City Developments (CDL) is attempting to put its ill-fated $1.9 billion investment in Sincere Property Group behind. By any measure, it is not a small amount of money, even for billionaire property tycoons.
As a result of a $1.78 billion impairment for its investment in Sincere, CDL’s NAV was down 19.1% y-o-y to $9.38 as at Dec 31, 2020. NAV including fair value gains on properties but with hotels stated at cost, was $14.26 per share. If all the properties were held at fair value, NAV would be $16.88.
Gearing has also risen from 62% at Dec 31, 2019, to 93% at Dec 31, 2020, based on historical cost accounting. Gearing would also have fallen to 62% versus 43% a year ago if fair value was included.
Unsurprisingly, during the recent results briefing on Feb 26, analysts and media were focused on the impact of Sincere’s impairment and possible recapitalisation on CDL. Although CDL’s senior management team gamely answered the questions, at one point, this became too much for executive chairman Kwek Leng Beng, who had stayed quiet thus far but felt it was time for him to put things into the right perspective.
“A lot of questions have been asked about Sincere. We have written off Sincere and we will not put in any more money; but it has a lot of assets,” he said. “Our partner has a different view from us. The way he operated is also different from the way we operated. Whatever we can resuscitate, we will definitely do so.” Kwek was referring to Wu Xu, the founder of Sincere whom market watchers think was the one who took CDL for a ride.
The way the purchase agreement is structured, Wu appears to be in joint control of Sincere despite having a much smaller stake than CDL. Now, Kwek wants CDL to move on from its disastrous attempt at building scale in China and focus instead on the deep value in its Millennium & Copthorne (M&C) hotels unit, which was privatised in late 2019 after years of having its own separate listing in the UK.
“Hotels will recover faster than what you think because of the vaccines. I believe by this year, in September, all the hotels will recover. Some are closed, converted, but my own view is hotels should be coming back quite quickly. Most of you don’t realise the inherent and deep value in our hotel portfolio. We privatised at GBP6.85 per share, which is way below the deep, deep value in our hotel chain we have yet to unlock,” says Kwek. “I want to move to the next chapter — to grow the company. People talk about warehouses and logistics. How do we do it in such a way the demand will be fantastic?”
Unlocking existing value In Singapore
CDL is planning to unlock value and redevelop FujiXerox Tower and Central Mall. Both are likely to come with an uplift in gross floor area (GFA). Fuji-Xerox, a freehold office property which is carried at cost on CDL’s balance sheet, could experience a significant uplift in valuation. CDL is planning a mixed development with 655,000 sq ft of GFA, which is 25% higher than the property’s current GFA. Of this, 35% will comprise 286 residential units, 25% for serviced residences and 40% commercial use.
Meanwhile, Central Mall, which CDL had bought back from Profit Participation Securities 2, is likely to be redeveloped into an integrated development with 70% retained for commercial use, and 25% earmarked for hotel and serviced residences use.
“For Central Mall, we will work with our neighbour, Far East Hospitality Trust, to look at jointly submitting and applying for the redevelopment of the whole area under the Strategic Development Incentive Scheme,” says Sherman Kwek, CDL group CEO and the chairman’s elder son. Incidentally, Far East Hospitality Trust owns Central Square and Village Residences Clarke Quay next door.
There are also plans to unveil the redevelopment of Liang Court some time in the second half of this year, which is likely to comprise some 696 residential units. The redevelopment will be done through a JV with CapitaLand.
Elsewhere, the launch of the 540- unit Irwell Hill Residences is likely to be in 2Q2021. Altogether, CDL’s launch pipeline comprises around 1,200 units this year. In FY2020 ended Dec 31, 2020, CDL sold 1,318 units with a total sales value of $1.846 billion in future billings. Indeed, CDL is most comfortable when developing residential properties in Singapore. However, it is an increasingly crowded market with limited land, and developers from China and Hong Kong are muscling in on CDL’s home turf.
Still, CDL can redevelop some of its older, freehold buildings in and around the CBD given URA’s 2019 Master Plan.
In the UK, since finding deep value in the M&C portfolio could take some time, the urgency for CDL to list its commercial properties via a REIT could become significant. Frank Khoo, CDL’s group CIO, says, “On the UK REIT, we hear bigger is better because it attracts more institutional investors. We can’t confirm the size but are hunting for a third asset that could come from a partner. We are trying to go for a more sizeable REIT.” In 2018, CDL acquired 125 Old Broad Street in London for GBP385 million, which gives a yield of 4.9%. A second property Aldgate House was acquired for GBP183 million with a yield of 4.7%. The yield on these assets could be improved in a REIT because of the debt it carries. Therefore, a REIT with a unit yield of between 5% and 6% is plausible.
One of CDL’s investment successes with assets overseas is IREIT Global, which has a portfolio of primarily income-producing office real estate in Europe. In 2019, it acquired an 8.4% stake in IREIT Global. Last October, CDL supported IREIT Global in a rights issue, raising its stake to 21% at a rights price of 49 cents. IREIT Global is now trading at 66 cents. Apart from IREIT Global, CDL’s forays overseas have not really endeared investors to it.
Since 2013, CDL has invested around GBP600 million ($1.1 billion) in residential property in the UK, excluding the two office buildings earmarked for the UK commercial REIT and Monk Bridge in Leeds. Its very first property in Knightsbridge is fully sold, according to Kwek Eik Sheng, group chief strategy officer at CDL and nephew of the chairman. However, the returns have not been revealed. Teddington Riverside, which was acquired for around GBP80 million, is a work in progress. Eik Sheng says that someof the units are being rented out.
“We are still working on the other sites. For the Pavilion Road site, we were looking at [transforming] it into a hotel but it’s on hold. The largest site was Stag Brewery which has gone through many rounds of planning with the local council, but with the pandemic, progress has slowed,” Eik Sheng says.
In 2014, CDL, together with a US investment firm, acquired a 16,815 sq m site in Shirokane, Tokyo, for $356 million. Although there were plans to redevelop the site, to date it remains untouched.
Post-mortem of a debacle
As CDL nurses its wounds in China, many market watchers want to know what happened at Sincere. Here is a brief explanation. Last April, CDL announced it was acquiring a 51.01% stake in Sincere for RMB4.39 billion ($880 million). Part of this investment was used to repay the RMB2.75 billion loan extended by CDL to Sincere in 2019. Upon completion, CDL held a joint controlling interest in Sincere. Wu, Sincere’s founder, saw his stake reduced from 60% to 29%, while the stake of the other JV partner, Hong Kong-listed Chinese developer Greenland Holdings Group Co, fell from 40% to 19.99%. The transaction had provisions stipulating that key decisions for Sincere would be made jointly by CDL and Wu.
CDL also had a call option to acquire a further 9% stake in Sincere, although this is now unlikely to be exercised. However, Greenland has a put option to put the shares back into Sincere but this is an agreement between Wu and Greenland. The legal ramifications of these agreements are unclear for now. “When we acquired [Sincere], the deal was 51% plus a 9% call option, if we exercise. For Greenland, there was a put option to put shares back into the hands of Sincere’s shareholders but this was supposed to be between the founder and Greenland. We could potentially have recourse against the existing founder,” says Yiong Yim Ming, group CFO at CDL.
In the April update, CDL said Sincere owns and operates nine retail malls with a GFA of about 565,000 sqm, a serviced residence with 404 apartments, and four hotels with more than 1,000 rooms. In a 2019 announcement, CDL also said that Sincere had 15 business parks under development or in operation, with a total GFA over 5 million sqm.
Less than two years later after the initial agreement, and 10 months following the April 2020 announcement, it turns out that Sincere has adebt pile of RMB32.9 billion. Of this, RMB26 billion or 78% are in secured loans. In other words, RMB26 billion worth of assets are pledged to lenders while the remaining RMB7 billion is unsecured.
Based on CDL’s Feb 26 presentation, Sincere’s NAV is RMB15.4 billion, based on PRC GAAP. According to CDL, Sincere’s net debt to equity was revealed as 180% as at Dec 31, 2020. This was way above the 100% stipulated in China’s so-called “three red lines”, a set of regulations rolled out by the Chinese government to curb excessive debt from building up in its property sector. The second red line was not met by Sincere as Total liabilities less advances received/Total assets less advances received was 79% compared to less than 70% stipulated by the government. For the third red line, Sincere reported Cash/Short-term liabilities of 13% as at Dec 31, 2020, way below the 100% policy target.
At any rate, the secured loans, of which RMB9.6 billion will mature this year, are likely to wipe out any equity Sincere has, where NAV is estimated at RMB800 million, based on IFRS (international financial reporting standard). This is the reason why CDL had to write off nearly all its investment in Sincere, which by Oct 2020 turned out to be $1.9 billion. This comprised an equity investment of RMB4.4 billion, US$230 million subscription of bonds issued by Sincere, and a working capital loan of RMB650 million. In addition, CDL also provided a liquidity support undertaking totalling RMB1.5 billion relating to the bonds that matured on Oct 26, 2020, and a RMB1.5 billion corporate guarantee in relation to an external bank loan obtained by Sincere.
During the results briefing, Goh Ann Nee, CDL’s chief transformation officer, said that CDL’s balance sheet is ring-fenced from Sincere’s debt pile and any default that is likely to materialise this year. “CDL will not be pumping in new funds until Sincere stabilises,” Goh says. There is a need to emphasise that CDL is ring-fenced despite its 51.01% stake because Sincere is very likely to default on RMB4.6 billion of bonds due this year, which, in turn, would trigger cross defaults.
In total, Sincere’s impairment of $1.78 billion in FY2020 comprised $806 million equity investment, financing a US dollar bond at $288 million, trade and receivables of $324 million, provision of guarantee of $283 million, and reversal of fair value gain of $51 million.
“To be candid, the one thing that was far more difficult and challenging was debt restructuring and there are many financial institutions to deal with, and this presented a very tough challenge for the working team. At the time we entered [the transaction], the terms were favourable. But there was a gap between accounts kept in China and IFRS,” admits Sherman.
CDL still a ‘buy’
Analysts remain hopeful that CDL could salvage some money from the Sincere debacle. “Any realisable value from its investment could provide future upside surprise,” says Credit Suisse. “While the investment did not pan out as expected given liquidity challenges, we believe the market now has clarity that CDL will not be providing further financial support to Sincere. Any upside to realisable value from its debt or equity investments, or ability to extract attractive assets such as Tusincere could provide further upside surprise.”
On Feb 22, CDL announced it paid a further $174 million for a 55% stake in Shenzhen Longgang Tusincere Tech Park, acquired from Sincere and Ping An, the conglomerate whose subsidiaries mainly deal with insurance, banking, and financial services.
UOB Kay Hian believes that CDL will manage its debt maturities well. “Despite the outsized loss in 2020, CDL’s financial health remains robust in our view — as at end 2020, cash and available undrawn committed bank facilities total $5.2 billion and net gearing was 62%. Its debt maturity profile does not appear onerous with $312 million, $100 million and $400 million of bonds maturing over 2021, 2022 and 2023 respectively. Bank loans of $2.5 billion and $4.1 billion due in 2021 and 2022 appear larger but CDL should be able to refinance these in our view,” UOB Kay Hian estimates.
“The impairments on Sincere were much larger than our expectations as its financial condition was severely impacted by China’s credit tightening measures. With these write-downs, CDL has ring fenced its balance sheet from potential bond defaults and further losses in Sincere with a maximum further downside of around $130 million,” notes RHB Research.
What should investors do?
Almost all the analysts have reiterated their “buy” recommendations, albeit with lower targets for some. OCBC is calling CDL a “buy” with a $9.12 target price; RHB has kept its “buy” call, with a target price of $8.70; UBS’s call is “neutral” but with the same $8.70 target price. While waiting for CDL to unlock value, investors may decide to look at Bukit Sembawang Estates which provides a purer Singapore residential play, or to REITs for yield, and the agencies for higher short-term returns.
