Thursday, December 10, 2015

Reflection on Silverlake Axis

Sooner or later, the markets always humble people. I believe in it and have my fair share of being humbled. While I was not hurt in monetary terms as I sold it off 2 years ago on price discipline, it will be good to do a personal reflection.

My mistakes were

1) I failed to pay attention to the related party transactions
2) The past deals action did not come across as red flags to me as I thought I had invested in the new entity where the whole Silverlake Group is inside the listco.

I tend to be bias to the short seller and will be glad to have more short report in the market as it improves the market process and mechanism. Who is razor99? razor99 called a short on Longtop months before Citron launched a successful attack on the company. Longtop specialises in software catered to the financial institutions, an area similar to Silverlake. Both his experience with Longtop and the release of a fraudulent claim in May probably led razor99 to look into Silverlake.

The most damaging claim

Razor99 made many claims in his 42 pages report, including concerns of bribery. However, only 1 claim was truly critical. According to razor99's claim, margin at Silverlake was inflated through related party transactions. The evidence was a jump in revenue and margin at to-be-acquired entities. Another evidence was the losses suffered at Goh's private co such as Sprint.

Legally, it might be hard to accuse Silverlake of fraud as the company has followed the proper procedures:
1) The mandate for IPT was approved by shareholders annually since 2008 and had always been disclosed since the 2003 IPO
2) The details of the IPT was disclosed in the annual circular (inclusive of pricing)
( )
3) Auditors will review every IPT transactions every year

What are the related party transactions (RPT)?

The IPT mandate approved by shareholder annually holds the critical information to understand the RPTs. In addition, lets take a look at Silverlake listco after 2011 since that is the current corporate structure.

Source: razor99 report

The bulk of the RPT revenue is from software licensing while the bulk of the RPT expense is from service fees paid.

RPT Revenue % per segment

To put the information in another perspective, it will be to view the segment revenue and determine how % of segmental RPT revenue against the actual segment revenue. It can be seen that the bulk of the software licensing revenue (more than half of it) comes from RPT. This deserves a deeper look since software licensing has the highest margin (90%) and account for at least 40% of Silverlake's profit.

Master License Agreement

Everything is properly accounted for under the MLA, inclusive of the minimum fee of US$20 million and how the points are allocated. Under the Master License Agreement (MLA), the interested person is granted the right to "resell, implement, copy, customise or use the software" and to "sub-license the right to use the Software to End-Users". Essentially, when the interested person wins a new software contract, Silverlake will earn a license fee while the implementation and employee costs are borne by the interested person. This explains the 90% profit margin for the software licensing revenue. You don't expect to pay any cost other than your R&D amortization and expenses.

Master Services Agreement

Under the Master Services Agreement (MSA), this deals with the receipt of "Customisation, Implementation and Maintenance services by the Group from the Interested Persons". The MSA explains the 50 million service fees paid, which is almost all of the expenses paid out to the related party. With the MSA, Silverlake sub-contracts or outsources part or whole of the implementation and maintenance job to the interested party for a fee. Once again, everything is properly accounted for with the use of "Man-Day Rates" and "estimated man-days required to complete the work"

Peer Analysis, Source: razor99's report

With an understanding of the MLA and MSA, it is a lot clearer why the peer analysis results in Silverlake having a low employee expenses %, much higher profit margin and much higher revenue per employee. A huge portion of a new software contract implementation is outsourced to the Interested Person. An unknown portion of the costs for maintenance and enhancement is also outsourced to the Interested Person.

Legally correct but still a governance concern

Being right legally is not equivalent to being right in principle to the shareholders though it is highly debatable in this case. Inevitably, the question in shareholder's mind will be what kind of profit is Mr Goh's private entity making from these MLA and MSA contracts. 
  1. If it is a loss, Mr Goh runs the risk of being accused of hiding expenses and inflating margin (although everything is properly and legally accounted for, so it is a false accusation).

    And a subsequent question will be how long is he willing and able to sustain the loss on his own account? Ans: For as long as he continues to be generous. (With regards to the ability, high dividend payout creates a feedback loop and share sales can top up the remaining amount)
  2. If it is a profit, why not share it with the shareholder to show an alignment of interest?
  3. Even if it break-even, why not consolidate all the private co into the listco and nobody can accuse you of anything in the future?
There are of course numerous clues that point to 1 particular scenario above if one read razor99's report and understand what have been written so far on the MLA and MSA.

In any case, for proper corporate governance, it is still best to consolidate the private co into the list co as the Nash Equilibrium. Shareholders can recommend to Mr Goh and they also have the right to vote against the IPT.

Saturday, August 15, 2015

Swiber Holdings - When Cheap is not Cheap and Perpetual is not Perpetual

Share price of Swiber Holdings has fallen more than 60% in the past 1 year due to the sharp fall in crude oil prices which has caught many investors off-guards. At the current share price of SGD $0.136, Swiber Holdings is only trading at a price to book ratio of only 0.156x (based on 2Q15 NAV of USD 0.621 and exchange rate of 1 USD to 1.4 SGD). Is it considered cheap?

When Perpetual is not Perpetual

Perpetual bond is an attractive financing tool for company as they are able to treat the security as an equity to lower gearing ratio. The rationale behind the accounting treatment is that 1) the company can choose not to repay the perpetual bond indefinitely 2) the interest paid can be deferred.

However, financiers are known to creative in the way that a security can be structured. In the case of Swiber, the perpetual bond is structured such that Swiber is likely to redeem the security 3 years from the issuance date of 25 Sept 2012 (which they have announced that they have the intention to redeem). A step-up margin of 3% is imposed on the perpetual bond every 3 years. This signifies that Swiber will have to pay an interest rate of 12.75% if Swiber don't redeem the perpetual next month. If Swiber don't redeem in 2018, the interest rate will jump to 15.75%.

Given such onerous step-up margin every 3 years, it is questionable whether these securities meet the accounting treatment of equity. Swiber is not the only company that issues perpetual bond that has high step-up margin and a short reset date of 3 years. Ezra did a dilutive rights issue recently so that it can redeem its S$ 150 million 8.75% perpetual bond issued on 18 Sept 2012 with a similar step-up margin of 3% every 3 years. Ezion also has a S$ 125 million 7.8% perpetual bond issued on 14 Sept 2012 with a step-up margin of 3% every 3 years again. If you have noticed, all 3 perpetuals were issued in Sept 2012 with the same step-up margin every 3 years.

We will do the relevant adjustment for the perpetual later.

When Cheap is not Cheap

The issues that many investors have with Swiber is that it is highly geared and a persistently high receivables outstanding. These are certainly valid concerns and a look at its balance sheet shows a high liquidity risk.

The reported debt to equity ratio for Swiber is 1.45x as of 2Q 2015. The gearing went down slightly after the rights issue early in the year. Gearing ratio gives us a clue of the extent of indebtedness and default risk for a company. However, it is only when a company is unable to repay (default) on a bond/loan, that equity value will be threatened.

Swiber is likely to repay the S$ 80 million perpetual security on 25 Sept 2015 (they have started buying from the open market). Therefore, if the company don't generate any free cash flow or get additional loans from the bank, the cash level for Swiber will dwindle down to USD 60 million.

Next year, Swiber will have 3 bonds with a total principal amount of SGD 305 million to be redeemed upon maturity. It is highly unlikely that Swiber will be able to repay the bonds with its current cash level. What alternatives are available?

1) Issue another bond - With the yield to maturity at more than 30% (look at the column - Evaluated Bid Yield) for most of its bonds, Swiber is effectively shut out of the bond market. Swiber will need to offer a bond yield of close to 30% for its new bond issuance, else an investor will be better off to invest in the current bonds which offers higher yield and shorter maturity (lower default risk).

2) Raise equity - Swiber has a current market capitalisation of SGD 136 million. At the current huge discount to book value, a rights issue will only destroy more shareholder value. It is highly probable that Swiber will do another rights issues or share placement, but the amount of equity that can be raised will be highly limited.

3) Sell assets - Swiber has USD 748 million of PPE as of 31 Dec 2014. However, USD 241 million of it is finance lease, which means Swiber don't have ownership of the assets. In addition, Swiber has pledged USD 221 million of assets for bank borrowings. These assets are secured and will be difficult for Swiber to sell (or if sales happen, likely that money will be used to repay the secured loan). This leaves the company with USD 286 million of PPE that can be sold. With the current downturn in O&G industry and the lower charter rates, Swiber will have to sell the remaining salable assets at a discount to its carrying value.

4) Collect trade receivables - Swiber has current trade receivables of USD 443 million, other receivables of USD 377 million. Of the trade receivables , USD 76 million arise from "unbilled receivables arising from variation claims on construction contracts submitted to customers amounting to US$76,447,000". The sum is unbilled and arising from variation claims does not sound good. In addition, 1 debtor represents 50% of the trade receivables in FY 2013 and FY 2014. Who is this debtor and does the debtor has the ability to pay the receivables? There might be a need for further impairment.

As for the other receivables, USD 75 million are capitalised vessel cost which is capitalised expense that is more like prepaid expenses. The rest are mostly receivables and loans from joint venture and associates. The bulk of the other receivables are likely to be in its 27% owned Vallianz Holding. However, if one take a look at the balance sheet of Vallianz, it is doubtful how Vallianz will be able to repay the loans.

Swiber's Annual Report 2014

5) Borrow from bank to refinance bond - Swiber has a current bank borrowing of SGD 209 million which will be up for repayment. It is possible for Swiber to do a refinancing of its borrowing, but it will be tough to raise additional bank loan since banks will be looking to reduce their oil and gas exposure at this moment. This option will depend heavily on Swiber's banking relationship and the bank's risk management policies. 

As an equity investor, we benefit from higher upside when the company reports higher profit. However, when a company is in distress, it is always the holder of the loans and bonds that get the priority claim over the assets of a company. With the limited options that Swiber has, even a successful repayment of the loan is likely to further destroy shareholder value.


Back to the question of whether Swiber is cheap, let's do some adjustment:

Adjustment for associates
Carrying value of its 27% owned associate Vallianz is USD 95.9 million (equity of USD 73.4 million and perpetual securities of USD 22.5).
Market value is 27% * SGD 163 million = SGD 44 million or USD 31 million
Adjustment: USD 42 million

After adjustment, Swiber is trading at around 25-30% of book value. However, this has yet taken into account 1) potential impairment of trade and other receivables of USD 871 million 2) potential impairment in market value of vessels. Swiber will be able to sustain a positive equity as long as it does not impair a maximum of 25% of trade and other receivables and its property, plant and equipment.

Do your own impairment adjustment and it is your call on the value of the equity. This is certainly a highly leveraged play!

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.

Monday, July 22, 2013

SPH REIT - A Lesson on Financial Engineering 101

SPH REIT is a spin-off from SPH, comprising of Paragon Mall and Clementi Mall, offering an annualised yield of 5.58% for FY 2013. At this income supported yield, it offers a 0.5% higher yield than CMT and 0.2% lower than Fraser Centrepoint Trust. Retail REIT has always been a favourite of REIT investor due to their defensiveness and ability to squeeze extra rental cost from the tenant.

However, why is it that they delayed their listing on 24th June 2013 before lodging their prospectus on 9th July 2013? In a mere 3 weeks, an unattractive IPO is now the hottest thing on the market, with an indication of interest from institutional investor being 42x the placement tranche. . At the end of the day, many investors define the attractiveness of a REIT based on the yield. This prompts me to look at what forms of financial engineering have been used to increase the yield. Shall start the analysis with the most obvious and end with the hidden trap. The hidden trap is what that allows SPH REIT to be priced at 0.5% higher yield than CMT.

99 Years Lease. Similar to K-REIT, SPH sold a 99 years lease of Paragon Mall to SPH REIT while retaining the freehold ownership of Paragon Mall in our prized Orchard Road. According to the Knight Frank valuation certificate on the circular by SPH, Paragon mall is worth $2.61 billion as a freehold property and $2.5 billion as a 99 years leasehold property. The Freehold Lease is worth only $110 million, which is ridiculous. Who will not want to pay an extra 4% of their property value to upgrade their property from a 99 years lease to freehold? 99 years lease represent a 1% depreciation each year, which means the payback is theoretically 4 years to secure the freehold right. Of course, it is likely that maintenance and capex will be needed for an asset past 99 years.

Income Support. SPH has guaranteed that Clementi Mall will produce $31 million in NPI for the next 5 years. The reason is that Clementi Mall is a relatively new mall and that the current rent signed is lower than the market rental. Income support is common for such new property, but does SPH really lose money from providing income support? According to the valuation report in the prospectus, the $570 million Clementi Mall is only worth $550 million without the income support. Projected NPI from Clementi Mall is $26.7 million in FY 2014. On the conservative assumption that it remains the same for the next 5 years, SPH will provide a total income support of $4.3 million x 5 = $21.5 million. Thus, SPH is unlikely to have to fork out more money by providing the income support on a net basis (it earns extra $20 million from selling at $570 million). Yet, investor can be sold on a higher dividend yield though it is a partial capital return of the IPO investor. In addition, given the income support for 5 years, it means that growth for Clementi Mall will already be factored in for the unitholders unless they can grow their NPI beyond the income support mark of $31 million.

Lower capitalisation rate in valuation. The gearing ratio of 27% looks attractive and helps to alleviate fear of rising interest rate. However, gearing ratio can be engineered through a change of the property valuation which is the denominator. A cap rate of 4.75% and 5% have been used to value Paragon Mall and Clementi Mall (the income support has been taken into account) respectively. In comparison, CMT uses an average cap rate of 5.4% to 5.85% while FCT uses an average cap rate of 5.50% to 5.75% to value their properties. Some might argue that as 99 years leasehold asset, they should be worth a much higher valuation than the 70+ or 80+ years remaining leasehold asset. However, Atrium@Orchard with 94 years remaining lease and Yee Tee Point with 92 years remaining lease do not have a lower cap rate. This reflects how conservative or aggressive a management has been in valuing the property and thus tweaking the gearing ratio.


Lower interest rate. According to the prospectus, SPH REIT has been assumed to pay a constant 2.35% interest rate on its loan. The $850 million loan is to be repayable 1/3 each in 3,5 and 7 years time which gives an average loan maturity of 5 years. s of 31 March 2013, the effective interest rate for FCT and CMT are 2.73% and 3.3% on average term to maturity of 3.35 years and 4 years respectively. How did SPH REIT manage to secure a lower interest rate of 2.35% and higher term to maturity of 5 years when the fear is that interest rate is going to rise in the near term? Firstly, I cannot find the exact interest rate charged on the loan in the prospectus and the 2.35% has been quoted as an assumption. Thus the actual interest rate might be much higher than the assumed 2.35%.

Even if the assumption is true, how did SPH REIT do it? They actually got a secured loan over Paragon Mall which accounts for 80% of their total value. CMT's unencumbered assets as % of total asset is 76.7% and FCT is 43% compared to 20% for SPH REIT. (Unemcumbered means the asset has not been mortgaged. A secured loan is cheaper than an unsecured loan. However, when financial crisis comes, an unsecured asset might be what that will give the bank the confidence to lend you money. Thus, by taking a secured loan up to 80% of their total asset, SPH REIT is taking a higher refinance risk as compared to CMT and FCT just to inch out a lower interest rate and hence 0.19% higher dividend yield. On the other hand, it is likely that CMT will not face much refinancing issue given their unencumbered assets and well-spread debt profile.

The Finale

This is the most important point to take note of on how SPH REIT actually financial engineered a 0.5% higher dividend yield than CMT using an old, legal and similar technique of option expensing.

The Manager's management fee is $15.2 million in FY 2014 and they have chosen to be paid 100% in units. This is equivalent to taking a stock option, which convert employee's cash expense into 0 though it actually results in dilution in EPS the subsequent year. The $15.2 million to be paid in units is equivalent to 11.6% of the Income Available for Distribution. In contrast, the proportion of management fees paid in unit as percentage of Income Available for Distribution is only 1.5-2.5% for CMT and FCT.

Looking at the DPU sensitivity yield above, if SPH REIT were to take 100% of management fee in cash, the annualised yield for SPH will drop to 4.93% and 5.15% for FY 2013 and 2014, which will price it at a lower dividend yield than CMT. This is but a financial engineering move as the dilutive effect and selling of shares will weigh on the share price in the long run. The reason why the management fee is such a high percentage of distributable income is because SPH charges 0.25% of asset value and 5% of NPI as a REIT Manager and 2% of Revenue and 2% of NPI as a Property Manager.

To conclude, it is certainly not fair to simply compare the dividend yield of the REIT and determine how attractive it is. As always, the devil is in the details and I believe the market is a weighing machine in the long run.

Monday, July 1, 2013

Random Thoughts on Investing

Ever since I got started in Sep 2011, I have been in the market for close to 2 years. I have had many thoughts about investment but have yet to pen them down. This will be random thoughts about investing and the lessons that I have learnt. I can't find a way to categorise them, so there's no structure and it's pretty messy.

Value investment is not about buying something at ridiculously low PE/PB nor buying a company with a sustainable competitive advantage. Neither is it about buying low nor selling high. Who purchases an equity share without believing that he is buying low and selling high? Or rather who buys the share of a company believing that he is buying high and will be selling low? No one, but belief and action often diverge in the market.

Whether it is buying Graham's net-net or buying Buffett's strong moat company, these are merely manifestation of the underlying value investment philosophy. It is easy to be confused that anyone buying the same "value investment kind" of company as Buffett, Seth Klarman and e.t.c. are value investors. One might even buy the exact same companies at the exact same price as the renown value investors are, but that will not make you as successful as they are.

The 2 key principles that define a value investor lies in Mr Market and margin of safety. They are mentioned in the famous chapter 8 and 20 of The Intelligent Investor. Mr Market is the fluctuation in prices of securities and mood of the market. One can profit from the maniac of Mr Market if he is able to control his emotion and avoid being a slave to Mr Market. Understanding the existence of Mr Market entails that price fluctuation and volatility is part and parcel of the market. Price can move in either direction and intensity regardless if you have made the right decision. However, by making the right decision, you know you will come up right in the long run.

Margin of safety is about protecting your downside and reducing the risk. This is often quoted as buying something worth $1 for $0.50. There're many reasons for it:
1) We might make an error in our judgement of its fair value
2) We do not have perfect information to make a good judgement
3) There's no way we can predict the future with 100% accuracy
4) It might be fake/fraud
5) Black Swan ( Anything that you can't think of - that's why it's called black swan)

Margin of safety is demanded in areas other than the price. Diversification is needed because you do not want to let a single mistake or black swan wipe you off the game. However, the problem is that people often diversify for the sake of diversifying, which increases their risk instead of reducing it. Diversification should be done only if one can find a company that can offer similar or even better risk return profile than the portfolio.

Investing is a game of probability or even a gamble. Before the outcome is out, there's no way to know if we will win or lose. In a casino game, the edge is always with the house and statistically we will lose money in the long run. However, the game in the market differs from the casino as the autonomy is with us. We get to decide the probability of the game by choosing which hand we are interested to play. If we consistently choose to play a game where the risk reward ratio is not attractive, we are likely to lose money in the long run. If we choose to play a game only when the odd is highly tilt to our favours, we are likely to profit in the long run.

Over a long period of time, the law of large number will ensure that your investment return will track the kind of odds that you play with. However, in the short run, it is easy to assume that early success equates ability to spot games with asymmetrical risk return profile where others are not capable of. Success in investing does not come from out-performance in the market, though that is the easiest method of evaluation. Instead, an investor should focus on the analysis and decision that he has made.

As it is a game of probability, excellent analysis and decision made does not equate to a rise in share price. Even if the share under-performs, an investor should not blame himself if he knows that he has made the right analysis and decision at that point in time. Instead, he should continue making the same kind of decision if he knows that he did not make any mistake. Do not let a good decision gone wrong becomes a baggage for you in the future. In a game of probability, we can never be right 100% of the time even if we made the right decision 100% of the time. Similarly, if you have profited in a situation where you made an erroneous analysis or decision, be glad that it didn't cost you a penny but remind yourself that you should not repeat the same mistake.

While a fan of Buffett might not be interested in cigar butt or a fan of Graham will not be interested in investing in an excellent business at fair value, they are not contradictory in nature. One is buying at a discount to future value while another is buying at a discount to present value. Benjamin Graham knew that he cannot predict the future with much accuracy and feel that it is much safer to look at the current state of the company than future profitability. Warren Buffett's experience with Berkshire Hathaway as a textile business taught him that finding great companies that are able to consistently deliver return above the cost of capital is likely to present a more attractive option. Both are great and they play the game according to their personality, style and area of competency. It is not the style that matter but the underlying philosophy and principles that drive their decision.

Investing is never easy but there will always be people that try to convince you that by obeying a set of rules and formulas you can easily outperform the market and compound your wealth. Because the famous investor has been using it, copying them will allow you to reach the level of wealth and competence they have. Before you can get your hand onto it, you will have to pay a significant fee to attend the course or even buy some robots.

Investing is not easy as it is often a zero-sum game. A trade constitutes a buyer and a seller who have similar motive in making profit but whose action contradicts one another. Either the buyer or the seller is right, it is rare to have both correct. How do you know that you are on the correct side of the trade? You can try to increase the chance that you are right by asking yourselves what insights do you have about this company that others do not? It is not about possessing insider information, but forming your own independent opinion and analysis about the company. If everybody thinks that Myanmar is going to experience fast growth, obviously this will have been factored into the price of the stock and there will be not be significant upside potential other than speculation.

Investing is when you buy an asset at a discount to its fair value and expect that the fair value can be realised or the fair value can grow. On the other hand, speculation is when you buy an asset in the expectation that a greater fool is going to buy it from you one day. It is often hard to distinguish investing from speculation merely by looking at the stock purchased or the price paid. Famous phrase like "This Time is Different" is often used to justify the act of speculation. Perhaps, only the investor/speculator will know whether he is investing or speculating, that's if he has been able to control his emotion and think rationally.