CapitaLand Restructuring: Cheap at Current Prices

On 22 March 2021, CapitaLand announced a restructuring of its business involving the divestment of its development business at 0.95x of its NAV (equivalent to $0.951), distribution of some CICT units, and the grouping of its remaining business into an entity called CapitaLand Investment Management (CLIM). With this, investors buying shares of CapitaLand now are really buying shares in CLIM – and a sprinkling of CICT.

Source: CapitaLand’s presentation on 22 March 2021. Note that the same presentation also confirms that “CapitaLand’s FY 2020 dividends of S$0.09 per share is not part of the Implied Consideration and will still be payable to shareholders”

I view this offloading development assets at 0.95x NAV as a good deal for shareholders as I would not pay book value for these assets that are still under construction. These assets are valued based on cost incurred so far. Not based on net rental income or actual property yield. Not that it is worthless, but the risk profile is very different. Especially so for their mega projects under development in China like the China-Singapore Guangzhou Knowledge City and the Sino-Singapore Tianjin Eco City.

On the other hand, I like the remaining businesses under CLIM a lot. A lot more it seems than the rest of the market. If the market values CLIM at 1x NAV, the share price of CapitaLand should be at least $4.192 now.

However, as at market close on 26 March 2021, CapitaLand’s share price is at $3.85, giving us an implied valuation of $2.477 per CLIM share (0.88x NAV).

What is CLIM?

When you buy a CLIM share, what you are getting is the following three segments:

Group 1. Stakes in REITs and Funds
CapitaLand’s existing stakes in its REITs and Funds worth $13.3b will remain under CLIM. Being an investor in its own managed REITs and Funds ensures that there is some alignment between CLIM and other unitholders. Shareholders of CLIM will also get to own what is effectively a CapitaLand REIT and Funds ETF. As CapitaLand REITs are considered to be blue-chip, I am happy to pay market price for this.

Group 2. Investment properties (to be monetized)
CLIM has $10.1b worth of investment properties. These are completed and mature, rent generating properties that they intend to monetize within 3 years. Monetizing refers to divesting to one of its REITs/ Funds or selling to third parties. Historically, such properties have been divested at prices ~11% above book value.

REITs face more restrictions in taking on acquisitions mainly due to the regulatory gearing ratio cap. Furthermore, REITs will not have a lot of cash on hand given that they must distribute 90% of its income. This means is that when REITs acquire properties, they usually have to do so with some new equity (placement or rights). CLIM however, has no such restrictions. It can act quick to buy the property first and then sell to the REIT when the REIT is able to raise capital at good rates. The idea is to do the transaction at a win-win price that is both profitable for CLIM and DPU accretive for the REIT.

Group 3. Fund management platforms
This is the crown jewel of CLIM. Fees earned from investors include a base fee for managing REITs and funds and serviced residences, and additional fees for increasing DPU, fund raising exercises, acquisitions, divestments etc. Fees are also collected from tenants for property management services such as cleaning and security, which they will outsource to subcontractors. These fees are earned based on services provided by humans and not assets. So the book value of this segment is minimal, made up of things like furniture, computers etc, resulting in a valuation of almost zero if it is valued by NAV. This segment should be valued by profits, with Funds Under Management (FUM) as the key indicator for investors to look out for.

By managing the REITs well (well means with increasing DPU), CLIM will attract more investors to its REITs, thereby growing their asset base and fees earned. With the increased earnings, CLIM can purchase more properties to divest into new or existing REITs at profitable but DPU accretive prices. And this goes on and on in a profitable, virtuous cycle as illustrated in the diagram in the above section.

Heartlandboy has done up a nice summary on the types of fees earned by REIT managers. You can read more here: https://heartlandboy.com/watch-out-for-reit-manager-fee/

Valuation of CLIM

The NTA of CLIM is $14.7b, or $2.823 per share. This is almost entirely made up of Group 1 and 2 above, with the Group 3 (fund management business) having negligible NAV. For the reasons explained above, I do not see a need to impose a discount on CLIM’s NAV (Group 1 and 2), and would for that matter note that the fund management business is almost valued as free if we use only NAV.

In 2016, just 2 weeks before ARA was privatized, DBS published an analyst report valuing ARA at a price that was almost the same as ARA’s privatization price. SOTP valuation was used with the following:

• 1 x NAV of ARA’s stakes in REITs, Funds, and cash
• 18 x PATMI for the fee management business

Back then, ARA had an FUM of $30b which was forecasted grow $2b per annum. That is only about 7% which is much slower than CapitaLand’s 11% historical FUM CAGR. But to be conservative, I decided to stick to 18x PATMI to in my attempt to estimate CLIM’s valuation.

Unfortunately CapitaLand’s past reports and presentations did not contain enough information to show how profitable its fee-generating businesses were. An update on the profitability of each segment of fee-generating businesses will help investors value to business better. Nevertheless, I used some conservative estimates, and this is what I got:

In conclusion, I estimate CLIM to be worth at least $3.29/ share conservatively, which if reflected in CapitaLand’s share price, would result in the price CapitaLand to be at $4.66/ share. CapitaLand is therefore a BUY for me at current prices.

Key risks

1. NAV of CLIM’s investment properties and stakes in REITs & Funds may decrease, especially if there is a major recession
2. The proposed restructuring may not happen if shareholders do not approve it

Disclosure

1. The contents of this post reflect only my personal opinions. It is not professional advice. Please do your own due diligence.
2. I did not own any shares of CapitaLand prior to 22 March 2021 but have since bought a number of shares at an average price of $3.80.