Secondary fundraising - Rights issue (The tale of Keppel KBS USD Reit)

REITs are one of the favorite tools of investors, they give predictable dividends, easy to understand and generally have the nature of democratizing ownership of an otherwise very illiquid asset such as a shopping mall or malls.

Unfortunately REITs also have a strategy to grow its dividend and opportunity sets are limited due to only 10% of capital retained and a 45% gearing cap set by the regulator.

As such, to acquire new assets. A company needs to raise funds either by debt, equity or a mix of both (e.g. perpetuals).

In recent days, there were many destructive deals of the sort
1. OUE Commercial REIT
2. Kep KBS Reit
3. Cromwell Reit (not looking at this deal yet)

OUE Commercial REIT generally dragged its share price all the way down from the mid 60s to just 10 bps above its right issue price. You may also look at the NAV and DPU dilutive damage that the corporate action taken on its price - https://risknreturns.com/2018/09/15/oue-commercial-reit-rights-issue-a-case-study-of-value-destruction/

Kep KBS Reit represented the quickest destruction of value for its early adopters at USD 0.88 per share. Today it trades at USD 0.54. Taking into account its 3.82cents distribution, this represented a lost of 43% for the existing shareholders assuming they do not subscribe for their rights and do not sell it either.

Personally I was interested in USA assets because they are direct proxies to a growing economy and the resurgent economic power. But being very aware of the ground zero nature of rising interest rates. One needs to be very careful on this matter.

I did my calculations, and I do believe a lot of value is starting to emerge.

Pros:

1. Attractive yield at 10.355% compared with fund Nareit 3.32% yield, Manulife reit 7.89%

2. Macro trend of improving USA economy will bode well for assets

3. Semi-protected from aspects of trade war due to locality

Risks:

1. Manager may be impatient to offload other assets (another acquisition worth 10% of AUM is being looked at)

2. Large exposure to rising interest rates (3.47% effective IR. Increase is mitigated by 75% swop floating for fixed. Aggregate leverage relatively low at 33.3%) 

3. Large number of tenants (400+) could make it more challenging to manage. Also Tenant quality may not be too certain (not entirely well known names apart from Occulus)

4. Possible revision to USA Tax policy could result in 30% reduction in dividends received

Conclusion

It would be interesting to be able to get the shares as close to USD 0.50. And this taking into account the worse case scenario of 30% dividend reduction (result of dividend withholding tax) and 5% effective interest rate (additional 5.385m of interest expenses). We would get a DPU of 3.452 cents and this gives about 6.9% on USD0.50. If interest rate remains the same, we would get 7.8% yield even with the 30% dividend reduction

- Not too bad a deal if the max downside is 7% yield while the upside is up till 11.2% yield.

- Margin of safety appears to be pretty thick if we are income investors.

- Likely company is under-priced due to rights issue, size of REIT and lack of understanding by investors.

Certainly private placement (issuance to institutional) or usage of perpetuals (hybrid instruments that receive regular dividends) bodes well for shareholders. It is quicker, cleaner and the discount doesn't kill the share price. Unfortunately it is often not an option for small cap REITs. 

Retail Electric Marketplace

Today, I will cover a topic of interest - Retail Electric Marketplace

With a little promotion to a local bank you can sign up for the new good deals here. - https://www.dbs.com.sg/personal/electricity-marketplace/default.page

Independent comparison: https://compare.openelectricitymarket.sg/#/home

Now down to the numbers and how I derived my findings through a basic data comparison.
The premise is that electricity tariffs are heavily dependent on crude oil prices, the former is charged by SP Group (Government) and the latter is market driven and denominated in USD

1. Downloaded data from the EMA (Energy Market Authority) that dates back till 2014
2. Obtained the prices of crude oil prices (USD) from macrotrends.net
3. Obtained the FX rates from XE.com (USD/SGD)

Doing some derivation, I converted the prices of crude oil prices to SGD and charted the market rates.

From the details, I discovered 3 key findings. Keeping in mind Warren Buffett's saying "Praise by name and criticize by category"

1. Since Jan 2014, the prices of electricity has remain within a band of 30% from peak to bottom. To some extent, I believe that electricity prices are controlled to ensure affordability for the common man.

2. While oil prices fell nearly 60% from peak to through, this did not translate into 60% savings. Was the authority making money here while making less money / subsidizing electricity usage when oil price was in the triple figures?

Unfortunately, without a good understanding of the entire value chain and what is the true costs of production. All these would merely be guesses.

WIIFM. As a Distinguished Toastmaster often said, this is his favorite channel - What is in it for me?

3. Applicable knowledge. Asking the right questions may get you the right answers. In this case, the most important question is the liberalization of the open electricity marketplace offering good value for consumers?

The answer is Yes.

Just taking Keppel as the key player.
- Fixed rate for 36 months is 0.1798 cents/KWH (incl GST). This is a 30% discount to the current market rate!

- If you like a bit more speculative flavor, you may consider Pacificlight or Sembcorp/Keppel which offers 21% and 20.5% off the regulated tariffs. (This effectively means you can benefit if the regulated prices fall)

Conclusion:
In my limited knowledge of the world, I understand that 2016 oil prices is a real abnormal situation. With oil barrel prices falling to as low as 50.62 SGD equivalent and electricity tariffs not even breaking 18 cents/KWH, I heavily doubt that the regulated prices would ever break that point. As such you are better off taking a fixed plan instead of sticking with SP Group.

What about flexi-plan? I estimated the breakeven point would need to be - regulated price at 0.22475 for a 20% discount to be 0.1798. How possible is this? Given the strong economy at the moment and rising oil prices, quite unlikely. But never say never.

Better to switch to to a private operator (fixed gets my vote at the moment).

Table 1: Historical data with estimates

Crude oil prices in SGD (left) | Electricity charged by SP Group (Right)

Aggregated chart

Musings about housing and alternatives in real estate investments

As you manage your portfolio over different phases of life, you tend to find what sticks. What is predictable, what you can control and what you can't.

One key thing that always stood out was the sustainability of real estate as an investment. As a friend of mine (who happens to be a real estate lawyer) once said - based on his view of the world, real estate is one of the asset that is sure to endure and make money.

I find the saying quite true, property acts as a good store of wealth, it is linked to the real economy being creating a valued proposition of shelter and comfort. A place where people enjoy a certain lifestyle of living and the such.

It is no wonder why Singaporeans are so fanatic about property. Even the government had to step in recently to curb the enthusiasm. En-bloc fever, rising developer bids, easy money - lots of these contributed to the recovery of SG property market. Yet the truth is that SG property remains very affordable as compared to overseas market on a cost to median income ratio. Have a read below if you don't believe me (https://sbr.com.sg/residential-property/news/chart-day-singapore-bucks-trend-higher-price-income-ratio)

But for now, back to the crux of the matter.

Post-cooling measures (and quite timely) as well, people begun to focus their minds on the rising interest rates and the REITs market. Interest rate in truth is gravity on all assets. Yes, you heard right - ALL assets.

The reality is that the easy liquidity of the last 10 years have resulted in bubbles in many countries. These has created artificially high prices in some areas and could even attributed to the stock market highs we seen in 2017 and the bitcoin mania.

Now that the Fed has raised interest rates to 2-2.25% and guided for another 5 increases over the next 3 years. We are facing the new game of how to invest.

As Warren Buffett said, nothing in investing really changed over the last century. The game remains pretty much the same - look for quality companies run by great management and buy them at cheap prices.

In the Singapore market, two of the favorite industrial reits are Ascendas REIT and Mapletree Industrial Trust. In quantifying the two of very similar nature, I begun to see that there may be some value that is beginning to emerge.

For me personally, I enjoy looking to see how each stock piece fits into my puzzle. To create a well-tuned wealth machine, one has to often prune the Bonsai tree, slowly but surely - you begin to appreciate how getting rid of bad stocks and adding to good ones help build your portfolio.

On the metric side, A-REIT beats Mapletree Industrial Trust on 8 out of 10 metrics. Some of it may be repetitive and quite clearly A-Reit deserves the higher credit rating.

If I had to drive it down to 3 key questions, they are:
1. Is the debt tenor of the company matching the WALE as closely as possible?
- In this case, the WALE of both companies outstrip the debt tenor. Typically this is fine for a falling rates environment but in a rising rate environment, this may be a negative.

2. Is the debt hedged against rising rates?
- Yes, fully hedged on the duration for A-Reit for 72.4%
- Partially hedged for MINT for 2.7 years for 77.9%
(in this case, both are fine)

3. Which company is in better shape for the long run?
- Both look like fantastic companies. I quite like MINT for its data center exposure in USA but even Ascendas have no shortage of opportunities with a better diversified portfolio.
- Both companies also have a tailwind of recovering economy in terms of industrial activity and improving rents

Fig 1. Metrics of A-REIT v MINT

The Author has no exposure to either share at the current point of time but may be initiating some on A-REIT in time to come.

Fixed Income: On Singapore Savings Bonds, Hyflux Perps, PE-backed corporate bonds

In the past couple of month, there were quite a number of local news relating to the fixed income space. Have a look below:

1. MAS scraps $50k issue limit for Singapore Savings Bonds (The Straits Times on March 02, 2018)

2. Trading of Hyflux shares, perpetual securities halted (The Straits Times on May 24, 2018)

3. Investors can consider Temasek's first retail private equity bond to help supplement retirement income: Ho Ching (The Straits Times on JUN 4, 2018)

Introduction

There are 3 parts to the article today relating to the 3 articles above.

1. The burgeoning demand of the growing wealth of retail investors seeking higher yield.
2. A cautionary tale that sometimes all that glitters may not be gold
3. The "right" way to introduce a new product to the retail market


First, it was often thought of as unusual that Singapore, a first world country with one of the highest GDP per capita in the world does not have a thriving retail bond market.

- Most bonds are only opened to sophisticated institutional investors
- Minimum size of $250,000 per bond
- Lacking liquidity (hypothetically given the size of each bond)....this likely also contributes to a wider Bid-Ask spread


Part 1 - SSB
When the SSB was introduced in July 2015, I took part in it as it was a great way to take part in a new instrument backed by the Singapore Government.
1. Better rates than bank deposits
2. Flexible in terms of exit ($2 admin fee only)
3. An interest rate effectively anything from 1 year - 10 year bond depending on when you exit
4. Another advantage is that as it is not traded, you do not risk any capital losses should you need to exit early. The trade-off is that you do not get capital gains should the general interest rates fall.

Recent news of the removal of $50k application limit simply just tells that while you can apply for more....it doesn't mean you can get more (allocation limits still apply)....which really points back to the original question of why a $50k application cap was there to begin with - probably more of an administrative issue.

Conclusion: SSB remains a great tool for income building as an area for rainy day fund. The rising interest rates also allow Singaporeans to get better returns on their buck in time to come. The $100k ceiling also ensures that this remains open to the man on the street.


Part 2 - Hyflux 6% Perps

Subscribing to Hyflux latest 6% Perps felt like a good deal in 2016. I too took part in that event being fully cognizant of the risks. For one, 6% return was a really good payout and utilities (power and water) being a very center piece of Singapore security would mean that it is unlikely that it would be allowed to fail.

How wrong everyone was on that assumption...

In 2018, Feb - I begun to be quite concerned about the falling price of both Hyflux (mainboard shares) and the price of the perps. It was the facts that stood out
1. Chronic inability to generate cashflow
2. Current ratio falling alarmingly low (as of 1Q2018 - a simple look would have seen it as 1.46 but actually it was more likely closer to 0.41 given that an "asset for sale" was parked under the current assets listing)
3. Loss-making huge asset (Tuas Spring)

I asked myself in my quarterly/annual review....if I had to sell everything and buy them back. Which would I buy?

Would I buy a company that was losing money? Would I buy a company with huge debt burdens that could not be serviced within a year? Would I buy companies with high capex yet the cashflow cannot meet the working capital needs?

I begun to saw similar trends in the power business. Olivia Lum (Hyflux CEO) herself stated that a bunch of them (utilities operator) wrote to the government and "complained" about the glut in the business environment - that it was not sustainable.

Certainly not music to my ears!

I exited Hyflux at about 17% losses after taking into account 2 semi-annual payouts that I received.

Certainly a painful decision! However, not as painful as what was to come in the next 6 months.....

When the notice of delay in redemption and payouts of the perps became news on the straits times...it became increasingly clear that the cash pile had run dry.

How will Hyflux work this out? I certainly do not know....it is quite possible that there are several options out there:

1. Declare the equivalent of "chapter 11" bankruptcy
- This would result in an appointment of a Judicial Management that will manage and sell the assets of the companies to pay back the debt.

2. Infusion of new capital (White knights to the rescue)
- Unless there's a good viable business that remains...or a new strategy out of this issue...it can be hard to convince new (or even existing) investors to put money in there as it may tantamount to throwing "good money" after bad.
- Other questions also remain whether this business is "cyclical".....I think utilities are anything but cyclical...it tends to be more stable with the exception of cost of production (e.g. crude oil prices).

3. Exchange of debt for equity deal
- Existing debts (banks, bonds, perps) will have to be exchanged for equity in addition to new credit lines for the company....this scenario was common in the recent offshore crisis where many smaller O&M companies like MarcoPolo Marine, Ezion made deals to manage their cashflows through the downcycle.

I am thankful for getting out of this with my hat. Looking back, I think it was a very risky investment with high idiosyncratic risk. Current debt holders face a big headache and a very lengthy journey in getting back a portion of their money (my guess is probably somewhere between $0.15-$0.30 on the dollar if they are lucky)

Imagine the losses - at last traded 0.50. I would have lost 44% of my capital and possibly up to 79% of my capital in the worse case ($0.15 on the dollar estimate).

Conclusion: If something doesn't look right, it is best to exit quickly and decisively. There are tell-tale signs and we can always pay more attention to these first signals.


Part 3 - Astrea IV Class A-1 Retail Bond (4.35% p.a - semi annual payout)

After a big debacle with Hyflux, you would wonder who would be interested in bonds. Hyflux turned out to be a high risk, low return proposition that burnt many fingers. Imagine that original $500m of perps issued....nearly half of it has been wiped out to-date!

Enter a new product which has links to Temasek. The first ever retail bond funded by the cashflows of the 36 PE funds that the money is invested in.

I found this interesting as well as exciting that Ho Ching (CEO of Temasek) actually introduced it in a very similar way to how they introduced the first ever S-Reit Capitaland Mall Trust (CMT). In some way - the "democratization", introduction and allowing the retail investor to have some share in this new asset class excited the investment community (myself included).

To cut the long story short. I invested in the bond and was delighted to have received 4 lots.

Here are some key reasons why I placed my money there:

1. You make some money buying it on day 1 because some "money was left on the table"

4.35% p.a. semi-annual payment (this compares to the average 3.1% for a similarly A-rated 5 year corporate bond). Based on my calculations - the bond is worth $1057.08 on first day of trading so it is really a return of 5.71% just by buying it on day zero.

It also has step up 1% from the 6th - 10th year if it is not called in the 5th....this effectively makes it a 4.85% bond if you hold it for 10 years. This compares very favorably to the average A-rated 10 year corporate bond at 3.65%). Based on my calculations - the bond is worth $1099.05 on first day of trading so a return of 9.9% just by buying it on day zero.

Conclusion 1: Immediate returns of 5.71% - 9.9% does sound good to me.

2. 5 Structural safeguards in place

a) Reserves Accounts - cash build up over time will be used to repay the principal of the class A-1 and A-2 bond. (Basically means it will definitely be redeemed if there are sufficient money available)

b) Sponsor Sharing - after payment of performance fees, expenses  are met, 50% of remaining cashflows are allocated to the reserves account. This allows for faster build up of reserves for the 5th year call redemption timeline

c) Maximum LTV ratio of 50% ensures that there is a need to pay the reserves account and redeem Class B bonds until the maximum ratio is no longer exceeded. In this scenario, should the value of the portfolio falls - the sponsors will have to maintain a prudent ship by managing the debt ratios through redeeming bonds.

d) Liquidity Facility allows the issuer to drawdown from the bank to pay senior payments, expenses and interest payments of the Bonds if there are insufficient cash. This is up to USD100m

e) Capital Call Facility, similar to the liquidity facility allows a drawdown from the banks to pay capital calls.

Conclusion 2: Plenty of protection for the retail investor (although probably not everyone understands how they work - I haven't heard of some before)

3. Understanding the tranching of the CDO in the risk/return context

If you recall the 07-08 financial crisis. The nature of the CDOs were rated as top grade, some even argued that this was not wrong as there were good mortgage debt in the top most tranche but these were also mixed with bad debt from NINJA (people w mortgage loans but no income, no jobs)....given the risk drivers was only housing prices rising...it became a very dangerous bubble then.

In this case, we refer to the below picture of being in the A-1 & A-2 top tranche.

The most important picture

Given the risk/return quantum, it would appear that we have a defensive cushion of at least 65% (USD713.96m) made up of Equity and Class B before it would impact our portfolio.

Conclusion 3: The risks are indeed low and we should sleep well knowing that it would take quite a few of that 36 portfolios to go under collectively before it would impact the Class A group (this is what we get for getting a fixed payment while the equity could have many folds on their return)


Possible risks
1. Liquidity risk - Well highlighted by DBS Bank head of fixed income, Clifford Lee accurately stated that this instrument is new and "it may take some time for a secondary market in PE-backed bonds to develop". This actually means you may have trouble in finding liquidity for this bond should you need to sell and get back your cash

2. Interest Rate Risk - Over the next few years, interest rate is expected to rise. The element of interest rate risk cannot be discounted if you need to exit prior to the 5 year / 10 year redemption mark. As interest rate rises, your bond would fall in price. Interest rate acts as gravity on asset prices and it would affect pretty much ALL asset classes (unless the asset has a floating rate element that helps you to capture the upside)

3. Default risk - Expected to be low as the funds are managed by relatively big PE players as well as generally mature profile (7 years since vintage)....these funds are expected to be cash generative as the deals are exit.



Overall conclusion: Buy and hold as we will expect it to be redeemed in 5 years. It is after all one of the A grade bonds that have first surfaced under the Temasek branding and we look forward to more of such issues for the man on the street.

Divesting when the case no longer holds (special situation concluded)

On Monday, I woke up to a news on Bloomberg flashing news about the Singh brothers of Fortis Healthcare, the sponsor of RHT Healthtrust. 

https://www.bloomberg.com/news/articles/2018-01-28/billionaire-singh-brothers-accused-in-lawsuit-of-siphoning-money

Long story short, the news was bad for the case of special situation (at least the position I was taking). In addition to the earlier case of Japanese investor (Daiichi Sankyo) suing Singh brothers for the fraud. This was an additional nail to the coffin which would prevent divestment of any of their personal assets (i.e Fortis or Religare shareholding) to raise funds for the RHT assets buyout. 

I quickly sold my stake that morning. The basis was that while the Japanese investor could have their case overturned, American investors being involved added a whole new conundrum to the game. This was a measured probability that the acquisition funds was very unlikely to be found in the next 1 year time frame.

The red flags

It didn't take a genius to figure out other red flags in this deal:

A. Delayed payments of leasing fees by Fortis Healthcare

B. Double lawsuits that potentially block any capital raising required for the acquisition by independent parties (First the Japanese, followed by the Americans)

C. The case of fraud and question of character

Everything begun collapsing pretty quick

1. Around Mid Jan - RHT Healthtrust reported to the regulators that the delayed payments would be given as of 31st January.....sounds positive? It turned out only 1/3 of the payment was received. If someone could barely find money to pay his water bill, would you trust his agreement to buy your house?

2. The Ranbaxy deal was touted as "Dirty Medicine" by Fortune Magazine. I leave you to go and figure out what that means. In any case, with the impending lawsuit ongoing, courts tend to stick to the earlier judgments. As I learned in law school, if judges overturned each other cases like a pancake machine - the country would be pretty chaotic.

Turns out that yesterday, news broke the Delhi court upheld the case "Malvinder Singh and Shivinder Singh must pay Daiichi Sankyo Co. 35 billion rupees ($550 million) awarded in an arbitration over the sale of a drugmaker controlled by the brothers, an Indian court ruled."

More cash problems? Still think he can pay for your house?

3. Lastly if someone tells you somebody can't be trusted. You may say hmm, this two may have disagreements and bad blood, I should reserve my judgement till I meet him myself. If a couple of days later, someone from far away, tells you this chap can't be trusted - I think it begins to form a pretty complete picture of what he is.

Like Warren Buffett said - I look for 3 things in an individual, Talent, Energy and Integrity. Unfortunately, if he does not have the 3rd one, let's not even discuss the first two.

As of today. RHT price trades at 3.63% below my sale price. I may be right, I may be wrong - but nothing beats a peace of mind. Best to move on.