Flash Note: Capitaland Mall Trust acquisition of remaining interest in Westgate

Today, Capitaland Mall Trust finally released more information on its proposed acquisition of Westgate as part of its EGM circular to unitholders. As a unitholder myself, I thought I’ll dive in, give my quick thoughts and speculate a bit.

The circular and presentation can be found here.

Overview

Capitaland Mall Trust is proposing to acquire the remaining 70% interest in Westgate that it doesn’t own from its sponsor, Capitaland. It will be holding an EGM on 10 am, 25th October 2018 to obtain unitholders’ approval to proceed with the acquisition.

Westgate.jpg

As most Singaporeans know, Westgate is a mall located next to Jurong East MRT and is part of a mixed use development of retail and office space. It is also located within the Jurong Lake District, the planned 2nd CBD in Singapore. As such, it is a fantastic property location wise with some growth potential as the Lake District develops and matures.

Financing Details

The main details that were revealed as part of this circular relates to potential funding structures and their potential impact on the key valuation metrics of the REIT. 3 potential models of funding was illustrated: 70% debt funded, 85% debt funded and 100% debt funded, with the balance funded by equity where necessary.

Gearing

Gearing Comparison

Source: Capitaland Mall Trust EGM Circular

As you can see here, the REIT has ability to fully fund the acquisition with debt without busting MAS gearing caps. Whether they choose to do so really depends on economic conditions at the time of fund raising.

Distribution per Unit

DPU Comparison

Source: Capitaland Mall Trust EGM Circular

A key assumption for this illustration is that equity is raised at $2 per unit, which is a 8.3% discount to today’s closing price of $2.18. Under the above conditions (No more than 30% of funding raised by equity and at $2 per unit), the acquisition is yield accretive. This is only true if management keeps the financing structure within these parameters.

Net asset value

NAV Comparison

Source: Capitaland Mall Trust EGM Circular

NAV post acquisition doesn’t change much. This means that the REIT is highly likely to be able to issue equity at a premium to book (based on illustrative price of $2 versus NAV of $1.93), which explains why the acquisition is able to be yield accretive at up to 70% LTV.

My Guess

Here we enter the realm of speculation, let’s assume the acquisition is approved at the EGM, which is highly likely given the merits of the deal.

First question: What would the final financing structure be?

Whether they ultimately choose to fund it entirely through debt or partially fund it with equity really depends on economic factors like interest rate and cost of equity. As the REIT is currently trading at a premium to NAV, cost of equity is low as it is able to issue equity at a premium to valuation. Coupled with the fact that the REIT potentially might need the debt headroom for other acquisitions or to complete the construction of Funan, it definitely makes sense for the REIT to issue equity.

Second question: Since equity is likely to be issued, will there be a rights issue? In order to answer that, let’s take a look at a hypothetical scenario – if it was a rights issue for 70% LTV scenario, what would be the likely structure of the deal?

Rights issue ratio.JPG

For convenience, I ignored the effects of the acquisition fee. I also included a “worst case” scenario where the Managers fund the acquisition at NAV.

A whopping 3.5 units per 100 shares! Given a rights issue / preferential offering is much more expensive to conduct as compared to a private placement, my money is on the REIT managers doing a private placement instead, should they choose to partially fund it through equity.

So my best guess is that the acquisition will be funded by a mix of debt and equity, while equity will most likely be raised via private placement. So don’t feel too compelled to raise cash to participate in a potential rights issue. Let’s see if I’m ultimately right 😛

Do you agree with my guess? Let me know your thoughts!

Happy Hunting,
KK

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

Logo

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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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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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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If Professor Oak introduced Investing

Professor Oak

Introduction

Hello there! Welcome to the world of Pokemon Investing! My name is Oak! People call me the Investment Prof! This world has many instruments for investing! For some people, they invest to build passive cash flow. Others invest for capital gain. Myself… I study investments as a profession, and I’m here to provide you with a beginner’s guide to investing!

How investments accumulate wealth

There are generally 2 ways you can profit from investments – Capital gain and Dividends.

Capital gain refers to the “Buy Low, Sell High” concept. Dividends refers to cash distributions to shareholders as and when announced. Here’s Meowth to illustrate this.

Meowth explains investing

Let’s say you recently caught a Meowth. As you train Meowth, it grows in levels and becomes of higher level. Also, from time to time, Meowth successfully casts its signature move Pay Day and generates cash for you. Now replace Meowth with the investment you just bought, leveling up represents growth in investment value and capital gain, while Pay Day proceeds represents cash flows and dividends.

These 2 factors combine to increase your wealth.

Choosing a suitable investment vehicle

So you are ready to catch your first investment, but which investment type should you buy? To answer this, there are 2 questions you have to ask yourself:

1) What is your risk appetite?

Risk appetite refers to your willingness and ability to accept volatility in your investment value. It is like choosing a Pokemon. A risk adverse trainer might choose a lovable, nurturing Chansey as your Pokemon, slowly and steadying training it to higher levels with no expectation of explosive growth. A risk taking trainer might choose a volatile Charmander as your Pokemon, which might experience explosive growth when it evolves into a Charizard, but you might get burnt from time to time.

Pokemon Risk Appetite

Similarly, a risk adverse investor will be happy with steady but comparatively lower returns, while a risk taking investor will have to accept more volatile but potentially higher returns.

2) How active do you want to manage your investment portfolio?

This essentially means how much time you wish to spend managing your portfolio. Are you like a Snorlax and would rather Rest than manage your portfolio? Or are you a hard working Magikarp that tirelessly Splashes your way to Gyarados financial freedom?

active-vs-passive.jpg

Based on your answers to those questions, you can choose the investments suitable to your personality.

Investment Options.JPG

Conclusion

As a beginner investor, picking the right investment class to start with is very much like choosing a starting Pokemon. Aligning your risk appetite and involvement with the suitable investment allows you to be comfortable with your investments through thick and thin. Till next time!

Happy Hunting,
KK Professor Oak

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