Wishlist of a Capitaland Shareholder

Two months after the announcement of its proposed restructuring, Capitaland’s share price performance remains lacklustre. While I am still confident of the prospects of Capitaland and its stock, I think that more can be done by management to help investors better appreciate the value of the company. In this post, I will quickly cover the recent 1Q21 results, and then indulge myself with a long nag on my wishlist as a current Capitaland shareholder. It is a long shot, but I think that my suggestions are reasonable and hope that they will be considered by Capitaland’s management.

1Q21 Results

Capitaland announced their 1Q21 results on 12 May 2021. The presentation deck felt a bit awkward because they were reporting on the performance as a whole, including the development business. Of course, this has to be so since the restructuring has yet to be confirmed and executed. But to many investors and myself, we are assuming that the restructuring will take place and our focus is now solely on the non-development businesses. In any case, the CLIM part of Capitaland did well for the quarter.

Fund management fee income has increased by more than 30% due to higher value of properties bought and sold. As a fund manager, CLIM earns fees when they execute acquisitions and disposals for their funds. In this regard, they can also be seen as a property agent, and business seem to be quite brisk.

As there were more purchases than disposals, FUM has also expanded by 2% quarter-on-quarter. 2% might not seem like a lot. But if you compound it, it is 8.243% annually. More importantly, unlike fees earned from transactions which are one-off, increases in FUM will result is higher recurrent earnings – both from fund management and property management.

While fee income from fund management increased by $23.3m, total fee income increased by only $16.9m. This means that there was a $6.4m decrease in other fee income. Indeed, as we see below, the proportion of fees by segments were relatively stable except for a 5% decrease in “Others” and a 5% increase in REIT Management fees. As described in the footnote, this Others segment include things like leasing commissions and marketing fees, which presumably have been badly hit given the Covid situation these days.

So the results are not 100% good, but overall, it is more good than bad. I am satisfied.

Wishlist of a Capitaland (future CLIM) investor

1. Dividend Policy
The dividend policy of CLIM has not yet been formalised or published. This uncertainty itself is unwelcome by investors, who may not want to invest in Capitaland until there some clarity and visibility on this.

I suggest that the dividend policy of CLIM should include 100% of distributions received by CLIM from the REITs/ funds it owns + 100% of net property income of directly owned properties + around 20% of profits from fee income.

By distributing all of the distributions/ rent of its REIT/ funds/ property holdings, investors of CLIM will enjoy the full value of CLIM’s real estate holdings while participating in the growth of its fee generation business. If these distributions are withheld, investors are going to value CLIM’s stakes in REITs, Funds, and individual properties with a big discount and we will be going back to square one.

CLIM will still be able to reinvest in growing its business from the 80% or so profits of its fee generating businesses. I do not expect management to require too low a payout ratio since CLIM is supposed to have an asset light model.

2. Profitability of the fee generating business
The total fee income is reported every quarter ($203.6m in 1Q21), but we don’t know the PATMI from this fee income. Since the focus of CLIM will be on its fee generating business, investors should be given more information on the profitability of this fee-generating business, preferably by segment. The fee-generating business must be profitable and cash flow generative for investors to put a good value on it. And it is probably so.

As it stands now, investors still don’t have a clear picture on how profitable it is. So the market is now effectively valuing this fee-generating business at a negative amount. Not just zero, but negative. With the restructuring, the share price’s discount to book value cannot be attributed to the market’s impatience for development projects anymore. With better visibility on its profitability and prospects, the market should place a more decent valuation on the fee-generating business.

3. Publishing the list of properties under CLIM
Aside from its stakes in REITs and Funds, CLIM will also be starting off with a portfolio of properties valued at around $10.1b. What is included and excluded in this $10.1b properties? I am not sure.

Investors in Capitaland today are effectively investing in CLIM. We want to know what we are buying into, and that should include a full list of properties that will be part of CLIM post restructuring.

From the announcements so far, all I can make out is that the following will not be part of CLIM: Raffles City Chongqing (excluding components developed for sale), CapitaSpring, Suzhou Center Mall & Suzhou Center Office, Jewel Changi Airport (Retail), CapitaMall SKY+, Capital Square, Rochester Commons, Ascent, 9 Tai Seng Drive, China-Singapore Guangzhou Knowledge City, Ascott Heng Shan Shanghai, Innov Center Phase II, 5 Science Park Drive, Ascendas OneHub GKC and Ascendas-Xinsu Portfolio.

4. Clarity on CLIM’s asset light strategy
The proposed restructuring is supposedly going to result in an entity, CLIM, being an asset light business that is focused on growing its fee income. However, CLIM is projected to own $23.4b of real estate assets (some in the form of REITs/ trusts/ funds) out of its $14.7b of NAV. Not only is CLIM clinging on to a huge amount of real estate, it is even taking on debt to do so.

This is a very different approach to ARA Asset Management when it was still listed. ARA was a net cash company. And it did not keep a portfolio of properties aside from their stakes in REITs and Funds, which amounted only to $461.4m compared to their fee income PATMI of $74m. The total net real estate assets to fee income PATMI ratio (I shall call this “Net REA to Fee PATMI ratio”) is 6.2x. On the other hand, assuming a 50% fee income PATMI margin for CLIM’s fee income, CLIM’s Net REA to Fee PATMI ratio is 14.4x. More than double of ARA. If we use total real estate assets (without netting off debt), CLIM’s ratio would be 23x.

CLIM holding on to these assets are not a completely bad thing. I have written in a previous post about how CLIM can be an intermediary to hold on to assets before divesting to its REITs at a later time. It could ultimately lead to higher transactions, fee income, and capital gains for CLIM shareholders. But certainly this does not seem to be asset light at all. I hope management can explain and persuade shareholders how their current plans will boost ROE and why this is better than the very asset light approach taken by ARA.

I am not uncomfortable with the current situation. But I think CLIM can achieve better ROE by reducing the size its real estate asset holdings relative to its fee generating businesses. Ideally, this should be done by aggressively growing FUM. For instance, CLIM could also sell some of their $10.1b properties to its REITs and fund the acquisition through new placements. CLIM will substantially decrease its stake in the asset, and at the same time increase its FUM. But if CLIM is unable to expand its investor base fast enough, it should return the proceeds to shareholders rather than recycling it into new acquisitions.

5. Addressing the CICT odd lots issue
The consideration for this proposed restructuring is made up of $0.951 of cash + 1 CLIM share + 0.155 units of CICT per Capitaland share. This 0.155 units (0.075 from Capitaland + 0.08 from the offeror) of CICT is going to create a lot of odd lots among retail investors. In order to have a fully sellable amount of CICT (multiple of 100), you need 20,000 shares of Capitaland. Which means you will be stuck with some odd lots unless you invest in multiples of 20,000 Capitaland shares (more than $70k).

I hate odd lots. I am sure everyone else does. And I think that this is quite an unnecessary inconvenience. I suggest that that this be resolved by adjusting its distribution of CICT units to a more convenient amount. The current offer will see Capitaland distributing an equivalent of 6.0% of CICT’s outstanding units to its shareholders, bringing its current 28.9% stake in CICT to 22.9%.

How about distributing 0.12 units of CICT instead of 0.075 units? This will bring the total consideration in the form of CICT units to 0.2 per Capitaland share. While there is still a potential for odd lots, the threshold to avoid odd lots will be much lower at 500 Capitaland shares (0.2 x 500 = 100) instead of 20,000 Capitaland shares. More retail investors will therefore be able to afford avoiding the odd lots.

This will also result in a distribution of 9.6% of CICT’s outstanding units, bringing CLIM’s stake in CICT to 19.3%. Still a significant stake that will align CLIM with CICT’s unitholders, but at the same time reducing CLIM’s heavy asset base.

Conclusion

This feels like a complain post. It is somewhat. But I remain overall a satisfied shareholder and continue to be confident that there is deep value in this stock which will eventually be realised. Credit must go to Capitaland’s management for creating this value in the first place. But I think we can do better to now realise this value.