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 (http://investing.businessweek.com/research/stocks/snapshot/snapshot.asp?ticker=FNH:MK) 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

Valuation is not that complicated as Knight Frank, CBRE and DTZ have been hired to do the fair valuation (http://fraserandneave.com/contentview.aspx?article_id=3938) 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
Period".

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.

(vested)

12 comments :

  1. Hi,

    U bought FCL at $1.50, and u mentioned u are are not comfortable of adding at $1.61. The difference is only 7.3%. Are you rational? Or are you expecting single digit return in this purchase?

    Rgds

    Man

    ReplyDelete
    Replies
    1. I am expecting return of more than 15%. This is an experiment into spin-off and my first time doing it. I did put in quite a lot of effort and think that the value proposition is there. But as this is my first time, I am exercising some caution though I am prepared to add more should it fall further

      Delete
  2. No offense meant, but I feel that you are straying away from what you are good at, identifying the economic moat of businesses so as to invest safely and profitably for the medium to long term.

    These valuation/mispricing gimmicks may seem mentally stimulating, but why not leave them to investment bankers and their marketing presentations?

    Btw are you aware that Frasers won two huge land tenders in Singapore late last year? (And probably significantly overpaid as well) Both projects' development costs are well above S$1 billion each, so I doubt that the company is able to run an asset-light strategy as a whole. FCL is still first and foremost, a property developer.

    ReplyDelete
    Replies
    1. It is really ok, I do welcome criticism since it helps to guard me against potential bias.

      I will say at the core, I am not straying away from value investing. Special situations such as spin-off, dropping from index and merger arbitrage can create opportunities with skewed risk-reward ratio. Other than Joel Greenblatt, Seth Klarman has also written about it in "Margin of Safety".

      Personally, I am more interested in the intellectual rigor that investing provides rather than the returns and money. If I have stayed true to my circle of competence, I will probably not have bought silverlake, boustead or be able to analyse reits. I supposed the key is to make sure that sufficient research, analysis and understanding of the company is done. If I still do not understand the company's business, I will still not look further into it.

      You did point out correctly that FCL is still a property developer and RNAV will still be the main valuation method. However, what I see is that there is a growing reit management business that many may not have paid attention to. With retail, commercial and hospitality arms, it provides them the opportunity to grow this reit management business and to recycle capital. As for the 2 tenders, one is a commercial project and the other is related to Northpoint. The retail portion of the latter will probably be divested to FCT in the future just like Northpoint 2.

      Delete
  3. Hi there,

    Have you considered that the discount to NAV of FCL is not too different compared to discount to NAV of listed developers/property owners in Singapore? In Greenblatt's book, quite often he does relative comparison to similar listcos and that is one way he derive margin of safety. Ultimately, for me, FCL has not dropped to a level where its clearly cheaper than other property developers/owners.

    Regards
    Wee

    ReplyDelete
    Replies
    1. You were right that for such special situation, more often relative comparison is used.

      When I bought it on the listing date, the prices of other developers have been 10% higher than what they were today. I think it is more appropriate to use RNAV than NAV for developer though RNAV can be garbage in garbage out at times. When i bought it at $1.50, the difference in discount to RNAV was at around 10%. In addition, one reason why many developers are trading at the current level is due to fear of the effectiveness of the cooling measures in Singapore. However, FCL has pre-sold 90% of its residential in Singapore which makes the discount to peers unwarranted since the fear of cooling residential demand has minimum impact on FCL's current book.

      Delete
    2. Thanks for your reply. I generally use NAV during this period because most developers revalue their assets annually, and where they do not, usually the figures estimated by the various houses are higher.

      Delete
    3. You are right that investment properties are revalued every year as required by accounting standard. But in this case, if you have used NAV, you will not have taken into account the 37.8 million pbit from its asset management business. In the revaluation model, most of the revaluations are for the local residential projects which are largely pre-sold.

      Currently, the discount to peer has narrowed quite a bit as the price of other developers has come down. Thank you for the discussion :)

      Delete
  4. Need careful and selective buying these days. This may be a weak year.

    A Happy 2014 New Year To You!!

    I would like to take up this chance to link up with you.
    As a gesture of good faith, I will add you to my blogroll first. Hope to see my blog in your site as well. Thanks in advance!!

    Dave (www.SmartPassiveCashFlow.com)

    ReplyDelete
  5. hello,
    for your info....RE: Frasers Cpt (FCL)
    More copycats on FCL coming through...

    DBS Vickers initiated coverage with target $2.08.

    Rising to the big ranks
     Complete value chain player with strong niche
    markets in Singapore, China and Australia
     Optimising risk and return with geographical
    and business diversification, strong balance
    sheet to support value creation activities
     Initiate with BUY and TP of S$2.08
    Complete value chain player with strong niche
    markets. We initiate coverage on Frasers Centrepoint Ltd
    (FCL) with a BUY rating. As the fourth largest listed developer,
    FCL offers investors a sizeable listed investment option with a
    market cap in excess of S$4bn and asset value of S$11.5bn.
    An estimated 47% of its gross asset value is exposed to
    development properties, 33% to investment properties and
    REITs, and the remaining to hospitality and other activities. Its
    core markets are Singapore, China and Australia.
    Geographical and business diversification leads to
    superior return metrics. FCL’s diverse geographic and
    business exposure that includes both emerging/developed
    markets and recurrent/development income, offer investors a
    stable cashflow base with good upside growth potential at
    optimal risk. This translates to superior core returns metrics of
    8-9% ROE when compared to peers. Furthermore, with a
    strong balance sheet, the group is well placed to undertake
    value creating activities on its investment property portfolio,
    with a view to unlocking value in the medium term through
    its REIT platform. FCL has a good track record in reading the
    residential market trends, particularly in Singapore and this
    will stand it in good stead to restock inventory going forward.
    Recommend BUY with a TP of S$2.08. We like FCL for
    its commanding niche in its key markets of Singapore, China
    and Australia and strong pre-sales that provides a very visible
    earnings stream over the next 2-3 years. Its sturdy balance
    sheet will enable the group to reinvest for future growth, as
    well as undertake value creation activities in its current
    portfolio. Key risk is its small free float, with major
    shareholders, TCC Group and Thai Beverage holding a total
    87.9%, which we believe can be addressed in the longer run.

    ReplyDelete