Rebuilding CapitaLand for the future

CapitaLand will distribute roughly 48% of shares in CLIM to all its shareholders, excluding CLA. CapitaLand will also distribute in specie 6% of units in CapitaLand Integrated Commercial Trust (CICT) to shareholders, excluding CLA. This will dilute CLA’s current 28.9% stake in CICT to 22.9%.

For every share held in CapitaLand, shareholders will receive one CLIM share valued at $2.823, between 0.155 and 0.143 CICT units valued at $0.328, and cash of $0.951. The cash portion excludes CapitaLand’s dividend per share (DPS) of 9 cents.

“In terms of the entire consideration, assuming CLIM trades at 1 times book value, and CICT units [at its last close], and comparing against the [volume weighted average price of CapitaLand’s] last close, there is 24%–28% upside for CapitaLand shareholders. There is immediate unlocking of value and shareholders will be able to participate in the growth of CLIM which will be separately listed by way of introduction on the Singapore Exchange,” says Lee Chee Koon, group CEO of CapitaLand, at a recent analysts and media briefing.

Pro forma NAV of CLIM stands at $14.7 billion as at December 2020 with assets under management (AUM) of $115 billion. The CLIM share is valued at its NAV which includes the NAV of the REITs. CICT, Ascendas REIT and Ascendas India Trust are trading above NAV while Ascott Residence Trust (ART) and CapitaLand China Trust (CLCT) are trading below NAV. The implied value per share for CapitaLand’s shareholders is $4.102, based on the current share capital of $3.969 and assuming fully diluted share capital should convertible bonds be exercised.

CapitaLand’s NAV per share as at Dec 31, 2020, is $4.30 and its NTA, which exclude goodwill, is $4.09. CapitaLand’s NAV for FY2020 ended December 2020 includes $1.637 billion of revaluation losses and $861 million of impairments. The plan is for CLIM to list with around $10 billion of projects that can be recycled into its REITs and funds.

Resolutions and timetable

The proposal to implement CLIM is by way of an EGM and a scheme of arrangement which will require a few steps with high barriers. CLA cannot vote in either resolution. The scheme document will be dispatched in 3Q2021 with the EGM also to be held in 3Q2021.

In the EGM, the resolution for the vote to approve the capital reduction to distribute CLIM shares to eligible shareholders and distribute 6% of CICT units to these shareholders, require 75% of shares present to vote for the resolution. In the second stage, under the scheme of arrangement, at least 75% of shares voted by more than 50% headcount of those present is needed to approve of the resolution to transfer CapitaLand shares to CLA. The resolutions are interdependent. If all goes according to plan, CLIM will be listed by way of introduction in 4Q2021.

Third-largest listed REIM

Immediately upon listing, CLIM would have $115 billion in AUM, making it the largest real estate investment manager (REIM) in Asia, and the third-largest listed REIM globally with funds under management (FUM) standing at $78 billion on listing.

CapitaLand has always aspired to be a globally competitive real estate manager, says Lee. “Our business model is very simple. It revolves all around the concept of value — find value, add value, and unlock value. And stay disciplined in capital management and execution.”

“Even though we create two entities, one listed and one unlisted, we want to preserve the ecosystem CapitaLand currently enjoys. Therefore, CLIM will be able to enjoy the development pipeline of assets that are stabilised and can continue to feed the growth of AUM whether of REITs or private equity funds. This will be a unique and distinct advantage compared to most other investment managers around the world,” Lee adds.

According to data in CapitaLand’s presentation slides, traditional developers trade at 0.6 times to 0.8 times book, while REIMs trade at 2.6 times book. “CapitaLand, for the last 10 to 20 years has traded at a 10% to 20% discount to book. Some of the investment managers such as Brookfield Asset Management and Goodman are trading at 2.6 times book,” Lee observes.

The same can be said for its forward priceto-earnings ratio. REIMs trade at much higher PE ratios than developers. “Fundamentally, we believe if we can list the investment management business separately which holds the REITs, private equity funds and investment properties that can be recycled within a short period, it will allow us to trade above what we’re trading today,” Lee says.

Lodging business in CLIM

Some investors may frown on CapitaLand’s lodging business being put into CLIM, but when the Covid-19 pandemic clears and economies recover in 2022 and 2023, this could be a blessing in disguise. Even during the pandemic, The Ascott, CapitaLand’s global serviced residence management platform, continues to sign management contracts and plans to open some 80 properties with 17,000 units this year.

Ascott is also positioning itself in other long-stay segments such as multi-family assets and student accommodation. In January, ART announced the acquisition of purpose-built student accommodation (PBSA) in Atlanta, the home of Georgia Institute of Technology.

“The lodging management platform also allows CLIM to scale up horizontally across the adjacent sectors such as student accommodation and the rental multi-family asset classes, creating further synergies with the funds and investment management business,” says Andrew Lim, group CFO of CapitaLand.

In fact, the second part of CLIM’s growth platform is its lodging business, according to Lim. “We are the leading long stay management company with 123,000 keys and 160,000 keys by 2023. I believe we are at an interesting inflexion point. We’ve been doing 20% CAGR in units [in the past five years]. At this clip, we will meet our 160,000 target earlier. Our average return in lodging is 70 basis points (bps) per dollar of AUM so it is more profitable than our 40bps per dollar of AUM for normal fee income,” Lim says.

“Every 10,000 keys give us $20 million to $25 million in fee income and the target is to maintain this growth over the medium term,” he says, adding that Ascott’s fee income goes straight to the bottom line.

In FY2020 ended December 2020, CapitaLand reported a total fee income of $735 million, up from $673 million in FY2019. Fees from the management of serviced residence management contributed 15% while REIT management fees, property management, private funds management and others contributed 30%, 22% 11% and 17% respectively.

To vote or not to vote

Some shareholders could vote against CLIM though. Top on the list of reasons for objection would be CapitaLand’s prized position in the FTSE EPRA NAREIT Developed Index. REITs from Singapore are well represented in the index. Most recently, ParkwayLife REIT became a constituent.

However, there is no guarantee that CLIM will remain part of the FTSE EPRA NAREIT Developed Index in two years.

CapitaLand is just one of three develoers from the Singapore market that is a constituent of this index (see table). The other two are City Developments (CDL) and UOL Group. Developers in Singapore tend to be tightly held, as in the case of United Industrial Corp and Frasers Property, and do not have sufficient free float to qualify.

Initial qualification for the index requires 75% of ebitda from developed markets, a freefloat market capitalisation of around US$1.3 billion ($1.75 billion) although this varies and can rise during very strong bull markets, and 90% of earnings from real estate.

In the near term, CLIM is likely to continue being a constituent if shareholders approve the sale of the development business to CLA as it lists with $10 billion–$11 billion of investment properties. However, as these properties are recycled into its REITs, and if CapitaLand’s original target of $3 billion a year is used, these properties would be transferred out of CLIM into REITs within three years. As of now, CLIM’s next steps at incubating investment properties are not clear.

Residential developments

To be sure, in CapitaLand’s largest markets of Singapore and China, government measures are increasingly making it awkward for developers to make a quick buck. Margins from property development are highest when developers start from the ground up and if done correctly. This was what attracted Chinese developers such as Qingjian and MCC Land to venture into Singapore.

Redevelopment projects may also yield significant margins, as in the case of Liang Court. In May 2019, CapitaLand and CDL jointly acquired Liang Court’s ageing retail mall for $400 million. While some observers viewed this as a high price for an old mall, CapitaLand and CDL had a plan to redevelop the Liang Court site, which was announced in November 2019.

The proposed integrated development with a total gross floor area (GFA) of 100,263 sq m comprises two residential towers offering some 700 apartment units, a commercial component, a hotel and a serviced residence with a hotel licence. ART will own and operate the serviced residence while CDL Hospitality Trusts will acquire the hotel. The JV partners also agreed that 60% of the GFA would be residential.

If the recent prices at CDL’s Irwell Hill Residences are anything to go by, the gross development value of the two residential towers is likely to be some $1.6 billion based on $2,500 psf, which would be well above the breakeven price that includes construction and land cost. Analysts have put total development cost at around $800 million.

In FY2020, CapitaLand impaired a mixed use site in Xinpaifang CBD of Chongqing in China. Raffles City Chongqing’s (RCCQ) commercial portion suffered a revaluation loss of more than RMB2 billion ($412 million). Lucas Loh, president, China, CapitaLand Group, told The Edge Singapore it would take a couple of years for RCCQ to regain its pre-Covid performance level. This means RCCQ may not make it into CLIM.

Separately, RCCQ’s total cost of development is around RMB25,800 psm including land, construction cost and other expenses. The average selling price of residential units, which have a lease of 70 years like the rest of China, is around RMB42,000 psm. So margins are pretty good.

But CEO Lee says the sales are slow. “In China, the government has recently issued the three red lines, and residential property is for staying, not for speculating,” he points out. Developers will be categorised based on how many “red lines” they breach and their debt growth will be curtailed accordingly.

Then there is Datansha, an urban renewal project. The whole island is around 3.5 sq km and CapitaLand’s portion is around 1.5 million sq m, and substantially residential. The entire urban renewal project is likely to take many years. “The private side, we can do urban renewal which takes 10 to 15 years, where you can get land on the cheap. But I’m not sure that the listed side wants to participate. You may want selective projects but not the whole thing,” Lee says.

“The development business in the traditional sense has a long gestation period and requires patient capital. And this restructure is to match capital to rewards and the returns investors are seeking. It does not preclude the CLIM platform from participating in development projects by raising development funds and getting exposure and it gives CLIM’s investors the choice of development projects the CLIM platform would like to participate in. There is enough flexibility for the CLIM platform to participate but not overly expose the balance sheet to huge development projects which may not be so appealing to public markets,” Lee reasons.

Overall though, CapitaLand’s China residential development is known to be a cash business despite the long gestation periods of certain projects like Datansha. At any rate, capital outlay is not excessive as CapitaLand only pays for the land once a clean title is assured.

Possible governance issues

While the entities within the restructured group leverage their collective strength to drive sustainable competitive advantage for the entire group, proper governance structure will be institutionalised to ensure they are separably accountable to their respective boards and shareholders, says the CapitaLand announcement on March 22.

One possible governance issue relates to deciding which entity gets which asset. CLIM has balance sheet assets that are easily monetisable in three years, CFO Lim says. At the unlisted parent level, Lim says CLA assets are longer in gestation but once they are stabilised, they can go to the offtake vehicles, he says, referring to the REITs. In future, assets that need patient capital will go to CLA, after which they will be offered to the REITs once they are stabilised.

“There is a scenario where CLIM and REITs co-acquire. For example, when REITs can’t afford to take the entire asset, we can co-invest,” Lim says.

In an example related to CapitaLand’s stated target of $5 billion in New Economy assets in China by 2024, greenfield developments could be carried out by CLA while brownfield developments including uncompleted buildings could either be acquired by CLIM or the private funds, or in special circumstances, CLIM and a REIT.

In 2017, CLCT and CapitaLand acquired Rock Square in Guangzhou together for RMB3.36 billion, with CLCT holding 51%. Last November, CLCT acquired the remaining 49% at a similar price.

Once again, Liang Court is another example of a redevelopment that comprises two developers and two REITs. Science Park could also be another potential redevelopment opportunity for CapitaLand that CLIM, CLA and Ascendas REIT could all partake of shortly.

“We can recycle the $11 billion to acquire something very interesting, we can co-invest with offtake vehicles for FUM growth down the line. There are interesting operating platform opportunities where there are operating assets, and CLA and CLIM or the REITs could participate,” Lee suggests. “With CLIM, we have the chance to be asset-light and selectively choose development projects. That’s the advantage we want to preserve.”

In fact, CICT was distributed to allow CICT to be de-consolidated from CLIM. Coincidentally, CLCT was also de-consolidated in the process. As CICT holds 11%–12% CLCT, the exclusion means CLCT will not be consolidated within CLIM’s balance sheet. CICT carries debt and has a debt-to-asset ratio of 40.6% as of Dec 20, 2020. REITs are asset-heavy.

“The balance sheet of CLIM opens up and allows us to go for growth. We thought 6% was not too much to ask of CICT and won’t stress or strain CICT too much,” says Lim.

Analysts and market watchers were quick to comment on CapitaLand’s major restructuring initiative. RHB analyst Vijay Natarajan says, “CapitaLand’s move to strategically restructure its portfolio by privatising its development arm and maintaining the listing of its investment management arm is a highly value-unlocking move.”

CGS-CIMB analyst Lock Mun Yee says, “We like the transaction as it sharpens the group’s focus and positions it as an asset-light and capital-efficient business through CLIM as well as unlocks value for investors through the scheme, in our view. CLIM will be an Asian-centric fully-integrated REIM with funds and property management capabilities across multiple asset classes.”

On the other hand, Jefferies analyst Krishna Guha disagrees. He prefers CDL at this stage and believes that ARA Asset Management offered better value when it was privatised.

What is left now for CapitaLand is to convince its minority shareholders that CLIM will work for them too.