Today, Temasek Holdings is not just a shareholder of companies headquartered in Singapore, but a commercially oriented global investor. Less than a quarter of its net portfolio value is in Singapore, while 42% is in the rest of Asia and the remaining elsewhere.
The proportion of Singapore-based companies is likely to fall over time due to the slowing growth of the companies, and Temasek’s increased focus on investments in the rest of the world, and pivot into fast-growing sectors such as technology and life sciences, where targets frequently include those outside the country.
However, Temasek-linked companies (TLCs) continue to be the most important issuers within the $103 billion Singapore corporate bond market.
In the Singapore dollar (SGD) corporate bond market, there is a noticeable preference for TLCs, as identified through tighter spreads, being the difference in yield between the Swap Offer Rate (SOR) and the yield of corporate bonds.
Spreads are often driven by credit quality differences, with companies perceived by investors as having a lower credit risk trading at narrower credit spreads.
Although there is no official definition of a TLC, such companies are typically identified as those at which issuers trade at a “Temasek Premium” — or where bondholders are happy to receive a lower return on their investments, in exchange for stability.
To put in another way, the cost of funding for TLCs in the SGD corporate bond market is generally lower than comparable companies operating in the same industries.
For bondholders to accept such a trade-off, these companies must be familiar to investors through their long operating history and presence in the local public capital markets.
Despite being listed as major investments and their sizeable value, Visa and Bayer are just two examples not seen as TLCs.
Happily accepting a lower return is not an entirely irrational phenomenon. Temasek holds its equity stakes as patient capital, typically with a multi-year horizon.
All things being equal, creditors would prefer lending to companies with strong shareholders where equity buffer is more permanent.
At OCBC Credit Research, we define first-tier TLCs as those that are listed as major investments and where Temasek also directly owns at least 20%, or through its various intermediate holding companies.
The concept of which other entities also make the cut to be considered as “second-tier TLCs” is more fluid, given that these entities are owned by other TLCs, rather than directly owned.
Examples of first-tier TLCs under our definition include CapitaLand and Singapore Telecommunications (Singtel), while “second-tier TLCs” include Singapore Post (22% owned by Singtel).
Clarifying common misconceptions
Many assume that Temasek would implicitly guarantee any debt issued by these TLCs, but Temasek has no legal obligation to do so.
Debt issued by Temasek is not explicitly guaranteed by the government, while Temasek does not guarantee the obligations and debt issued by its portfolio companies. Nevertheless, there is a bedrock of trust in such TLCs, bolstered by the facts that TLCs are usually market leaders in key economic sectors and are often the largest employers.
Misjudgment on this matter, however, has led to investor losses with a bond issued by Neptune Orient Lines (NOL) dropping from above par to a low of 73 cents to the dollar, while its short-dated bonds also reacted downwards.
In June 2016, Temasek announced the sale of its stake in NOL to France-based global shipping company CMA CGM Group, stripping NOL of its status as a TLC.
TLCs at an interesting point where event risk abounds
We are now at a point in the global economy where risks abound for incumbent companies, largely due to higher system-wide leverage, rise of disruptive technologies, low growth in developed markets and rising competition from new firms.
This means that as companies adapt to the environment, they are likely to pursue more corporate actions.
While corporate actions in themselves may not be credit negative events, such actions mean TLC bonds are likely to be more volatile than before.
One of the upsides of this situation to bondholders is that despite mixed share price performance in the past 10 years, bondholders of some of these TLCs still received higher total returns over the same period compared to equityholders, even after factoring in dividend income.
This is despite high-grade bonds being considered lower-risk investments versus equity of the same issuer, and that they should be garnering lower returns.
On the flipside, continued credit deterioration means that it would be overly simplistic to assume that all TLC bonds are high-grade.
Credit metrics of companies in Singapore have gradually eroded over the past five years, with Covid-19 making things worse. Total debt for TLCs (excluding REITs) has increased by 64% from end-2014 to end-2019, even though Ebitda, a measure of income, only increased by 20% over the same period of time.
Encouragingly, there were only a few instances where debt was raised to fund equity dividends or share buybacks, with the debt built up largely for capital expenditure and inorganic expansion such as taking over other companies to enter into new industries and geographies. In an environment of low returns, using more debt in the capital structure is also a way to boost returns, explaining some of the credit deterioration.
Complicating the returns outlook for TLCs, a large amount of capital is available to be put to work globally, with competitors for new investment opportunities no longer just other companies but also financial investors, be it for operating businesses as well as investment properties.
Shareholders are very likely aware of the risk of declining returns and the need for TLCs to earn more than their cost of capital. Since early January 2019, half of the first-tier TLCs have undergone major corporate actions. These include mergers and acquisitions, divestments and spin-offs of business units, and divestments of assets to become asset-light. We expect other TLCs to follow suit.
Many of these corporate actions would effectively reset the bond issuer from a different base. Corporate actions may not necessarily be credit negative — take for example, bonds issued by Sembcorp Industries, which increased in price on the back of the Sembcorp Marine spin-off.
Last week, CapitaLand announced a spin-off of its real estate investment management and lodging business, along with a number of stabilised investment properties, into a new listed entity.
While this is a highly welcome move for minority shareholders, existing bondholders and perpetual holders would be holding papers of a slimmed-down, unlisted company more exposed to development, which is more volatile in earnings.
CapitaLand’s bonds and perpetuals have reacted downwards on the back of this development. Organic growth initiatives have also been announced at several TLCs, though these are likely to take effect in the longer term. Aside from a handful of TLCs, publicised growth and return targets are rare in Singapore, making it difficult for the market to track progress, even though this is common in other capital markets.
At this stage, it is not yet clear if such organic growth efforts will be successful. With liquidity available and SGD bonds still generating real returns, TLCs continue to maintain ample access to debt capital markets and bank debt markets.
However, we expect bond investors to start analysing TLCs on a case-by-case basis, with credit spreads adjusting over time to reflect the fundamental changes happening at TLCs.
In a nutshell, there is no assurance that today’s Temasek Premium will be sustained through the life of a bond issue.
Ezien Hoo is a credit research analyst with OCBC
