Seeking FIRE - Route to Financial Freedom

Been months since I wrote a post here – I’ve started a full time role in the financial sector, which means that active investing has taken a back seat, as all my transactions have to be pre-cleared. I had sold off a number of positions right before I started my role, reducing my single stock holdings to just a handful of companies. Pursuing FIRE (Financial independence, retire early) has been a goal of mine for some time, and this post serves as a summary of the steps I’ve taken as well as the plan ahead. This might also be the last post here in a while, as I intend to mainly post updates on my Instagram page (@alpacainvestments).

Investment Portfolio

Going forward, I intend to post monthly portfolio updates (if any) mainly on my Instagram account. Working full time means that I don’t have the luxury to thoroughly research individual stocks and write lengthy posts on them. The majority of my portfolio is in ETFs – about 50% currently and with the intention to increase my allocation over time. I will still selectively take positions in single stocks, but these would mainly be large cap names simply to get exposure to a certain sector, for example, if I am bullish on the payments sector, I may buy V/MA/PYPL to be “overweight” on the sector in addition to ETF positions such as IVV/QQQ of which these are already constituent stocks.

SRS Account

Recently opened my SRS account by depositing $1. If you’ve yet to open one, please remember to do so before the end of this year because the retirement age will be increased from 62 to 63 next year. Correspondingly, the withdrawal age for our SRS monies will be increased to 63 too. There’s this good article by Seedly explaining the rationale for opening an SRS account with $1 here.  

Crypto

I am a complete beginner in this space therefore I don’t think there’s much for me to share, but I have started buying some cryptocurrencies and this will form a small part of my portfolio going forward. Current allocation is capped at 1-2% of portfolio.

Credit Cards

Applied for a number of credit cards mainly for the deals for new customers – perhaps too hurriedly which was detrimental to my credit score. The lesson learnt here is not to apply for a number of cards in a short period of time, as this may give the impression of a weak credit profile.

I try to use credit cards for nearly all my expenses. I see this as a way to reduce my “working capital”, similar to how companies seek to optimise their receivables and payables. If I were to pay for most expenses using cash/debit cards, it would mean that I have to keep a cash balance in my bank account for monthly spending. But with credit cards, I am literally living “paycheck to paycheck” (with emergency funds set aside, of course) where my current expenses are funded by the following month’s salary, and any excess cash can then be put to investments. The additional benefit of credit cards would be the cashback perks, but for now this is rather insignificant given my low expenses.

Seeking FIRE

The idea of FIRE has been a goal for me for some time. Recently, there was an article on Today which found that around 6 in 10 of young adults in Singapore aimed to retire early, which I found rather ironic given that the Govt has just announced that the retirement age will be raised. I think that there are too many variables to account for at this point of time, thus I would not want to set a specific net worth or age for FIRE. Instead, I believe that a simple three step strategy will eventually lead to attaining FIRE, whether it is 10, 15 or 20 years away. But it would be inevitable. My three steps involves: (1) Maximising income, (2) Keeping expenses below average, and (3) Investing consistently and prudently, and let compounding work its magic.

For point (1), the caveat would be what trade-offs one is willing to take – for example, one could take on various side hustles in addition to a full time role to maximise income, but that would be at the expense of burnout or sacrificing time spent with loved ones. Therefore, I think this should be framed as “given X number of hours I’m willing to work, what would allow me to maximise my income?”.

For point (3), “prudently” is open to interpretation and I think there will always be the temptation to bet on riskier stuff such as options or cryptocurrencies and hope for a 100x return. For me, I think that a more balanced approach would be more practical, keeping most of my investments in ETFs and perhaps having a small allocation to hopeful moonshots.

I’ve ran the preliminary numbers based on the expectation of having $4,500 SGD (in 2021 dollars, adjusted for inflation) of passive income monthly, which I consider to be Barista FIRE or Coast FIRE. This $4,500 figure represents the median income in Singapore and my perspective is that being able to generate this income would be sufficient to live the lifestyle of an average Singaporean. Any additional “luxuries” can then be funded through part-time employment.

My base case assumes a conservative 5.5% CAGR for my investments (100% equity), which I think is reasonable given that pension funds are projecting similar expected returns on their portfolios, which include fixed income. What I noticed when running the numbers was that the sequence of annual returns actually makes a difference on the portfolio’s growth trajectory. For example, having a -30% drawdown in the earlier years is better than a -30% drawdown in the later years, even though the CAGR over the period remains the same – meaning that $1 today still grows at a 5.5% projected rate over the projected period. The main difference would be because there would still be capital injections into the portfolio over time, thus it would be more ideal for the years with higher returns to be the later years when the portfolio is considerably larger.    

Conclusion

My perception is that the idea of early retirement is still pretty controversial, and there are people who are puzzled by the idea pursuing FIRE. My view is that it is simply to have the option to retire once one has accumulated enough wealth, regardless of which age you achieve it by. If someone attains a net worth of X million by 60 and retires, then why shouldn’t some who attained the same X million by 40 be able to retire? To me, as long as both portfolios generate the same amount of passive income, there is no difference.

In any capitalistic society, there is always the battle between Capital vs Labour. And more often than not, Capital is better rewarded than Labour. While most of us begin as salaried employees (Labour), the goal should be to invest in income generating assets over time (Capital), and eventually being able to depend on passive income instead of active income.

Ultimately, I view all our choices as trade-offs that we have to make. In our 20s and 30s, we are trading our time for money; the wealth accumulation stage. At some point, we would have to use that accumulated wealth to “buy” time – that is, to have earned yourself the freedom to pursue whatever you want. To me, that’s the true purpose of seeking FIRE.

Impact of P/NAV ratios on acquisitions and rights issues

 

Earlier this week, I was having a conversation where I was trying to explain how some REITs are able to consistently make acquisitions and grow their AUM, while other REITs are not. My view is that the difference is mainly down to their price to net asset value (P/NAV) ratio which the market assigns to the REITs. REITs with P/NAV greater than 1 are able to take advantage of this cheaper cost of equity to make yield and NAV accretive acquisitions, whereas REITs with P/NAV at or below 1 are unable to do the same – acquisitions would often not be feasible as this would result in NAV and yield being dilutive.

I illustrate this with the examples below.

Let’s say we have two REITs, Reit A and Reit B. Both have similar properties valued at 1 mil, and generate a gross yield of 4%. Interest costs are 2.5%, and the gearing ratio of both Reits are 40% - meaning that the capital structure of the reit comprises of 40% debt and 60% equity. Both Reits have 600,000 shares issued, which gives the Reits a net asset value of $1 per share each. Up till now, both Reits have exactly the same metrics.

Now, let’s assume that as the units of both Reits are traded on the market, somehow, Reit A’s units are trading at a P/NAV ratio of 0.9x, with a dividend yield of 5.56% (assuming 100% payout). Reit B’s units are trading at a P/NAV of 1.5x, with a dividend yield of 3.33%.

What would then happen if both Reits were to look at making an acquisition?

If both Reits were to look at acquiring a property at “market value”, in this case, meaning a property that gives the same gross yield as their existing properties (4%). The target property is valued at $100,000, and the acquisition would be financed by the same debt to equity structure (40% debt and 60% equity), in order to maintain the same gearing ratio for the Reits. This is where the difference in share prices would matter to the Reits. If the discount on new shares is 10%, Reit A, has to issue 74,074 new shares to raise $60,000 of equity, whereas Reit B only needs to issue 44,444 shares to raise the same amount of equity. This means that Reit B’s cost of equity is “cheaper”, because it needs to issue fewer shares to finance the acquisition, hence resulting in lesser dilution of its outstanding shares.

When evaluating the proposed acquisition, both Reits would publish the “pro forma” financial impact of the acquisitions. Here, the capital structure of both reits remain the same (40% debt 60% equity). The gross property yield remains the same, because we are purchasing a property which gives the same yield as the existing property portfolio, and the interest cost remains at 2.5%. The pro forma impact on both Reits would be that the acquisition would be dilutive Reit A’s NAV and yield. NAV will drop to $0.98, while dividend yield, based on the theoretical ex-rights price (TERP) would be 5.50%, down from 5.56%.

On the other hand, Reit B would see its NAV rise from $1 to $1.02, and its dividend yield would increase from 3.33% to 3.44% - both NAV and yield accretive.

What would be the impact of the proposed rights issue for both Reits?

It is likely that Reit A’s shareholders would not approve the deal – nobody likes coughing up more cash, only to see their NAV and dividends get diluted. In fact, the Reit manager for Reit A might not even propose the deal to shareholders, given that it is likely to fail. On the other hand Reit B’s shareholders would likely be glad to throw extra cash at the Reit – given that the deal is NAV and yield accretive.

What can we understand from these two examples?

Fundamentally speaking, there is no difference between the two Reits, as well as the property that is to be acquired. The only difference here is that Reit B is trading at a much higher P/NAV ratio, which allows it to issue fewer shares to make the same acquisition, hence resulting in it being NAV and yield accretive. The longer term impact would be more crucial. Reit B can continue to grow its AUM with more yield accretive acquisitions, and reap benefits such as lower interest costs on its larger asset base, as well as perceived “stability” from it being a much larger Reit. The market would also view Reit B as consistently “growing”, thus may be willing to pay a premium for Reit B. This results in a positive cycle for Reit B, all of which started from the mere fact that its P/NAV was higher than Reit A.

What can Reit A do to grow?

This is not the end of the road for Reit A. It can still grow, but it would require different approaches to grow its AUM. Firstly, Reit A would probably be more selective in its acquisition targets, looking for properties that yield above market gross yields (in this case, >4%). Reit A can also consider other financing options, such as issuing perpetual securities, which count as equity instead of debt. Lastly, Reit A can also consider taking on a more aggressive financing structure for the acquisition, for example, using a 60% debt/40% equity mix, and play around with the numbers until the acquisition can be yield and NAV accretive. However, this would increase the Reit’s overall gearing ratio.

Conclusion

The conclusion here is that simply having a higher P/NAV ratio can result in tangible long term benefits for a Reit, if the Reit is able to take advantage of their “cheap” cost of equity to make acquisitions. In fact, raising equity when share prices are high is what many companies are doing, for example, fast growing companies such as Tesla or Sea Ltd have taken advantage of their high share prices to raise equity. Even meme stocks such as AMC have done the same.

Of course, there are other factors that influence a Reit’s ability to grow, such as the sponsor strength, pipeline of properties from the sponsor, capital recycling etc, but this article mainly serves to explain the impact of having a high P/NAV on acquisitions and rights issues.

Disclaimer: This article is intended for informational and discussion purposes only, and do not constitute financial advice. When in doubt, please contact a licensed financial adviser.

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Summary of SATS Q1 FY22 Business Updates

 

SATS reported its Q1 FY22 Business Updates on Thursday, 22 July. SATS is a company that I’ve been following closely, and this article summarises my takeaways from the business updates provided.

Key Operating Statistics

SATS shared a number of key operating statistics, including number of flights handled, meals served, passengers handled, cargo tonnage and total number of employees. These operating statistics include SATS and its subsidiaries, but exclude JVs and associates. In their business updates, SATS had only provided figures for 5 quarters from Q1 FY21 (Apr to June 2020) to the latest quarter Q1 FY22 (Apr to June 2021). Given that Covid-19 had already resulted in a decline in air travel from early 2020, I have added in two more prior quarter’s of SATS’ operating metrics for a more meaningful comparison. Q1 FY21 coincided with the peak of the lockdown in Singapore, while Q4 FY20 was already impacted by a slowdown in aviation volumes. Q3 FY20 would represent pre-Covid operating statistics.

Number of Flights handled is still way below pre-covid levels, even though air travel in other parts of the world have largely recovered. For instance, airlines in the US are actually unable to keep up with demand due to the shortage of workers, leading them to cut flights. SATS’ disadvantage here is that Singapore does not have a domestic air travel market, unlike larger countries. On the positive side, SIA, which is SATS’ largest customer, recorded a 13.7% passenger load factor for April 2021, up from 4.6% in April 2020. SIA aims for 32% of pre pandemic capacity by July 2021.

The cargo segment continues its recovery, and SATS noted that global air cargo volumes has risen beyond pre pandemic levels.

SATS has also drastically reduced their workforce, from around 17,000 employees pre pandemic to around 11,000 employees in the latest quarter. Staff costs remains SATS’ largest operating expense, accounting for around 42% of group expenditure.   

Q1 FY22 Revenue Mix

One of the positives is that SATS has continued to diversify their revenue base beyond the travel sector, with 46% of Q1 FY22 revenue coming from its non travel related businesses. SATS’ non travel businesses include commercial catering, with SATS being one of the caterers for individuals under quarantine in Singapore.

Q1 FY22 Financial Performance

SATS reported Q1 PATMI of $6.4m, profitable for the second consecutive quarter. Govt reliefs continue to provide support to SATS’ financials, as SATS received total govt reliefs of $45.5m for the quarter. Without this, SATS would have reported a PATMI loss.

On an EBITDA basis, SATS has reported four quarters of positive EBITDA since Q2 FY21, recording negative EBITDA of 33.9m only in Q1 FY21, when travel restrictions were the strictest.

Free cash flow, defined as net cash from operating activities less cash capital expenditure, was a positive 7.9m for the quarter.

As of 30 June 2021, SATS had total debts of 726m, a reduction of 147m from the previous quarter as a 150m term loan had been repaid. If rights of use liabilities were excluded, total debt would be 531m instead. Compared to a cash position of 753m, SATS is in a net cash position of 222m. Debt to equity ratio stood at a manageable 34%.

Conclusion

SATS remains my preferred pick for betting on the recovery of the aviation sector, due to its cost structure being more variable as compared to airlines. Airlines face high capex requirements as contracts with manufacturers require them to continue taking delivery of aircraft even when business has slowed. Ongoing maintenance costs and fuel costs are also significant. Whereas SATS has proved to be extremely nimble in cost reductions to minimise losses. Tellingly, despite the huge drop in passenger numbers due to Covid-19, SATS remains in a net cash position with a reasonable gearing ratio of 34%, and has not required any rights issues to raise funding.

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ThaiBev Analysis: Value Starting to Emerge

 

To begin our analysis of ThaiBev (“THBEV”), we would have to go back to 2017, when THBEV made a blockbuster acquisition of a majority stake in SABECO, Vietnam’s national brewery. The massive acquisition was largely financed by debt, much like how private equity funds use significant amounts of leverage to finance buyouts of their target companies. The deal was valued at $4.8 billion USD, and Reuters reported that this was at a valuation of about 36x core earnings. The price that THBEV paid for SABECO was steep, given that comparable publicly traded global breweries were trading at an average of less than half that earnings multiple at that time. In addition, the leverage that THBEV took on to finance the acquisition also resulted in a deterioration of the balance sheet’s quality, as their gross interest bearing debt to equity ratio rose from 0.31x to 1.49x post acquisition.

Given the steep price that they paid, as well as the huge amount of debt financing, the stock market was certainly bearish, as THBEV’s share price subsequently declined from nearly $1 to bottom out around $0.60 in late 2018. Investor interest in THBEV was revived by talk of a potential spinoff of their beer assets, which consists of THBEV’s regional beer operations. THBEV’s share price climbed to a high of more than $0.90 in late 2019, before Covid-19 hit and equities sold off sharply. From their March 2020 lows of around $0.50, THBEV’s shares fluctuated for about a year before hitting its 2021 peak of $0.85 in February. Since then, THBEV’s stock price has fallen rather significantly due to a myriad of reasons including the delay of its BeerCo IPO, Thailand’s resurgence of Covid-19 cases as well as fears of stricter alcohol laws.

Gradual improvement of financial position since SABECO acquisition

The SABECO acquisition had loaded up THBEV’s balance sheet with debt. Since then, THBEV’s leverage ratios have been gradually improving, supported by its strong cash flows from operations. From the table below, THBEV has reduced its gross interest bearing debt to equity ratio from 1.49x in FY18 to 1.21x in FY20. Net interest bearing debt to equity ratio also improved from 1.32x to 1.00x.

Even if you hold the opinion that THBEV overpaid for the SABECO acquisition (which I do), their deleveraging process over the past three years would have substantially mitigated the negative impact from that. Arguably, THBEV should be in a stronger position today than it was right after the SABECO acquisition, given its reduced leverage ratios, higher NAV and stronger cash position.

THBEV as a reopening play?

Some investors have touted THBEV as a play on Thailand’s recovery, with the reopening of Phuket to vaccinated tourists as an encouraging sign. However, it would be good to note that the majority of THBEV’s sales from its more profitable spirits segment are off-premise, which means that the majority of consumers purchase them at supermarkets rather than consuming them at restaurants. For some perspective, in a year disrupted by Covid, THBEV’s overall revenue only fell by 5.2% in FY20 compare to FY19, which shows that the company fared way better than other F&B players like restaurants or tourism dependent companies.

This is both good and bad news – the good news is that THBEV’s sales may be more resilient even if further lockdown measures are imposed. However, it also means that there would be limited upside from reopening measures too, although we may hold the view that the overall economic recovery would be positive across all of THBEV’s business segments.

BeerCo IPO

In Feb 2021, THBEV announced its intention to spinoff its BeerCo via an IPO on the SGX. Reuters reported that THBEV was seeking to sell a 20% stake in BeerCo for $2 billion, which would have placed the valuation of BeerCo at almost 40x earnings, while peers such as Budweiser and Heineken were trading at an average of 27x earnings. However, in April 2021, THBEV decided to defer its listing of BeerCo, citing the resurgence of Covid-19 in Thailand as a reason for its decision.

Although a valuation of 40x earnings may have been ambitious, given that THBEV currently trades at ~17x P/E, if they are subsequently able to fetch a valuation of 20-30x earnings for BeerCo, it should still be a net positive for the company, as its strongest segment is the Spirits segment (which should logically command a higher valuation multiple) and not BeerCo. For some context, in 1HFY21, their Spirits segment has a net profit margin of 20.1%, compared to a net profit margin 4.1% for the Beer segment. The Spirits segment contributed 48% to revenue and 84% of net profit compared to 41% and 14% for the Beer segment respectively. The BeerCo IPO could be a potential catalyst when it is back on track.

THBEV’s Financials

THBEV’s operating cash flows have been strong, and currently trades at ~11x P/FY20 OCF. THBEV’s dividend policy is to pay out not less than 50% of net profit annually, subject to specified reserves, investment plans and approval from the board of directors. After a slight cut in dividends in FY20, THBEV increased their interim dividend to 0.15 Baht in 1H21 from 0.10 Baht in 1H20.

Risks

1) Thailand has extremely strict alcohol laws, which bans the sale of alcohol online and even simply posting a picture of alcohol online. Any further tightening of alcohol laws would be negative for THBEV. 2) General slowdown of Thailand’s economy due to further Covid-19 lockdown measures weakening domestic demand. Bangkok and nine other provinces are entering a lockdown from 12 Jul onwards. Thailand has been reporting increasing number of Covid cases recently.

Conclusion

With THBEV’s share price declining more than 20% from its Feb 2021 peak, I see value emerging and may take a long position if more near term negatives depresses the share price closer to $0.60. As of time of writing, I do not hold a position in THBEV.

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Disclaimer: This article is intended for informational and discussion purposes only, and do not constitute financial advice. When in doubt, please contact a licensed financial adviser.

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Things I've learnt from Manulife Reit's Corporate Presentation

 

Attended the Manulife Reit (“MUST”) Corporate Presentation earlier today organized by SmartKarma and SGX. Thought it would be useful for current and potential investors if I summarized the key points that were discussed during the presentation, as well as management’s responses to some of the questions raised by the participants.

Firstly, some generic information about MUST. MUST was listed on the SGX in 2016 with three properties. Since then, MUST has grown its AUM via acquisitions, and now owns a total of nine office assets across the US.

As of 31 Mar 2021, MUST’s key financial metrics include a gearing ratio of 41.3%, weighted average interest rate of 3.18%, weighted average debt maturity of 2.1 years and a 3.5x interest coverage ratio. Portfolio metrics as of 31 Mar 2021 include a 92% occupancy rate, 5.3 years WALE, and 2.1% annual portfolio rental escalations.

There were a few questions regarding the impact of Covid-19, and management indicated that they believe offices will still be relevant post-covid, as they expect the hybrid work arrangement to be the dominant model going forward. MUST’s tenants have gradually started bringing their employees back to office, with the physical occupancy of MUST’s properties gradually increasing from 13% in Jan 2021 to 20% as of May 2021. Across the US, a number of large employers are expecting to begin recalling employees back to offices by fall 2021. Management also disclosed that as a result of lower physical occupancy, carpark income has declined significantly.

The question of whether MUST was considering acquisitions was also raised, and a few questions were focused on the possibility of diversifying into other sectors such as logistics and data centres, as these were the beneficiaries of Covid-19. Management indicated that they are open to reviewing potential acquisitions across sectors, but the key would be that these would have to be yield accretive. They are also open to acquiring properties with single tenants, which they previously did not consider, if these single tenants are in high growth sectors and possess strong credit metrics, such as leading tech companies like Facebook or Google. In addition, other typical attributes such as long WALEs and high occupancy rates are also a must. (Following the publication of this article, MUST's IR team reached out to clarify the points which are highlighted in red. I think this is commendable and shows their proactiveness as they are the first IR team to have reached out after I have written an article on a company.) This is because they believe that MUST has built up a substantially diversified portfolio and can afford to take on the risks of a single tenant property.

There was a question regarding the age of MUST’s properties, as 6 out of 9 properties are aged 30 years and older. Management shared a bit of context regarding US properties as compared to Singapore properties. In Singapore, it may be common for us to see buildings facing en bloc sales once the properties age reaches ~20 years. Whereas in the US, buildings are generally well maintained even if they are 30-40 years old. Management also mentioned that MUST provides tenant improvement incentives which incentivises tenants to fitout common areas as well, which keeps the entire building well maintained.

Another point that management shared was the construction costs in the US are generally higher than Singapore, thus it would be less finically viable to tear down buildings once they reach ~20 years old for redevelopment. It would also be good to note that all of MUST’s properties are freehold, thus they would not face lease decay like leasehold properties.

There was a question regarding the issue of MUST trading at a higher yield as compared to Singapore office Reits. Management attributed this to the fact that MUST’s properties are located in the US, hence there is the uncertainty factor among local investors, but hopes that the yield spread will compress over time. However, in my view, I believe that MUST and other US office Reits are actually fairly priced. Prime Reit and KORE are also trading at ~7-8% yields, and are trading close to their book values. This means that investors are valuing the Reits’ units at a similar level as professional valuers’ valuations. Conversely, if we look at Reits such as Keppel DC or Mapletree Industrial which are trading at premiums to their book values, one would have to wonder whether it is the professional valuers who are wrong, or the investors who are wrong. My view is that as investors are chasing yield in a low yield environment, investors have place an emphasis on yield as compared to other metrics such as price to book ratios.

With MUST trading at a ~7.5% yield, management mentioned this relatively high cost of equity is a hurdle when looking for potential acquisitions, as it means that the cap rates of acquisition targets has to be high enough such that the ideal debt and equity mix would result in a yield accretive acquisition. Personally, I think that if we look at S-Reits such as Ascendas Reit or Mapletree Industrial, which trade at a high premium to their book values, it is much easier for them to make yield accretive acquisitions due to the lower cost of equity. For example, if the Reit’s units are trading at a yield of ~5%, then issuing units to acquire a property that is yielding 6% would most likely be accretive. Whereas for a Reit that is trading at a ~7% yield, acquiring the same property that is yielding 6% would require a much more aggressive debt load to ensure that the acquisition is yield accretive.

Lastly, management shared that at the point of IPO, the majority of the investors were individuals, possibly due to the relatively smaller size of the REIT. Management noted that MUST’s subsequent growth in AUM and the addition to the NAREIT index has helped lift its profile, resulting in a greater number of institutional investors among its shareholder base.

That’s all that I’ve gathered from today’s corporate presentation. Hope this would be informative.

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Tiger Brokers is running a promotion (limited to first 6,000 signups), offering new users who make an initial deposit of at least S$2,000 a free Apple share and 180 days of 60 commission free trades. Tiger Brokers Singapore is licensed by MAS and many of my friends have started using the platform - because of its simple user interface and low commission fees. Do not miss out on this great promotion!

If you’re keen to sign up, please click on the following link or use my referral code DUQ8NI to sign up.

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Moomoo Promotion

New users with Moomoo (ending 2nd August) also stand to receive 1 free Apple share (upon deposit of 2,700 SGD), 1 free NIO share (upon completion of 5 trades), 180 days of commission free trades and free access to US stock market Level 2 market data. Do not miss out on this too!

If you’re keen to sign up, please click on the following link for my referral to sign up.

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Disclaimer: This article is intended for informational and discussion purposes only, and do not constitute financial advice. When in doubt, please contact a licensed financial adviser.

Note: At the time of writing, I do not have a position in Manulife REIT. This may change from time to time without updates to this article.

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Valuing CapitaLand Post-Restructuring

 

I wrote about CapitaLand’s restructuring awhile back, taking a more qualitative approach to understand CapitaLand Investment Management’s (“CLIM”) business. This follow up post discusses how I would value CLIM, based on a sum of the parts (“SOTP”) analysis of its three main revenue sources – 1) Value CLIM’s stake in its REITs and Private Funds, 2) Value of Investment Properties, and 3) Value of Investment Management and Property Management Platform.

The SOTP analysis would give us the implied intrinsic value of CLIM, and if we were to compare that against the deal on the table now, which includes CICT shares as well as a cash portion, we can then decide whether it presents a compelling opportunity.

Capital Structure of CLIM

Firstly, based on the restructuring announcement in March, I estimated the level of debt CLIM is expected to carry. The announcement noted that CLIM would hold c.23.4 billion of assets, while the NAV of CLIM would be 14.7 billion. Working backwards, we would arrive at a debt level of 8.7 billion, in order to reconcile the amount of assets and net asset value. Of course, there would be a certain amount of net working capital (cash, receivables, payables etc), but we would exclude that for now as this information is unavailable.

Value of CLIM’s stake in its REITs and Private Funds

As the investment manager of these public and private funds, CLIM holds sizeable stakes in these funds, so that they have skin in the game and the interests of the manager and unitholders are aligned. The value of CLIM’s stakes in the REITs can be easily calculated based on the latest share prices of these REITs. For the Private Funds, we would have to use the value provided in March – 7.8 billion, and I adjusted that to reflect the same 1.5% decrease in value as its REITs. Note that post-restructuring, because of the units of CICT distributed, CLIM would hold 22.9% of CICT.

Value of CLIM’s Investment Properties

The restructuring involves the transfer of a number of investment properties to CLIM, which includes both commercial, retail and business park properties, with the view of eventually injection these assets into the REITs or selling them off to third party buyers. The value of these investment properties was stated to be 10.1 billion in the restructuring announcement. Given that the value of these properties we as of 31 Dec 2020, I believe an appropriate approximation would be to look at the price to book rations of comparable public REITs, and apply that to CLIM’s investment properties.

I computed the latest P/B ratios of Singapore listed REITs in similar sectors and arrived at an average P/B ratio of 0.92x. Do note that if we apply this P/B multiple to CLIM’s investment properties, we would we using a conservative estimate, as the P/B of the REITs are applied on NAV, whereas we would be applying the P/B multiple to the asset value of CLIM’s investment properties (without debt).

Value of CLIM’s Investment Management & Property Management Platform

CAPL currently has funds under management (“FUM”) of 79.2 billion as of Mar 2021, with a 100 billion FUM target by 2024. The acquisition of Ascendas Singbridge in 2019 provided a substantial boost to FUM. Going forward, CAPL has just announced its registration as a PE fund manager in China, which would allow it to further grow its FUM in China.

Valuing this business segment is probably the most subjective, yet it is the most lucrative segment of CLIM. In fact, one of the key reasons for the restructuring process was because CAPL’s management believes that the market does not realise the true value of the Investment Management platform, which is asset light, highly scalable and delivers a predictable stream of income. Currently, CAPL reports income from its fund management and property management/service residence platform separately, but going forward, CLIM would consolidate these figures for reporting, as “Total Fee Income”. The fund management platform has an average EBITDA margin of c.56% from 2017 to 2020, which indicates strong profitability and even rivals that of top tech companies. Given that there would be little depreciation and amortization for an asset light business segment, I estimated that the net profit margin for the investment management platform (Fund Management, Property Management and Serviced Residence) would be 25%.

The “Total Fee Income” figures reported by CAPL is computed by including fee income from consolidated REITs before elimination at group level, which I understand it to be the total fee income that REIT unitholders pay on a 100% basis. However, CAPL’s proportionate stake would have to be eliminated at group level; for example, if CAPL owns 30% of the REITs’ units, then the “actual” total fee income would only be 70% of the reported “Total Fee Income” as 30% of that is a related party transaction.

Using the “Total Fee Income” reported in the 1Q 2021 Business Update, CAPL earned Total Fee Income of 186.7 million and 203.6 million for 1Q ’20 and 1Q 21 respectively. On a run rate basis, Total Fee Income for FY21 would then be 814 million. Given that CAPL’s average stake in its REITs is 28.5%, the net amount of “Total Fee Income” would be 582.3 million. Using the 25% net profit margin mentioned above, the Investment Management segment would generate a net profit of 145.6 million. The restructuring announcement noted that comparable Real Estate Investment Managers trade at an average forward P/E multiple of 19.4x, thus I applied a 20x P/E multiple to value CLIM’s investment management platform.

SOTP Valuation

Based on the individual valuations of the three business segments, I computed the SOTP valuation of CLIM, using both CAPL’s current share capital as well as the fully diluted share capital:

 

I then computed CAPL’s implied share price, which includes the distribution of CICT shares and the cash consideration:

 

Risks

This valuation of CAPL assumes that the restructuring would be approved by shareholders, and also that the scheme conditions are not breached - for example, the Material Adverse Change clause that I have written about. 

Conclusion

Based on the SOTP valuation of CLIM, we arrive at an implied target price of $4.46 (current share capital) and $4.31 (fully diluted share capital) for CAPL, indicating an upside of 21% and 17% respectively from the closing price of $3.68 on 25 Jun 21.  

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Should SPH Shareholders take Umbrage at the Proposed Restructuring?

Imagine you are running a company that has multiple lines of businesses. Most of your businesses are doing well, except for your restaurant business that has seen declining profitability. Due to changing consumer preferences, your restaurant has seen falling revenues over the past decade, but was still profitable all along. Recently, due to Covid-19, your restaurant has recorded its first-ever loss in FY2020.

Now, because you believe that your restaurant would continue to make losses in the future, you want to get rid of your restaurant business. You look around for potential buyers/takers, and I offer to take over your failing restaurant business.

What would be a fair price for this business?

Suppose I told you – firstly, you will had over your business to me. Additionally, I want you to give me $80 million in cash and $30 million in shares of your company and your subsidiary. I also want you to give me two buildings – the building that your restaurant operates in, and also the corporate office of your restaurant, worth a combined $147 million. All in, you have to give me around $250 million to take over your failing restaurant business.

What would you say?

You’d probably wonder why I’d even propose such a deal. You might even think I’m crazy.

But that’s the deal on the table for SPH shareholders as part of the restructuring exercise. Talk about taking umbrage!

The Public Reaction

When I first watched the clip of the CEO’s heated response to the journalist, I honestly found it hilarious. How dare you! But I did not expect this to blow up into such a sensational issue. A lot has been said about the competency of having retired generals taking up roles in the private sector. My view is that it all boils down to corporate experience and culture.

Take the example of Mr Chew Shouzi, the Singaporean who recently took over as the CEO of TikTok. Similar to our public sector scholars, Mr Chew has stellar academic credentials, earning his undergraduate degree at UCL, followed by a Havard MBA. Subsequently, his career path included a stint at Goldman Sachs as an investment banker in the Technology, Media & Telecommunications sector, followed by making partner at a leading Tech-focused venture capital fund. During his tenure as the CFO of Xiaomi, he led their IPO process in Hong Kong. In his most recent role, he was the CFO of ByteDance (Tik Tok’s parent company) before assuming the role of TikTok CEO. All round relevant experience in the Tech and Media sector.

Now, if you could choose, what profile would you pick to be the CEO of SPH?

On the point of culture, in organisations where seniority takes absolute precedence, individuals in senor positions may be blindsided by issues on the ground, especially if their subordinates constantly seek to paint the best picture. Over time, one may be entrenched in such systems, and may find it difficult to adapt to roles which require innovation in competitive industries.

This is a systemic issue, and I came across an excellent article on Quora which discusses the issue.

https://www.quora.com/Do-you-think-an-overhaul-is-needed-in-the-Singapore-civil-service-in-how-we-select-our-leaders-government-scholarship

What’s Next for Shareholders?

Shareholders would have to vote on the proposed restructuring sometime in July/August 2021. Since it is and EGM, it probably requires the approval of 75% of shareholders for the restructuring to proceed. I spoke to an SPH shareholder, who somehow seems to think that the deal would definitely go through, as there are substantial shareholders who would definitely support the deal. However, this is not true, as under the Newspaper and Printing Press Act, nobody can become a substantial shareholder of SPH without the approval of the Minister. Hence, no shareholder controls more than 5% of SPH shares, and 99.9% of SPH shares are held by the public, as per its 2020 Annual Report.

I think some shareholders may have been confused with the management shares class that SPH issues. Basically, the management shares only have greater voting power (200 votes per share vs 1 vote per share for ordinary share) when it comes to issues such as appointing or dismissing directors or any member of the staff of the company. In all other situations, ordinary shares are entitled to the same voting rights (1 vote per share) as the management shares. Currently, there are 16.3 million management shares, compared to 609.3 million ordinary shares. Hence, the voting power during the EGM on the proposed restructuring lies in the hands of each and every SPH shareholder.

What are the potential scenarios?

1. As per the analogy described above, shareholders decide that the best choice would be to give away c.250 million in cash and kind, to get rid of the underperforming media business. The proposed restructuring gets approved.

2. Shareholders decide that giving away c.250 million to dispose the underperforming asset is ridiculous. Shareholders request that the management seek a better deal for them. Ideally, the CLG is seeded with cash from “private and public sources” first, which then buys over the media business from SPH on a willing buyer, willing seller basis. For a reference, Alibaba acquired the South China Morning Post for $266 million USD in December 2015, in an all cash deal. Alternatively, variations of the financial terms of the deal could be negotiated, for example, SPH pays less than $80 million, or SPH does not transfer SPH News Centre and Print Centre (worth a combined $147 million) but instead rents the building to the CLG, and continue to collect rental income. Finally, sometime down the road, the financial aspects of the become more acceptable to SPH shareholders, and they approve of the transaction.

3. The proposed restructuring is not approved by Shareholders, and SPH Media remains part of SPH for the foreseeable future. SPH Media is *expected* to make losses over the next few years. Do note that SPH Media has always been profitable pre-pandemic, and only recorded its first loss ever due to Covid-19. What I find interesting is that for companies that have always been making losses (Grab, WeWork etc), they always project some improvement to profitability in the future, no matter how far-fetched it may sound to some. Now, we’re seeing the exact opposite, where a business segment that has always been profitable, is expected to “incur losses and widen” over the next few years. My point being – what really happens in the future is really anyone’s guess.

Conclusion

Much of the debate has been around the issues of editorial integrity, advertiser interests, quality of journalism and the like, but the decision the SPH shareholders face is essentially a financial one. However, if we were to see SPH Media from the perspective of serving as a “public good”, as the provider of news and information to the public, then the issue becomes about who should bear the cost of providing public goods? Should it be the taxpayers, in the form of Government financing, or should it be the SPH shareholders (who are most likely taxpayers themselves too), who have already seen the value of the investments declined so drastically, and yet are expected fork out an additional $250 million? Tellingly, the SPH shareholder is the one with the power to decide, not the taxpayers.

There are definitely no easy answers, but I’m sure we would all be watching closely on how this plays out.

Disclaimer: This article is intended for informational and discussion purposes only, and do not constitute financial advice. When in doubt, please contact a licensed financial adviser.

Note: As of writing, I do not have a position in SPH. However, my positions may change from time to time without further any updates to this post. 

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