Plaza and its valuation? Why is Lippo China Resources (LCR) so generous to offer a 30% discount though LCR is not even owning any equity stake in OUE REIT?

Firstly, Lippo Plaza is a 14 years old building sitting on a 50 years land lease that will expire in 2044. Therefore, investor is buying an older building with only 30 years of lease remaining. This is unlike OUE Bayfront which has a remaining lease of 92 years. The depreciation rate for Lippo Plaza is 3.3% which means that out of the 5.2% NPI yield, only 1.9% is investment return as the rest is form of return of capital. With remaining lease of 30 years, how is the valuation worth $476 million or 3.7% NPI yield? Industrial REITs usually trades at a higher dividend yield to account for their shorter land lease period of 30 to 60 years. Industrial properties tend to be bought at capitalisation rate of 6% to 6.5% to account for the higher depreciation rate.

Secondly, Lippo Plaza Property is based in Shanghai, so it will be different as compared to a Singapore property for REIT. One key benefit of putting a property into REIT is to get tax exemption. Foreign property in S-REIT is exempted from taxation in Singapore but they are still required to pay tax in their local country. In the case of Lippo Plaza, it is supposed to pay 25% of its taxable income and 10% withholding tax for dividend paid to OUE C-REIT. This works out to be around $3.5 million in taxes each year after deducting expenses or 20% of the net property income of $17.4 million. Therefore, the effective NPI yield for a like-for-like comparison with Singapore property will only be 4.2%. If we deduct another 3.3% of capital return, investor is only getting an investment return of 0.9%. And if we take into account expenses like management fee and finance expense, one should really wonder why did OUE C-REIT take up this property and value it at $476 million?

Figure 10 - Forecast Occupancy Rate for Lippo Plaza

Figure 11- Forecast Assumption

For the appraised value, OUE C-REIT adopts the higher of the 2 valuers which is the one by Colliers. Colliers has assumed a 5% annual growth rate in rental which seems aggressive. The assumed occupancy rate of 95% for office seems high as the highest it has achieved is 92.1% in the past 3 years. This is a 14 years old building and it is unlikely to compete well against the newer building when it comes to higher rental and occupancy rate. Perhaps we should look at Lippo China Resources for some clues.

Figure 12 - Snippets from circular

Figure 12 contains some interesting opinions from the board of directors of Lippo China Resources. For LCR, Lippo Plaza is a mature 14 years old asset which requires high maintenance cost of around $6.5 million (not sure if it is one-off or annually). If LCR is realizing full value of its property at a 30% discount to valuation, then OUE C-REIT's revaluation is unjustifiable. The revaluation creates a "discount to book value" as well as reducing the gearing ratio. If we were to value Lippo Plaza simply based on its purchase price, the gearing ratio will now be 47.5% [ 681.4/ (1102+331.8) ]. This is the real incentive for having higher valuation - to disguise a much higher leverage.

This does not seem to be a rewarding deal to OUE C-REIT. LCR does not have to own any equity stake in OUE C-REIT while OUE needs to own 50% of OUE C-REIT. LCR needs not provide any form of income support unlike OUE which has to come up with $50 million for OUE Bayfront. OUE C-REIT bought a property with only 30 years remaining lease and does not enjoy tax-saving. While I do agree that Lippo Plaza only accounts for 30% of the total asset, this shows the incentive of the management. Why does not OUE C-REIT acquires both properties from OUE, instead of 1 from Lippo China Resources? The likely reason is that OUE is at the bottom of the pyramid with listed parent companies like Hong Kong Chinese Limited and Lippo Limited. The incentive is to reward the top more than the bottom. Certain management team and owner always have a consistent reputation and track record for being shareholder friendly or otherwise. It might be a good idea to take a look at the performance of some of the other Riady's companies listed in Singapore.

To conclude, a lot of work has been done to push the yield up and make it looks more attractive. The fundamental difference in office cap rate and dividend yield results in a situation where Office REITs often resort to numerous tricks. Yield accretive acquisition is also unlikely to take place with its current dividend yield and 42% gearing ratio. As with all REITs and investments,it is not about avoiding the risky one but a question of whether the current yield sufficiently compensates for the underlying risk of the REIT. Investor will probably do better to demand a much higher yield than 6.8% for OUE C-REIT.

Sunday, January 19, 2014

Purchase of Frasers Centrepoint Limited

I purchased Frasers Centrepoint Limited (FCL) on the first day of trading after the spin-off. Opportunities seem to be getting lesser in the Singapore market and I decide to venture into my first special situation play. I am guided and inspired by "You can be a stock market genius" by famed investor Joel Greenblatt. He is probably more known for his magic formula than his book on special situation. Given that this is my first time, I am not exactly confident if it will work out well and do correct me if I make any mistake.

A few special situations have occurred after the successful control of FNN by Thai Billionaire's Chareon. The first was when F&N was dropped from the MSCI Index, leading to index selling by many fund managers. The key to spin-off and index selling is to identify motivated seller who are selling not for fundamental reason. The return was 12% gain in 3 weeks, very nice annualized return. In addition, there is the catalyst of a debt-laden LBO owner who is desperate to reduce his debt. This did play out on hind sight as FNN declared a capital reduction of $3.28. At that time, I was not aware of such special situation so I did not catch it though quite a few at valuebuddies manage to make a good profit out of it.

In August 2013, details of the spin-off of FCL was announced. 2 shares of FCL will be given out dividend-in-specie for every 1 share owned in FNN. After the spin-off, FNN will be in 900 mil net cash position while FCL will take on 2 billion of net debt. It took another 4 months before the spin-off, which provides investors ample time opportunity. I looked into it during December when it was around $5.60 to $5.70. Valuation is easy since one has access to the JP Morgan's circular for independent director (during the bid for FNN by OUE and Chareon) and prospectus of FCL. At that time, I estimated a combined value of around $6.03 for FNN - $2.45 per share for FNN (Market Cap of 3,550 mil) and $1.79 per share for FCL (2 shares).

It seem like my valuation of FNN is off by a huge margin as FNN is currently trading at $3.48 per share and was trading probably near $3.80 on the xd date. What happened? Firstly, we will have to understand that FNN is now a holding company whose wholly-owned operations are only FNN Singapore and Publishing. I am sure my figure for the 56% stake in FNN Berhad is correct ( since it makes no sense that this 56% stake that FNN owned should be more than the value of FNN Berhad. Even if FNN Berhad is undervalued, it makes more sense to buy FNN Berhad instead of FNN. In any case, with its PER of 25 x, this certainly don't seem to be the case. Net cash of $900 million is also accurate. Vinamilk is a listed entity, so it will be same reasoning as FNN Berhad. Publishing is valued at $300 million using EV/EBITDA method, but I only give it  $100 million as it is not profitable. I am not sure if there will be people to buy it at $300 million. Even if it is valued at $300 million, it will only push valuation up to $2.60 per share.

FNN Singapore's valuation
Myammar Brewery Limited's valuation

That leaves us with only FNN Singapore and Myammar Brewery (MBL). FNN Singapore is not profitable and even if we use the transaction favourite metric EV/EBITDA, it is hardly cash generative especially if you subtract the capex. Thus, I just gives it a valuation of $100 million to be conservative unless this is just a temporary dip in net income. It seem like FNN Singapore's role is to own the brand and licensed it to FNN Berhad. Therefore, the only likelihood that market is paying a fair price for FNN at $3.48 will be if MBL deserves a valuation of $1.7 billion for the 55% stake. This will value it at nearly 60x PE, which I supposed the growth and dominance of MBL in Myammar should have been fully priced in. In addition, let's not forget that FNN is fighting a legal battle on the ownership of MBL at the moment. In any case, FNN certainly don't look attractive at the moment.

I do have 1 final explanation for the valuation of FNN.  Let me quote a paragraph from the Genius, "As a general rule, even if institutional investors are attracted to a parent company because an undesirable business is being spun off, they will wait until after the spinoff is completed before buying stock in the parent. This practice relives the institution from having to sell the stocks of unwanted spinoff and removes the risk of spinoff transaction not being completed."

Purchase of FCL

After I miss the ride on FNN, I have slightly more than a week to look at FCL. Once again, I was inspired by Joel Greenblatt's story on his Host Marriott and Marriott International trade. Marriott got into huge debt and the plan was to leave behind the hotel properties and all of the company debt at Host Marriott while spinning off the debt free and highly desirable management contract business in Marriott International. While everybody will have gone for Marriott International, Joel Greenblatt targeted Host Marriott, the company known to be left with toxic waste. As he thought "Who the hell is gonna want to own this thing?" Nonetheless, this is not just a simple contrarian play, but he bought it as he believed there is some value in Host Marriott that people will not have noticed. You can read his book to understand more about the story, but now I am going to touch on FCL.

Reasons for purchase

I was attracted to look into FCL as I believed that most people buying FNN was looking at the consumer staple business and not the property business. RNAV is out of reach and far too complicated for most people. With the property developer taking a hit after TDSR which has been effective at driving down property sale, property don't seem to be the hottest stock in the market. There is also no brokerage covering the stock before the spin-off and issuing a call. In addition, FNN declared a $0.42 dividend compared to FCL's $0.0173 dividend after the spin-off. FNN is in a net cash position as compared to FCL net debt. Thus, it is likely that most people are going to sell it away on the first day of trading regardless of fundamental. With many selling on the first day and much lesser people buying, this creates an opportunity.

FCL is not exactly just a property developer. It has 2 REITs, Frasers Commercial Trust and Frasers Centrepoint Trust, with total AUM of $3.5 billion. In addition, it has hospitality management contracts of 5,728 rooms where it does not own the serviced residence but is involved in managing the operation. This is an asset-light business similar to Marriott International. In LTM Jun 2013, this generated 37.8 million in profit before taxation for FCL which is rather comparable to ARA which generated 86 million in profit before taxation for FY 2012.

There has been ongoing news from the management that they are looking into setting up a hospitality REIT together with TCC Assets. FCL has 14 hospitality properties with 2280 rooms and book value of around $1.6 billion. It is likely that only a portion will be spin-off at the IPO. This will certainly help drive their AUM further up and allow them to monetise their asset to adopt an asset-light strategy where they will earn more REIT management fee and own the lucrative hotel management contract.

Non-REIT Commercial and Retail Properties

More importantly, FCL will have 3 different platforms to unload their assets to recycle capital - Retail, Office and Hospitality. On the balance sheet, the 50% stake in Changi City Point with book value of $199 million and fair value of $286 million has been classified as properties held for sale. By definition, properties held for sale are properties that the company intend to sell rather than to hold for rental or capital appreciation. It should not be an issue for FCT given its gearing ratio at the moment. FCL also have mature assets that can be offloaded to the REITs.

One of the greater concerns about Singapore residential developer will be that TDSR and the other cooling measures will lower their ability to sell the properties. Private home sales have indeed dropped quite a lot with 2013 annual new home sales volume 30% lower than 2012. However, this should not be a major concern for FCL which has 91% of Singapore residential units pre-sold and total unrecognised revenue of $2.4 billion. In Australia, approximately 56% have been pre-sold and it has a sizeable land bank.


Valuation is not that complicated as Knight Frank, CBRE and DTZ have been hired to do the fair valuation ( back then. I adjusted for the lower valuation of the 2 REITs as well as for the difference in book value of the circular and the latest prospectus. In addition, JP Morgan did not revalue and attribute future profit to the land bank. Do note that this figure is just a ballpark figure and is never the exact RNAV. You might also choose to adjust differently and arrive at your own RNAV. With the bulk of the revaluation surplus attributable to the pre-sold residential units and that an hospitality REIT is likely to come, it seem like there is a possibility for the discount to RNAV to narrow. Thus, I bought it at $1.50 on the first day. If we consider OUE's bid for FNN at 12.7 billion and subtract away the $2.7 billion of F&B business for Kirin, $900 net cash of FNN and $4.6 billion of dividend given out, that will imply that OUE values the property business at $4.5 billion or $1.55 per share. This excludes the interest cost that OUE has to take on to take over FNN.

Downside Risks

I have also identified a few risks that might adversely affect this special situation play.

Firstly, the free float of FCL is only 12% which means that there will be limited number of motivated sellers as compared to a stock with much higher free float. However, with a market capitalisation of around $4.5 billion, this will work out to be $500 million free float. Together with limited buying interest, I think the chance of motivated selling outstripping buying interest should not be too low. On the first day, total volume was around 5 million shares or total value of around $7.5 to $8 million. Thus, the extent of motivated selling was indeed limited though it helps that people are not comfortable with valuation of such company.

Shareholding Structure

Secondly, another concern that arises will be whether Chareon will take advantage of the minority shareholders. This is definitely a valid concern especially in Asia when we are dealing with the Godfathers. Chareon has a control interest of 88% and direct shareholding of 76.5%. Since the difference is only 11.5%, the probability of Chareon taking advantage of the minority shareholders is much lower given the alignment of interest. The danger comes in the form of a series of pyramid structure where the top will benefit at the expense of the bottom. If the asset swap took place, the effective shareholding of Chareon in FCL will rise. On the other hand, shareholders might need to be careful if he starts placing out more of his shares. We shall pay more attention to the hospitality REIT and potential sale of hospitality asset to FCL for signal of how shareholders will be treated.

Lastly, the share swap of FNN shares for FCL might incentivise the management to drive up price of FNN and drive down price of FCL temporarily. TCC Assets is more important to Chareon than Thai Beverage given the difference in ownership. Thus, it does make sense if TCC Assets wants to exchange its FNN shares for more of FCL shares. The share swap is not a market rumour if one looks at pg 63 of FCL prospectus under the Moratorium:
"In this regard, the SGX-ST has granted a waiver from the requirements under Rules 228 and 229(1)
in respect of such InterBev-TCCA Transfer during the Lock-up Period so long as it does not result in a
reduction in the effective interest of the ultimate controlling shareholders of our Company during the Lockup

No one knows how the share swap will occur as TCCA's 59.4% interest in FNN is almost double that of Thai Beverage's 28.6% interest in FCL even after the capital reduction of $0.42 at FNN. Given that FNN is a holding company, Thai Beverage may not need to buy over all the shares of FNN. Thai Beverage only needs 50% shareholding for control and consolidation of FNN's results into its financial statement. Controlling 100% or 50% of FNN will still gives it the same 55% shareholding right over FNN Berhad without the need to raise further debt or equity to acquire more of FNN.

At the current price of $1.61, I no longer feel as comfortable adding more of it. This has been an experiment into spin-off to apply what I have learnt from Joel Greenblatt's book. I do admit that this is definitely not the best spin-off situation given the limited free float though this is offset by a hidden opportunity in its REITs management, hospitality management business and its 91% pre-sold Singapore residential project. The holding period is likely to be less than a year as compared to my usual holding period of at least more than a year. Many of the points made earlier are speculative in nature so please do your own research and analysis.


Thursday, January 2, 2014

Divestment of Silverlake Axis and The Hour Glass

I have divested both companies around the period of October and November. Here's the reason for divestment:

Silverlake Axis

Silverlake was divested at the price of $0.795 though it went on to rise to an all-time high of $0.95. On hindsight, this looks like a mistake especially since it went up by 5% the day after I sell it. When to sell a stock seems to be a harder decision than when to buy and I know that I will never get to sell it an all-time high. Hence, the important thing will be for me to look at my reasons to sell 1-2 year from now to see if it makes sense.

The main reason is because of the high valuation of the stock which I get a bit uncomfortable of. At the price of $0.795, it works out to a market capitalization of $1.786 billion ( based on 2,247 million shares, inclusive of the 100 million share placement in June 2013). This represents a PER of 23.7 x based on exchange rate of 2.6 RM to 1 SGD and FY 13 net profit.

However, one has to take note that only the maintenance and enhancement services is recurring in nature and this accounts for only 40% of the EBIT, which works out to be around RM 92 million in NPAT. PER based solely on the maintenance and enhancement business will be around 50x. Obviously, it is not realistic to value Silverlake solely based on its recurring segment, but it should be somewhere in between. The rest of the business is largely order book driven and is likely to be more volatile in nature.

The next question will be how well is Silverlake Axis expected to perform going forward since it is the future profits that matter. Back in 2010, Silverlake Axis secured 4 contracts worth SGD 210 million, with the HNA and CIMB contracts contributing the bulk of it. Since then, they have secured 2 integration project in 2011, 2 small licensing project in Malaysia, RM 135 million contract in 2Q 2013, Hong Leong's EPP and Union Bank of Colombo in 3Q FY 2013. Ever since the bumper crop in 2010, the total dollar value of contracts secured from 2011 to 2013 are still likely to be much lower than SGD 210 million. Total software project services and licensing contract remaining should be around RM 300-350 million which is around 1.5 year of the segmental revenue in FY 2013.

Silverlake Axis cannot really be blamed since CIMB is the 2nd largest bank in Malaysia. 5 of 7 largest banks in Malaysia, UOB, OCBC, 4 of 10 largest banks in Indonesia  are already using their software. To get another project of similar size, the only potential client is RHB. Thus, it is unlikely that Silverlake Axis can continue to achieve its current level of software licensing revenue after FY 2014. At the current valuation, market seems to have priced in more than its achievable growth, believing that Silverlake will be able to grow its orderbook further than the level in 2010. 1Q 2014 results has been boosted by a RM 8.3 million gain in forex and inclusion of Merimem results.

Back when I initiated it in March 2012, the key thesis is that maintenance and enhancement profit will rise significantly such that PER based solely on the recurring segment will decrease from 20x to ~15x while the other order book revenue will serve as bonus. This has worked out and given that the market has more than priced in the growth potential, a decision to sell has been made. As of writing, price has gone to $0.910, which is at a PER of 28x. Potential catalyst will be new mega order win and perhaps the listing of its Chinese associates.

The Hour Glass

The Hour Glass (THG) was divested at the price of $1.645, at a PER of 8x. Due to the high working capital requirement, free cash flow has been around 30-45% of net profit which is a reason why it may be hard to expect much positive re-rating of stock.

Days Inventory Turnover has been more than 200 days as the luxury industry is hit by unexpected clampdown on luxury spending by the government in China since last October. Despite increase in sales by 14% from the increase in store network, profit has dropped by around 6% for past 2 quarters as gross margin has been hit. While THG has remained relatively more resilient, the margin pressure comes from industry wide inventory clearance as they are trying to de-stock. This does show the inherent weakness of retailer as the consumers identify more with the brand of the watch than the retailer. The ability to fend off competition is limited though the operation has been well managed as compared to others.

Return has been good since it was bought at 5x PER and decision to sell was made to clear off the weaker stock in the portfolio.

It has been quite some while since I last posted as I had been pretty busy with school. Not that I have given up analyzing stocks as I have actually analyzed more companies in greater detail than 2012, but it is just not blogging about it. Going forward, hopefully I will have more time to do so.

Currently, I am left with VICOM and Boustead, being in 55% cash position. There has been a lingering thought to liquidate the whole portfolio since the potential upside has been greatly reduced given current price. It is not too hard to sell away 2 stocks too. While the portfolio has delivered good return, I have also learnt about the numerous blind spots that I have missed in each companies that I have owned. I have learnt a lot more stuff over the past 2 years and it might be a good idea to restart to apply what I have learnt.