AlpacaInvestments: June 2021

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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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.