OUE Commercial REIT rights issue – a case study of value destruction

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Regular readers would know that I have shifted to a more income approach over the past year and as part of that strategic shift, it involves purchasing more REITs for my portfolio. Also, I have in the past espoused my love of rights issues / preferential offering as seen in my participation in the Frasers L&I Trust preferential offering.

Unfortunately, just as stocks are not born equal, REITs are also not born equal. Whether a rights issue is value accretive or destructive very much depends on the structure of the deal, with that heavily influenced by the REIT Sponsor and Manager. If you invest in a REIT that has a Sponsor who’s interest is not aligned with the interests of minority shareholders, you can get shafted with some pretty bad deals.

Today, I’ll examine one such example – OUE Commercial REIT’s proposed acquisition of OUE Downtown from its Sponsor, OUE Limited, and its associated rights issue.

“Art” of the Deal

Here’s a summary of the significant effects of the acquisition and associated rights issue:

Issue summary

*Calculated based on 10 September 2018 closing price
#Based on REIT data from The Fifth Person website

Right out of the gate, you can see that the rights issue is ridiculously dilutive to your investment, with your distribution yield falling from 7.02% to 6.21% if you only take your own entitlement of rights. Pay you my hard earned cash and I get less dividends as a result?

Thanks bro.

The market rightfully recognised this and the REIT’s price corrected over the past week.

OUE Commercial Chart

How low must the price be before you get the same yield post acquisition as pre-acquisition?

Let’s work this out backwards, pre-acquisition distribution yield was 7%, as such for distribution yield to remain at 7%:

Target TERP = $0.0354 / 7 x 100 = $0.505.

Target Price cum rights
= (0.505 x 2,852,129k post acq units – $587,500,000 proceeds) /  1,546,769k pre acq units
= $0.55

That is a whopping 17.3% drop from the 10 Sep price and a further 9.1% drop based on yesterday’s closing price of $0.605!

The worst part of this, this is of no fault of the REIT’s existing property portfolio performance. It’s like passing the ball to your soccer captain and he takes the ball, turns around and scores an own goal, leaving you wondering what you did wrong.

Moral of the Story

Investing in REITs require close examination of Sponsor and Manager behaviour, and not just studying them from a numbers perspective. Some REITs tend to have management and sponsors who couldn’t care less about minority shareholders and it is important to understand management before investing. If not, you risk being exposed to such value destructive behaviour.

For those invested, I feel you and I hope the rights issue works out well for you (ie you get a lot of excess rights, and I mean A LOT). For me, I’ll avoid this REIT like the plague until it is at a much much cheaper price.

Happy Hunting,
KK

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Keppel Corp Retail Shareholders Briefing 2018

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Keppel Corp held a retail shareholders briefing in collaboration with SIAS at the SGX Centre yesterday. It’s the 2nd year this briefing was held and it presents a rare chance to interact with the C suite, with CEO Loh Chin Hua and CFO Chan Hon Chew in attendance. I joined a predominantly Merdeka/Pioneer Generation audience to find out more.

Presentation slides used at the meeting can be found here.

Presentation

keppel-business-model.jpg

As previously described in my piece on Tianjin Eco City, Keppel has embarked on a strategy to be the one stop shop for sustainable urbanisation solutions. What this means is trying integrate the 4 disparate divisions into providing a single proposal for mega projects like smart cities in other countries. This has been part of Keppel’s business for the longest time with the Sino-Singapore Suzhou Industrial Park and Tianjin Eco City, just that they are now actively pursuing this as a future business focus.

The presentations by the CEO and CFO didn’t yield anything very different from my previous understanding of the business as mentioned in my Tianjin Eco City article.

Q&A

Questions were mostly answered by CEO Loh. Here’s a summary of topics asked that I felt was more informative:

1) Rationale for recently taking a 50% stake in Watermark Retirement Communities

The stake cost about $80 million and it was identified as a urbanisation trend that Keppel wanted to pursue as part of its sustainable urbanisation strategy. Watermark adopts a asset light strategy, where they are operators but not owners of Retirement Communities. This allows for rapid expansion through the use of others’ capital and ties in with the Keppel Capital platform. This is very much like the hospitality industry that I’m part of.

The ultimate aim is to bring this concept of retirement living to Asia, with potential countries like Singapore, China and Australia mentioned.

2) Upcoming Keppel Marina East Desalination Plant – Given Hyflux’s Tuas Spring woes, how is this project better?

Keppel was conservative when bidding for the project, the project is that currently on schedule and on budget. They are confident that the water prices negotiated with the Government as part of the tender process is set such that the plant is able to turn a profit.

3) Given the recent property cooling measures enacted by the SG Government and the ongoing rumblings of trade war between the US and China, how do you feel the company will be affected?

Sentiment will obviously be affected. That said, the company is not big in the SG residential market. Also the company’s land bank in Singapore and in China is relatively old (70% of China land bank is >7 years old), with a low resulting cost basis. This enables a higher likelihood of profitability when developed. Lastly, their land bank does not have deadlines for development, so they have the option to develop at a more favourable time if need be.

4) Keppel-KBS REIT – Co-sponsor KBS Realty is reported considering listing another US REIT in Singapore. As reliance is on KBS to bring deals to the REIT, do you have any concerns or comments on this news?

We exercise tight control by we providing the CFO for the REIT, but we will continue to work with our partners for the best of the REIT. (So a non answer haha)

5) Rationale for recent Keppel DC REIT divestment

The portion divested related to the portion owned by Keppel’s subsidiaries. It was decided that it was better to recycle the capital into their core business projects.

Summary

Staying on top your investments is a must. Attending such investor relations events can fast track your knowledge of the company you own through learning from management and from your fellow investors. I certainly learnt a lot.

Happy Hunting,
KK

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Retirement planning is as much about self sufficiency as it is about love

By now, at least some of you should have watched this heartwarming ad from NTUC Income about “The Worst Parents in the World”.

In the ad, the groom at his own wedding dinner described how he had a “terrible” childhood, no piano lessons, no expensive tuition, no expensive overseas trips or birthday celebrations. However, he expressed his gratitude that they did it, so that they could be self reliant in retirement and not be a burden to him.

Amid all the concern over Singapore’s cost of living and the cost of raising a family here, the ad reminded us that it is possible if you live within your means. It also shined a light on the consequences insufficient retirement planning can have on your children and the society.

It also reminded me of stories Mom would tell me of growing up with Ah Gong, Ah Ma and all her brothers and sisters. Of how Ah Gong and Ah Ma was generous with their money and didn’t control it well. Of how they had to support Ah Gong and Ah Ma in their old age. Of how Mom chose to forgo an overseas scholarship as it would mean years without income for her family, and of how she chose to forgo a career fast track so that she could spend more time raising my brother and I.

Lastly, it reminded me of how blessed I am to have grown up in a middle class family without worry or care, with my parents having the foresight to have sufficient funds to retire without having to rely on me. In the process, I am allowed the freedom to choose any career path that I fancy.

Don’t plan for retirement only because its about being self sufficient, do it because of the love of your family.

Thanks Mom & Dad.

Happy Hunting,
KK

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Portfolio @ August 2018

August

Another month, another portfolio review.

PortfolioPortfolio Value

Performance Indicators / Dividends

  • YTD Time weighted return: 4.49%
  • Dividends collected: $2,767.12
  • Upcoming Dividend Receipts:
    • Yuexiu Transportation Infrastructure: HKD 900
    • AA REIT: SGD 150
    • Visa: USD 11.76

Commentary

A month of milestones

The past month was a month of a few milestones – turning 30 and revisiting an old goal, scaling new heights in portfolio value and today, 1 year of financial blogging. My first blog post was a porfolio review as at August 2017 1 year ago and I’ve enjoyed writing for the past year. I’ve always enjoyed writing articles back in school and I’m glad I’ve a topic that I’m passionate enough to write about. Hopefully you guys learnt something in the process.

Monthly Performance

August was a pretty decent month, $2k of capital gains, $2k of cash injection and $1k of dividends brought the portfolio value up to $134k, yet another new record. Capital gains were largely driven by Frasers L&I Trust, Visa Inc and SingTel. There was only 1 new buy this month, Tencent Holdings, which I bought into weakness following their recent earnings report. My write up on the company is here. China stocks will continue to be volatile following the trade war and for Tencent, government regulations over video games. However, price volatility in Chinese / HK stocks is also what makes HK stocks increasingly attractive now, something which I’m watching really closely.

Health is wealth

My company has its annual charity month in September and I’ve been committed to complete 100 miles of walking/running/cycling/swimming for whole of the month for charity. That’s a whopping 5+ km per day! Since I’ve been volunteered for this, I thought its a good time to start exercising regularly to lose weight. So going forward, I’ll be writing more about my weight as health is wealth.

Here’s to an awesome sprint to the end of the year.

Happy Hunting,
KK

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Shifting my investing style

Many people tend to pigeon hole themselves into a particular style of investing they identify with – Value Investors, Growth Investors, Income Investors, Index Investors, the list goes on and on. The talks and courses I’ve attended to date also tend to teach a singular method to investing, maybe because it is easier to sell and structure into a course / talk.

I used to be very clear on what my style was – High growth stocks all the way. However, over the past year, I’ve transitioned to a more income approach as seen by my portfolio comparison below:

Portfolio comparisonPortfolio pie comparison

Why the shift?

The main reason for the shift is my gut feeling that we are at a late stage bull market cycle and I need to be more defensive in my stock picks. You may or may not agree with this assessment, but my gut has rarely failed me in my 5 years of investing.

With that said, I may have gone overboard in my shift to income investing as more than half of my portfolio is now in slow growing income stocks. This is why I have held off on adding more income to my portfolio and have been eyeing any weakness in high growth tech stocks as evidenced by my recent buys into Facebook in July and Tencent earlier this month.

Going forward, I hope to maintain a 50-50 growth to income stock portfolio. This may impair my ability to continue to churn out market beating gains but at least I can sleep better at night, knowing the certainty of my dividends.

So how would I define my investing style?

Course providers / Speakers say that you should stick to a single tried and tested method to achieve market beating returns.

To my undisciplined mind, I don’t care for a single consistent approach. I buy stocks that I feel will give me a return, the reason for that return does not have to be consistent. Who cares it is because the stock is undervalued, or if it pays me a sustainable dividend while I wait for the company’s recovery, or if it is overvalued but will eventually grow into its valuation. As long as you potentially give me a return, I’m in. I feel this level of flexibility is important to survive different market cycles.

I suppose my investment style is anything goes for capital appreciation. I guess I won’t be conducting any courses / talks soon.

Summary

I used to laugh whenever I read that a fund’s investment philosophy was for capital appreciation. It was like duh, isn’t that the aim of investing? But now that I’m running my own “fund”, I get it. It just means being flexible and nimble in the face of market changes.

Something I’ll be continually shifting in light of current market conditions.

Happy Hunting,
KK

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Tesla – Symptoms of poor governance pile up

Tesla Logo.png

US Tech stocks were my first love in my investing journey. That said, I’ve never felt compelled to jump on the Tesla (NASDAQ: TSLA) bandwagon. I initially didn’t bother because I hated the car manufacturing business. Slowly as the years went by, I saw Tesla as a company that at best was not operating to its fullest potential, at worst was a dysfunctional managerial mess.

With the recent public controversies over CEO Elon Musk’s tweets over a potential privatisation of Tesla and his emotional stress, I thought I’ll run through some of the symptoms that kept me away from buying into the Tesla story.

Symptom 1: Consistent inability to hit internal production targets

Tesla has faced manufacturing delays and struggles since they started making Model 3s, their entry model. The magic number currently thrown around by Musk for the longest time was 5,000 Model 3s a week. This was consistently missed until early July 2018 when they finally hit it, but not without having to put up temporary tents to assemble the cars. This landmark was celebrated with tweets of employee photos.

Is it worth celebrating though? For comparison, Toyota manufactured 13,400 cars per day in Japan back in 2014.  That’s about 94,000 cars a week, way outpacing Tesla in 2018.

Symptom 2: The Solarcity Acquisition

Tesla acquired Solarcity, a company Elon Musk co-founded with his cousins, in a cool USD2.6 billion all stock deal in late 2016. Setting aside all the conflict of interest issues with such a deal, the justification of such a deal goes against financial logic. A company with known cash flow issues going out and acquiring another with negative cash flows in a commoditising business boggles the mind. There may be strategic reasons for such a acquisition, but at face value, Solarcity was not a good fit for Tesla.

Symptom 3: Starting to fund the company through debt

In September 2017, Tesla issued bonds to fund its working capital needs instead of using equity as it had always previously done. For people who understand corporate finance, this is a pretty boneheaded move for 2 reasons:

1) There is no tax advantage

One advantage debt has over equity is that interest expenses are deductible against income, reducing the amount of taxable income. That said, it is only an advantage if Tesla was profitable and had income to be taxed. The last I checked, this was not the case.

2) Easy access to equity capital

Given the personality cult surrounding Elon Musk, it should be easy for Tesla to raise equity capital. It will dilute Musk’s share of the company yes, but a small percentage of a valuable company is still worth more than a significant percentage of a defaulted company.

If control was such a concern, I’m sure Musk can find solace in his god-like status among investors and a weak board which he easily controls.

What is going on?

The key problem with Tesla is the failure to adhere to good corporate governance principles arising from having a revolutionary CEO like Elon Musk.

Maverick genius, but poor operator

Having such a brilliant and strong minded CEO like Musk has been simultaneously Tesla’s greatest strength and weakness. On the one hand, it has produced some of the sexiest cars one can buy as well as some pretty sweet tech. On the other, you have a CEO with an immense ego and a predisposition to micro manage. All this is fine if the CEO is able to execute well. Tesla’s struggles with manufacturing indicate otherwise.

Not being able to manage well is common for tech company founders. Founders, like Amazon’s Jeff Bezos and Google’s Larry Page & Sergey Brin, struggled operationally at different points in their company’s life cycle. What is more important is recognising that weakness and hiring suitable people to manage those areas, something Musk’s ego and absolute need to micro manage (I’m speculating here) currently prevents him from recognising / doing. The fact that Tesla does not have a Chief Operating Officer to share the burden with Musk indicates this.

Rubber stamp board of directors

In a case where management is misfiring on all cylinders, the Board of Directors has to step in to make the tough decisions to right the ship. Unfortunately, a look at the board composition shows why the Board is potentially rubber stamps Musk’s decisions:

  1. Elon Musk – Chairman and CEO
  2. Kimbal Musk – Brother of Elon Musk and significant shareholder
  3. Brad W. Buss – Long time board member (since 2009) and ex-employee
  4. Ira Ehrenpreis – Venture Capitalist and SpaceX investor
  5. Antonio J Gracias – Venture Capitalist and SpaceX investor
  6. Steve Jurvetson – Venture Capitalist and SpaceX investor
  7. Robyn M. Dunholm – COO of Telstra (Australia telco)
  8. James Murdoch – CEO of 21st Century Fox
  9. Linda Johnson Rice – CEO of Johnson Publishing Company

Firstly, nobody really jumps out as a famous name other than James Murdoch who might combat Musk. Secondly, Musk is both Chairman of the Board and CEO, which is a huge concentration of power sitting in one person. Thirdly, about 2/3 of the board is kind of friendly to Elon Musk (The first 6 names on the list), who might be less challenging to his decisions. Lastly, there is little to no technology or car manufacturing brain trust on the board, leading to potential difficulty in offering constructive advice to Musk.

Dysfunctional finance function

Symptom 2 and 3 is indicative of a CFO who is either doesn’t know what he’s doing or doesn’t have the power or strength to push back on potentially financially disastrous moves. CFO Deepak Ahuja has been with the company since 2009, with a hiatus between 2015 to 2017 due to retirement. His deep historical ties with Tesla and the fact he came out of retirement to “save the company” may indicate a close relationship with Musk.

What Next?

A company with the best and most revolutionary tech in the world can fail with poor execution. Tesla is tethering on the brink, but it is currently not irretrievable.

The immediate change that I feel Musk and the Board should consider is hiring a capable COO, someone with car manufacturing experience preferably. This allows him to delegate day to day operations to somebody so that he can concentrate on the areas he is good at, like design and being the big picture thinker. This also helps with succession planning.

The board should re-look at board composition to include more truly independent directors, preferably till at least a 50-50 ratio. This will allow the board to truly be able to function properly and challenge managerial decisions.

Lastly, Musk should learn to delegate and let go more. Given his disinterest in answering investment analyst questions, let CFO Deepak answer and manage them. Also, forget about the short sellers. The best way to get back at short sellers is to manage your company well and defy their expectations, and not to break false stock price moving news over Twitter.

Only when these moves and a substantial drop in share price (my personal reference price is $180) happen will I then start considering Tesla as a investment again.

Happy Hunting,
KK

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Understanding Islamic banking principles and its application to investing

islamic-finance

In the past few months, I’ve been sharing on-and-off with a Muslim colleague on generating passive income and my own journey to financial freedom. It was through these discussions that I was reminded of the existence of Islamic banking. As someone who has read next to nothing on this topic, I thought I’ll do some reading of my own and present my findings here.

(Disclaimer: I’m a free thinker and do not presume to know everything about Islam or its guiding banking principles. While I endeavour to make sure the information is accurate as far as possible, take it with that caveat in mind.)

Islamic Banking Guiding Principles

There are generally 3 major interlinking principles that guide what Muslims can or cannot invest in:

1) Prohibition of Interest (Riba)

Earning of interest is specifically prohibited in Islam. There are 2 reasons for this.

Firstly, the concept of interest implies guaranteed returns with no element of profit and risk sharing. This ties in with the 3rd principle.

Secondly, guaranteed returns encourages investors to turn a blind eye to how the funds are being used. It is thought that society suffers as a result if riba infects the entire economy. This also ties in with the 2nd principle.

2) Ethical and Moral use of funds

This principle means that you can only invest in ventures that are beneficial to society and not in vice industries. Well known haram (forbidden by Islamic law) areas include:

  • The sex industry
  • Alcohol
  • Pork
  • Gambling and speculation
  • Drugs

3) Risk and Profit sharing

This principle prescribes that profit is “good profit” only when the various parties participating in a venture take their proportionate share of risk and their proportionate resulting profit/loss. In relation to debt instruments, it is viewed that you are not taking any risk as you are guaranteed a return. Under Shariah law, you are essentially an economic leech and a sinner.

Implications of guiding principles

These guiding principles create certain areas that are strictly off limits, while also create various grey areas that are open to interpretation on what you can or cannot invest in. I’ll go through each asset class and discuss whether it is Halal according to the principles, while also highlighting any Shariah compliant alternatives that the banking industry has come up with similar characteristics.

1. Saving Deposits / Fixed deposits

Savings and fixed deposits in their traditional sense are prohibited due to interests paid. For Islamic savings deposits, hibah (gift/donation) is paid instead at the bank’s discretion.

As for Islamic fixed deposits, a popular model used is called murabahah (fixed cost plus model). For example, if you put $10k into the account, you effectively purchase $10k of commodities that the bank agrees to buy back at maturity at a fixed price including markup. The “interest” you earn is the fixed profit margin agreed at the start, thus mimicking the properties of fixed deposits.

As an interesting sidepoint, Maybank seems to deposit the profits the day after you make the deposit, unlike FDs that pay out at maturity.

2. Bonds / Debt instruments

Traditional bonds and debt instruments are a definite no as they pay interest. That said, there is a popular bond-like instrument called Sukuk, or “Islamic bonds”. Sukuk is usually tied to a specific venture / asset and investors are paid from the underlying profits and cash flows from the asset. It is a investment trust of sorts.

3. Equities / REITs

Equities generally comply with Shariah law provided the company’s activities do not contravene the 2nd principle. Muslim equity investors have to be extra careful to understand the company’s business activities and make sure they are not engaging in vice. This should already be practised anyway even if you are non-Muslim.

The grey area that I’ve come across is equities of companies with debt like property developers, construction companies or REITs. Some say it is a strict no-no, while others say it is OK as long as it is not a significant proportion of the balance sheet. The debate over what “a significant proportion” means is also a matter of interpretation. Throw in the fact that most of the world’s companies are funded by debt to some degree and you have a real practical application issue on your hands. Makes you wonder how the Kingdom Holding Company (Investment vehicle of Saudi Prince Alwaleed) reconciles these grey areas in his own equity investment strategy.

As a sidepoint, the world’s largest Shariah compliant REIT by asset value Sabana REIT is listed on the SGX.

5. Derivatives (Futures, options, etc)

This is another grey area due to the nature of derivatives trading. Derivatives trading are generally speculative in nature and thus haram. With that said, futures and options do serve a purpose in risk management if not traded speculatively.

6. Cryptocurrencies

There is little discussion on whether this is haram or not, but I would argue that it is haram based on its speculative and volatile nature, and lack of real world value. Crypto HODLers will argue with me till the cows come home, but for now, I think I am right.

Final Thoughts

Islamic banking and investing is a form of ethical and socially responsible investing that Muslims have to follow as far as possible in their quest for financial freedom. Navigating its guiding principles and grey areas can be complicated. My advice, as a practical free thinking outsider, is to find a middle ground you are comfortable with so that you can explain your actions when you meet your maker.

Happy Hunting,
KK

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