CapitaLand’s Restructuring – Is this bad for the CapitaLand / Ascendas REITs? (Part II)

In case you missed it, CapitaLand announced a really big restructuring / privatization of their development business on Monday.

It’s like fine wine, because the more I think about it, the more I appreciate the genius.

Anyway – lots of you have asked for a deeper dive into:

• What’s the fair value of CapitaLand after this restructuring?
• Is CapitaLand a buy now?
• Is this bad for the CapitaLand / Ascendas REITs?

Lots to cover, so let’s go!

Basics: What is going on with CapitaLand?

I wrote a full article on Monday to cover what’s going on with the CapitaLand restructuring.

Seriously, just go read it, it’ll cover all you need to know.

Anyway – the TLDR version is:

• CapitaLand is privatizing its development business
• Consideration is $1.121 which is 0.95x NAV
• This will be paid in a mix of cash and units in CapitaLand Integrated Commercial Trust (CICT)
• This is being done to “unlock shareholder value”

CapitaLand’s share price reacted very positively to the news.

CapitaLand jumped from 3.3 to 3.9 on Tuesday morning. The flood of selling brought it down to 3.7s, but it trended upwards for the rest of the week to settle around 3.85.

5 year chart below:

Source:  ShareInvestor WebPro

What do you get if you buy CapitaLand today?

If you buy CapitaLand today, what you will get when the transaction completes in end 2021 (approx.), is:

• CapitaLand Investment Management (CLIM) at NAV (worth S$2.823)
• 0.951 cash consideration
• 0.155 (0.08 + 0.075) units in CICT – (worth S$0.3286 – assuming CICT at current market price 2.12, 1.05x book value)
• 0.09 dividend for FY2020

Totalling $4.193

The official presentations don’t count the 0.09 dividend, but I think it’s fair to include.

Because practically, when you buy CapitaLand today, this is what you’re going to get by end of the year.

But at today’s price of 3.85, that’s almost a 10% discount to “fair value”.

What are we missing here?

What is the fair value of CapitaLand Investment Management (CLIM)?

And of course, the big question mark is what is the fair value of CLIM.

The number above assumes CLIM tradin at 1.0x NAV, which may or may not hold true.

So I did some sensitivity testing, to see how fair value changes based on how CLIM is valued:

Price/NAV of CLIM	“Fair Value” of CapitaLand today
1.2	4.76
1.15	4.62
1.1	4.47
1.05	4.33
1	4.19
0.95	4.05
0.9	3.91
0.85	3.77
0.8	3.63
0.75	3.49
0.7	3.35

At today’s price of $3.85, the market is valuing CLIM at about 0.87x book value.

So the million dollar question here – Is CLIM worth more or less than 0.87x book value?

More and I buy it, less and I sell or hold.

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What does CLIM hold?

Let’s dive into what CLIM is going to hold post restructuring. Basically, it will be:

1. The listed CapitaLand / Ascendas REITs:
   • CapitaLand China Trust
   • CapitaLand Integrated Commercial Trust
   • CapitaLand Malaysia Mall Trust
   • Ascott REIT
   • Ascendas REIT
   • Ascendas India Trust
2. The unlisted private Funds (eg. the Raffles City Funds)
3. The mature properties (eg. Ion Orchard, Galaxis)
4. The hospitality business (Ascott)
5. The operating platforms (property managers)

So we’ll do a sum of the parts analysis, and calculate each part separately.

The listed CapitaLand / Ascendas REITs

REITs	Market Cap ($ billion)	Price / Book	CLIM’s Stake (after restructuring)	Value of CLIM’s Stake ($ billion)
CapitaLand Integrated Commercial Trust	7.8	1.05	22.90%	1.79
Ascendas REIT	11.0	1.33	21.59%	2.37
CapitaLand China Trust	1.68	0.88	35.34%	0.59
Ascott Resident Trust	3.29	0.83	40.09%	1.32
Ascendas India Trust	1.69	1.36	21.52%	0.36
Total				6.44
Pro Forma NAV of CLIM ($ billion)	14.7
Listed REITs as % of CLIM	44%
Average P/B of CLIM’s stake	1.07

So CLIM’s stakes of the REITs, using market value today, is $6.44 billion.

This is fair because even if you buy the stakes on the open market today, you’re already paying $6.44 billion (probably more).

The average Price/Book of this stake is 1.07, so the fact that CLIM is trading at 0.87x Price/Book today looks like a good deal.

CLIM’s NAV is $14.7 billion, so the listed REITs alone are worth 44% of CLIM.

The Unlisted Funds (eg. the Raffles City Funds)

Unfortunately we don’t know the percentage interest that CapitaLand holds in the unlisted funds.

Let’s just assume it’s 20%, then it would be worth $5.2 billion at 1.0x NAV (Update: This was disclosed in the presentation as being $5.5 billion).

Stakes in the Mature Properties

We don’t know how much this is worth.

But looking at the list of properties above, they’re very solid, very blue chip properties.

So if we take the REITs + Unlisted Funds, we get about $11.64 billion, which is 79% of CLIM’s NAV.

Throw in the mature properties, give or take, and we’re looking at about 80% – 90% of CLIM comprised of high quality properties.

So where does the remaining 10% – 20% come from? The hospitality business, and the REIT/Fund Managers

Hospitality Business (Ascott)

I’m less excited about this one.

I’m just not super bullish on hotels / serviced residence the coming years.

I still think the better way to play the hospitality recovery is via the online travel agents, or something like oil.

I would probably think this part of the business should trade at a discount to NAV.

REIT Manager / Fund Manager / Property Managers

This part of the business though, I really like.

These are the REIT managers and Fund Managers of the REITs / Private Funds.

You know all that fees you pay to the REIT manager to manage the REIT for you? Which typically add up to about 6% to 9% of the REIT’s revenue?

Yeah, those go to the REIT Manager.

It’s very stable, recurring fee income.

So this part of the business is sheer gold, and it should deserve to trade at a big premium to book.

Putting it all together – the new CapitaLand

So basically with CLIM:

1. 44% is the stakes in the listed REITs
2. 35% is the stakes in the private funds (assuming 20% ownership)
3. 5% – 10% is the stakes in the mature business
4. The remaining 10% – 20% is the:
   1. Hospitality business
   2. REIT/Fund management

Looking at how high quality the property portfolio is, I would say items 1 – 3 should trade at book value.

Item 4a trades at a discount, and Item 4b trades at a premium.

Put that all together, and we have a good argument that CLIM’s fair value is 1.0x NAV.

But… not as good as a REIT?

There are 2 big reasons why REITs are loved by investors:

1. It pays a massive dividend (90%+ payout ratio)
2. It is tax transparent (no income tax on the property income)

CLIM isn’t the same.

Dividend Policy

Historically, CapitaLand has a 30% – 40% dividend payout ratio.

Note: The research for this article (and the charts) are sourced from ShareInvestor Webpro. It’s a great way to quickly perform research on Singapore stocks, more comprehensive than other options like Yahoo Finance.

You can learn more in my review on ShareInvestor Webpro here.

That translates to a 3% – 4% dividend, which is pretty low compared to the REITs.

Will that change going forward?

Do we see CLIM paying a bigger dividend?

Logically the answer should be yes, because there’s no need to retain all the funds right?

With the development business out of the way, all the cash can be used to payout as dividends, or to buy new properties and grow.

But I couldn’t find any official communication from management on this, so there’s still a bit of an uncertainty here.

This isn’t like a REIT where they’re forced to pay out 90% of income every year.

Not as tax efficient as a REIT

When a REIT pays out 90% of its distributable income, it pays absolutely 0% in tax.

Not the same with CLIM, because it is a company.

When you hold real estate via a company, the holding structure is less efficient from a tax perspective.

Corporate income tax in Singapore is 17%, so there will be some leakage of income to tax.

Because of this, and because of uncertainty over the dividend policy, I think a discount to fair value is required.

I would say about 10% discount is fair for these points.

Which gets us to 0.9x NAV as fair value for CLIM.

Price/NAV of CLIM	“Fair Value” of CapitaLand today
1.2	4.76
1.15	4.62
1.1	4.47
1.05	4.33
1	4.19
0.95	4.05
0.9	3.91
0.85	3.77
0.8	3.63
0.75	3.49
0.7	3.35

Which means the Financial Horse fair value for CapitaLand today, is $3.91.

My calculations are very rough, so we buffer in a range of outcomes – giving us a range of $3.8 – $4.0.

Super, super close to where it trades today at $3.85.

I’m mind blown at how efficient the market is.

Impact on CapitaLand / Ascendas REITs – CLIM is an alternative to buying the REITs?

Quite a few of you have asked me what is the potential impact on the CapitaLand / Ascendas REITs.

I get that CICT may be impacted because of the increased public float, but I didn’t get why the other REITs would be impacted.

But then the others REITs sold off about 2% – 3% on Tuesday, and then I realized my mistake.

Because technically, CLIM can be an alternative to holding the REITs.

Think about it this way – if CLIM is trading at 0.8x book value, and the underlying CapitaLand / Ascendas REITs are at 1.2x book value, you may just decide to buy CLIM instead of the REITs

Which introduces an alternative, which is negative for the REITs.

It’s supply demand right.

It’s played out to a small extent so far, and it will be interesting to see how this dynamic evolves going forward.

If you’re a new investor today and you want to buy all the CapitaLand and Ascendas REITs, do you buy them individually, or do you buy CLIM?

I still think the impact is minimal, but let’s see.

Is CapitaLand a good investment?

A big caveat – my fair value above is on a short term basis.

It means the short term valuation of CapitaLand is $3.8 – $4.0, and if I buy at this price I’m getting fair value.

But longer term, it can still be a good investment if property prices go up across the board.

Think about it this way.

A condo is on the market at $1.0 million, which is the fair market value.

Most people out there try to buy the condo at $0.9 million, and they spend their time finding this magical undervalued condo. That to me, is just wasting time. This isn’t the 1990s, markets are more efficient today.

Longer term, the bigger money is to be made by finding the condo that will go to $1.5 million in time, and buying it at $1.0 million.

Buy good stuff, at fair value.

Focus on the long term upside.

Long term outlook for Real Estate

Here I’m pretty bullish.

As discussed previously – I think we’re going into a more inflationary environment, and at the same time the Feds will be forced to keep yields down.

That’s great news for real estate in the mid term, and I plan to add heavily to REITs in 2021 as the rising yields play out this year.

CapitaLand has been on the FH Stock Watch for the longest time ever, and I don’t think that changes.

All the restructuring does is to effectively divest the development business at 0.95x NAV, and because of that the fair value adjusts accordingly.

Closing Thoughts: What am I doing with my CapitaLand stake?

Full disclosure – I have a stake in CapitaLand.

I like this transaction, I really do.

It’s like fine wine, the more I think about it, the more I like it.

But the dividend policy and tax structure are real issues here.

Dividend policy is one that can be cleared up by management if they choose to.

The tax structure, not much can be done there unless IRAS steps in – it’s a fundamental disconnect between the corporate structure and the REIT structure.

So in some ways, I don’t think my investment strategy towards real estate has changed much since before the restructuring.

I’m bullish on real estate, and with CapitaLand so close to fair value it doesn’t make sense to sell for me. I can just hold and let the mid term play out.

Going forward, I’ll still add to REIT positions + CapitaLand positions, depending on which one is showing weakness.

CLIM is like an ETF, while the REITs are like stock picking.

With CLIM I have to buy the entire portfolio, I can’t buy 1 industry only.

For example, industrials are weak now, and if I want to add there, I can’t with CapitaLand. But I can with Ascendas REIT or Mapletree Industrial Trust.

If the ETF is trading at a discount to book, I buy the ETF of course. But if its fair valued, I can hold, and buy the REITs to stock pick.

So yes, big fan of this transaction. But fundamentally, I think there’s still a place for both CLIM and the REITs going forward. Very good news for the Singapore investing scene.

For those who are keen, my portfolio and Stock Watch are available on Patron.

Love to hear your views!

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As always, this article is written on 27 March 2021 and will not be updated going forward. Latest thoughts (and my stock watch and personal portfolio) are available on Patron.

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