tag:blogger.com,1999:blog-62133540746345387142024-03-14T01:49:17.180+08:00(The) Boring InvestorTrading shares may be exciting, but it's usually the boring stuffs that make money consistently.Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.comBlogger286125tag:blogger.com,1999:blog-6213354074634538714.post-19787045481964691002021-02-21T22:55:00.000+08:002021-02-21T22:55:21.134+08:00Will ARA US HT Carry Out a Rights Issue?<p style="text-align: justify;">The financial reporting period for REITs has almost come to a close. One of my biggest worries in the COVID-19 fallout is the devaluation of assets held by REITs, which could lead to their aggregate leverage ratios rising above the regulatory limit and needing to carry out massive rights issues. So far, this worry has not materialised. The 2 REITs that had to carry out massive rights issues are Lippo Malls and First Reit, both of which are related to financial difficulties at their sponsors, Lippo Karawaci. </p><p style="text-align: justify;">Among the various REIT asset classes, hospitality trusts (HTs) are at most risks because international tourism has largely been decimated by border closures to control the spread of COVID-19. Both occupancy and room rates took a dive, resulting in significantly reduced revenue. Ancilliary facilities like restaurants, banquet halls and convention rooms, etc. did no better as governments imposed lockdowns and stringent safe distancing measures. To survive, some hotels serve as quarantine centres for visitors and residents returning from abroad. Nevertheless, in terms of asset devaluation, the HTs that have announced full year results have not performed too badly, with the exception of Eagle HT, whose troubles are widely known. The table below shows the devaluation that the HTs had to take in their full-year financial results (for Eagle HT, the results are for 3Q2020).<br /></p><p style="text-align: center;">
</p><table border="0" cellpadding="0" cellspacing="0" style="margin-left: auto; margin-right: auto; text-align: left; width: 380px;"><colgroup><col style="mso-width-alt: 3364; mso-width-source: userset; width: 69pt;" width="92"></col>
<col span="2" style="mso-width-alt: 3145; mso-width-source: userset; width: 65pt;" width="86"></col>
<col style="mso-width-alt: 4242; mso-width-source: userset; width: 87pt;" width="116"></col>
</colgroup><tbody><tr height="60" style="height: 15pt;">
<td class="xl65" height="60" style="height: 15pt; width: 69pt;" width="92"><b>Counter</b></td>
<td class="xl67" style="text-align: center; width: 65pt;" width="86"><b>Devaluation</b></td>
<td class="xl67" style="text-align: center; width: 65pt;" width="86"><b>Properties</b></td>
<td class="xl67" style="text-align: center; width: 87pt;" width="116"><b>% Devaluation</b></td>
</tr>
<tr height="20" style="height: 15pt;">
<td height="20" style="height: 15pt;">Ascott</td>
<td class="xl66" style="text-align: center;"><span style="mso-spacerun: yes;"></span>$379,092 </td>
<td class="xl66" style="text-align: center;"><span style="mso-spacerun: yes;"></span>$6,096,138 </td>
<td class="xl68" style="text-align: center;">6.2%</td>
</tr>
<tr height="20" style="height: 15pt;">
<td height="20" style="height: 15pt;">CDL HT</td>
<td class="xl66" style="text-align: center;"><span style="mso-spacerun: yes;"></span>$185,523 </td>
<td class="xl66" style="text-align: center;"><span style="mso-spacerun: yes;"></span>$2,513,235 </td>
<td class="xl68" style="text-align: center;">7.4%</td>
</tr>
<tr height="20" style="height: 15pt;">
<td height="20" style="height: 15pt;">Eagle</td>
<td class="xl66" style="text-align: center;"><span style="mso-spacerun: yes;"></span>$534,234 </td>
<td class="xl66" style="text-align: center;"><span style="mso-spacerun: yes;"></span>$1,267,480 </td>
<td class="xl68" style="text-align: center;">42.1%</td>
</tr>
<tr height="20" style="height: 15pt;">
<td height="20" style="height: 15pt;">Far East HT</td>
<td class="xl66" style="text-align: center;"><span style="mso-spacerun: yes;"></span>$121,219 </td>
<td class="xl66" style="text-align: center;"><span style="mso-spacerun: yes;"></span>$2,645,700 </td>
<td class="xl68" style="text-align: center;">4.6%</td>
</tr>
<tr height="20" style="height: 15pt;">
<td height="20" style="height: 15pt;">Frasers HT</td>
<td class="xl66" style="text-align: center;"><span style="mso-spacerun: yes;"></span>$145,985 </td>
<td class="xl66" style="text-align: center;"><span style="mso-spacerun: yes;"></span>$2,330,332 </td>
<td class="xl68" style="text-align: center;">6.3%</td>
</tr>
<tr height="20" style="height: 15pt;">
<td class="xl65" height="20" style="height: 15pt;"><b>Average</b></td>
<td class="xl67" style="text-align: center;"><b><br /></b></td>
<td class="xl67" style="text-align: center;"><b><br /></b></td>
<td class="xl69" style="text-align: center;"><b>13.3%</b></td>
</tr>
<tr height="20" style="height: 15pt;">
<td class="xl65" height="20" style="height: 15pt;"><b>Median</b></td>
<td class="xl67" style="text-align: center;"><b><br /></b></td>
<td class="xl67" style="text-align: center;"><b><br /></b></td>
<td class="xl69" style="text-align: center;"><b>6.3%</b></td>
</tr>
</tbody></table><p style="text-align: justify;">Excluding Eagle HT, asset devaluation ranges from 4.6% for Far East HT to 7.4% for CDL HT. One reason for the lower asset devaluation for Far East HT is because all its hotels and serviced residences are under master leases whereas the other HTs have management contracts and franchises in addition to master leases. In a master lease, the owner (i.e. HT) leases the hotel to an operator in return for a pre-defined fixed or variable rent. In a management contract, the owner engages an operator to run the hotel and receives the profit/loss from hotel operations. In a franchise, the owner runs the hotel using the franchisor's brand and receives the profit/loss from hotel operations. Thus, when the hospitality industry is in a recession, master leases will be less impacted. See <a href="https://boringinvestor.blogspot.com/2020/04/not-all-hospitality-trusts-are-created.html">Not All Hospitality Trusts Are Created Equal</a> for more details.<br /></p><p style="text-align: justify;">The remaining HT that has not reported its full-year financial results is ARA US HT. It is due to report results this coming Wednesday, before market opens. How much will its asset devaluation be, and will it be required to carry out a rights issue?</p><p style="text-align: justify;">As at Sep 2020, its aggregate leverage ratio is 43.0%. A 14% devaluation will bring this ratio to the regulatory limit of 50%. It is already in breach of loan covenants but has obtained a 12-month waiver from the banks from Apr 2020 till Mar 2021.</p><p style="text-align: justify;">Not only that, its cash balance is also running low. As at Sep 2020, its cash balance is only USD19.6M. This is a drop from USD45.2M in Dec 2019, USD22.0M in Mar 2020 and USD21.5M in Jun 2020. On 18 Dec 2020, it announced that it had obtained USD10.0M in unsecured revolving credit facilities to partially refinance operating expenses. </p><p style="text-align: justify;">Will ARA US HT carry out a rights issue? Considering the potential asset devaluation, low cash balance and breach of loan covenants, my opinion is that it will. </p><p style="text-align: justify;"><br /></p><p style="text-align: justify;">See related blog posts:</p><ul style="text-align: left;"><li><a href="https://boringinvestor.blogspot.com/2020/04/not-all-hospitality-trusts-are-created.html">Not All Hospitality Trusts Are Created Equal</a></li><li><a href="https://boringinvestor.blogspot.com/2021/01/will-suntec-reit-carry-out-rights-issue.html">Will Suntec Reit Carry Out a Rights Issue?</a></li><li><a href="https://boringinvestor.blogspot.com/2021/01/should-first-reit-be-given-second-chance.html">Should First Reit Be Given a Second Chance?</a></li></ul>Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com0tag:blogger.com,1999:blog-6213354074634538714.post-44303201223850750422021-01-17T21:58:00.000+08:002021-01-17T21:58:24.481+08:00Should First Reit Be Given a Second Chance?<div style="text-align: justify;">
First Reit had been a good investment for me over the years. It had provided
good distributions regularly and also some capital gains. The reason I sold it
away was because its Debt-to-Equity ratio had exceeded my comfort zone of 50%
or less. For investments that I do not have time to monitor regularly, it is
best that their debts are low in the first place. <br />
</div>
<div>
<p style="text-align: justify;">
Last year, First Reit's share price had been dropping since the COVID-19 outbreak and the announcement by its sponsor, Lippo Karawaci (LPKR), to
restructure the master leases of the hospitals that it lease from First
Reit. The low share price attracted my attention, but when First Reit
announced that the rents would be paid in Indonesian Rupiah (IDR) instead of
Singapore Dollars (SGD) in future, I was no longer interested. Having the
rents paid in IDR instead of SGD would subject it to foreign exchange risks.
Not only that, the assets would be devalued in line with the depreciation of
IDR while the liabilities would continue to be in SGD. This would lead to a
sharp drop in Net Asset Value (NAV). This was exactly what happened to
another REIT with Indonesian assets, Lippo Malls Indonesia Retail Trust,
when IDR depreciated sharply against SGD in 2013. First Reit, however, was
not affected then as its rent revenue was pegged to SGD instead of IDR. See
<a href="https://boringinvestor.blogspot.com/2014/03/a-tale-of-2-indonesian-reits.html">A Tale of 2 Indonesian REITs</a>
for more details. <br />
</p>
<p style="text-align: justify;">
Arising from the lease restructuring, First Reit's revenue in FY2019 will
drop from SGD115.3 mil to SGD77.6 mil. 73% of this revenue (SGD56.7 mil)
will be paid in IDR. NAV will also drop from $1.00 to $0.52. Leverage will
correspondingly rise from 34.5% to 47.9%. In addition, lenders are
uncomfortable with the sustainability of First Reit's capital structure and
decided to only refinance SGD260 mil out of the SGD400 mil loan, of which
the first tranche of SGD196.6 mil will mature on 1 Mar 2021. First Reit has
proposed a 98-for-100 rights issue at a heavily discounted price of $0.20 to
bridge the funding gap of SGD140 mil. Post rights issue, NAV will drop to
$0.36 while leverage will drop to 33.9%.<br />
</p>
<p style="text-align: justify;">
While I do not own First Reit, my family has it. Thus, a key question we
have been discussing is whether to subscribe for the rights and give First
Reit another chance. Will it be throwing good money after bad, or will it be
a rare opportunity to invest more money in a REIT that had provided good,
regular distributions for the past 13 years?<br />
</p>
<p style="text-align: justify;">
As part of the lease restructuring, the Base Rent for hospitals leased to
LPKR and Metropolis Propertindo Utama (MPU), a related company to LPKR, will
be reset from SGD92.2 mil in FY2019 to IDR613.1 bil (equivalent to SGD56.7
mil at an exchange rate of SGD1:IDR10,830) in FY2021. The Base Rent will
increase annually at a rate of 4.5%<span></span>. In addition, there will be
a Performance Based Rent pegged at 8% of the hospitals' Gross Operating
Revenue. The rent payable will be the higher of the Base Rent and the
Performance Based Rent, on an asset-by-asset basis.<br />
</p>
<p style="text-align: justify;"><b>Opportunities</b></p>
<p style="text-align: justify;">
Although the rents for the Indonesian hospitals will be paid in IDR instead
of SGD in future, the Performance Based Rents are likely to provide some
upside. Fig. 1 below shows that the revenue of Siloam International
Hospitals, which leases the hospitals from LPKR, MPU and First Reit as the
end user, has been increasing since 2011. <br />
</p>
<p style="text-align: left;"></p>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;">
<tbody>
<tr>
<td style="text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiiDwPOoPHEGoHsPI2S_PFqfNp5432Bt4BAETKef8LoiuCg-GTBxqz-ksaRxb91VVc4RQaFI87g3A2B4EexaiBkaZQn88fXeyrwz4JAg1jzEb-9UI7gff47AP9FC1Z_DUTtJoWAnGhQRAQ/s1422/SiloamRev.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="252" data-original-width="1422" height="71" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiiDwPOoPHEGoHsPI2S_PFqfNp5432Bt4BAETKef8LoiuCg-GTBxqz-ksaRxb91VVc4RQaFI87g3A2B4EexaiBkaZQn88fXeyrwz4JAg1jzEb-9UI7gff47AP9FC1Z_DUTtJoWAnGhQRAQ/w400-h71/SiloamRev.png" width="400" /></a>
</td>
</tr>
<tr>
<td class="tr-caption" style="text-align: center;">
Fig. 1: Revenue of Siloam Hospitals International<br />
</td>
</tr>
</tbody>
</table>
<p></p>
<p style="text-align: justify;">
Siloam also reports the revenue of its major hospitals in its annual
reports. Fig. 2 below shows the total revenue and rent paid by LPKR to First
Reit for hospitals which revenue data is available from FY2014 to FY2019.
</p>
</div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;">
<tbody>
<tr>
<td style="text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLAr5eD2kDDlWLoa-EuduBz7j2kwRjzpHC8UoUBx5WAMlRytW5aEJ1iVFHE_9LnDK8uoVGMCn1uUosc7otoSkpQgFplWU97SfZqbGikwvEQSs1bsJBGVIbQRTlBHQJ3Duk8R4ip5ThEOE/s1528/SiloamRevenueRent.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="999" data-original-width="1528" height="261" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLAr5eD2kDDlWLoa-EuduBz7j2kwRjzpHC8UoUBx5WAMlRytW5aEJ1iVFHE_9LnDK8uoVGMCn1uUosc7otoSkpQgFplWU97SfZqbGikwvEQSs1bsJBGVIbQRTlBHQJ3Duk8R4ip5ThEOE/w400-h261/SiloamRevenueRent.png" width="400" /></a>
</td>
</tr>
<tr>
<td class="tr-caption" style="text-align: center;">
Fig. 2: Revenue and Rent Paid to First Reit for 6 Hospitals
</td>
</tr>
</tbody>
</table>
<p style="text-align: justify;">
The figure shows that the revenue in IDR has increased at an annual rate of
12.2% from FY2014 to FY2019. When converted to SGD, the revenue has increased
at an annual rate of 10.4%. Over the same period, IDR has depreciated against
SGD by an average of 1.6% annually. In contrast, the rent paid to First Reit
has stayed constant.
</p>
<div>
<p style="text-align: justify;">
Assuming revenue in IDR in FY2021 recovers to the same level as FY2019 after
COVID-19 and continues to grow at an annual rate of 10% from FY2021 to
FY2035, the Base Rent and Performance Based Rent in IDR will be as shown in
Fig. 3 below.
</p>
</div>
<p></p>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;">
<tbody>
<tr>
<td style="text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi00gSBnWOyNGBELhJRfPmzYvPVNUiIfEBzjExGsUhUzIPPVGFj0_s-DQx9YcZjB9y-eMyFYAcZR5RnjNRM9hZMEOQLhhavL1rzna25Ca2eng_3DpQzjcizSw8h71gbhI1BHiSGFxD-_h0/s1528/SiloamRentIDR.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="999" data-original-width="1528" height="261" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi00gSBnWOyNGBELhJRfPmzYvPVNUiIfEBzjExGsUhUzIPPVGFj0_s-DQx9YcZjB9y-eMyFYAcZR5RnjNRM9hZMEOQLhhavL1rzna25Ca2eng_3DpQzjcizSw8h71gbhI1BHiSGFxD-_h0/w400-h261/SiloamRentIDR.png" width="400" /></a>
</td>
</tr>
<tr>
<td class="tr-caption" style="text-align: center;">
Fig. 3: Projected Base & Performance Rent in IDR
</td>
</tr>
</tbody>
</table>
<div class="separator" style="clear: both; text-align: center;"></div>
<p style="text-align: justify;">
From Dec 2006 when First Reit was first listed till now, IDR has depreciated
against SGD at an average rate of 4.3%. Assuming this historical depreciation
rate continues, when converted to SGD, the Base Rent and Performance Based
Rent in SGD will be as shown in Fig. 4 below. <br />
</p>
<p></p>
<p></p>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgopWLMmrZEc0usbGY50cTFoYvfXy7SRIvYvSZTcYSMeOS7j6yToSQwb5qkgKHNgaTTvZqP8U2x-IKq9wZo-U5hTMBsvCt0foV76FTppeWMiZTyJS13WUA6WUx6qtwv2vfbp3oJ4Q4t71A/s1528/SiloamRentSGD.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="999" data-original-width="1528" height="261" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgopWLMmrZEc0usbGY50cTFoYvfXy7SRIvYvSZTcYSMeOS7j6yToSQwb5qkgKHNgaTTvZqP8U2x-IKq9wZo-U5hTMBsvCt0foV76FTppeWMiZTyJS13WUA6WUx6qtwv2vfbp3oJ4Q4t71A/w400-h261/SiloamRentSGD.png" width="400" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Fig. 4: Projected Base & Performance Rent in SGD
</td></tr></tbody></table><div class="separator" style="clear: both; text-align: center;">
</div><div class="separator" style="clear: both; text-align: center;"></div>
<p></p>
<p></p>
<p style="text-align: justify;"> Based on Fig. 4, the projected Base Rent in SGD will largely stay flat as the
annual rent increase of 4.5% barely outstrips the historical IDR depreciation
rate of 4.3%. Performance Based Rent in SGD is projected to exceed the Base
Rent in 2031. It is projected to reach SGD73.3 mil in FY2035 when the leases
expire, 20% short of the existing Base Rent of SGD92.2 mil in FY2019. If this revenue
growth materialises, it will provide some upside to the Distribution Per Unit (DPU) in the last 5 years of the 15-year leases. </p><p style="text-align: justify;">Without the revenue growth, DPU will be around 2.59 cents immediately after the lease restructuring and rights issue. Maintaining the DPU at this level requires other risks not materialising in future.<br /></p>
<p style="text-align: justify;"><b>Risks</b><br /></p>
<p style="text-align: justify;">
There are plenty of risks with this investment. The first and foremost is
whether LPKR and MPU will continue to face financial difficulties and default
on the rents payable to First Reit. If that is the case, all bets are off. Its
Indonesian assets which are leased to LPKR, MPU and Siloam, including those not subject to the current lease
restructuring, comprise 95% of its assets post-restructuring. These assets will
be significantly impaired. First Reit will likely default on its loans.
</p>
<p style="text-align: justify;">
The second risk is the currency mismatch between its assets of which 81% are
valued in IDR and loan liabilities which are in SGD. This is the same problem
encountered by Lippo Malls when IDR depreciated sharply against SGD in 2013.
It is important to monitor whether First Reit will take steps to minimise the
currency mismatch by converting the SGD loans to IDR loans. Entering into
forward contracts to hedge the IDR receivables into SGD is another option, but
there is a limit to the no. of years you can hedge. Hopefully, there is no
sharp depreciation around the time loans mature and First Reit enters into
discussions with banks for refinancing. <br />
</p>
<div>
<p style="text-align: justify;">
The third risk is that after the current SGD400 mil loan has been refinanced with
the rights issue, there remains another SGD100 mil loan due in May 2022. The
concern is whether First Reit is able to refinance this loan in full. If it
is unable to, there is risk of another rights issue.
</p>
<p style="text-align: justify;">
However, I am not too concerned with this loan. The existing SGD400 mil loan
was a syndicated loan from OCBC while the SGD100 mil loan was from OCBC and
CIMB jointly. The new SGD260 mil loan to partially refinance the SGD400 mil
loan is also from OCBC and CIMB jointly. That means that the 2 banks have
considered First Reit's ability to repay the SGD100 mil loan when they
decided to offer the new SGD260 mil loan to First Reit. My guess is when it
is time to refinance the SGD100 mil loan, both OCBC and CIMB will come
together again.
</p>
<p style="text-align: justify;">
Having said the above, the ability to refinance the SGD100 mil loan depends
greatly on whether there are any other adverse developments affecting First
Reit's ability to collect rent from its assets, such as whether LPKR's and
MPU's financials continue to deteriorate further, or whether there is a
sharp depreciation in IDR that is unhedged.
</p>
<p style="text-align: justify;">
The fourth risk is there is a SGD60 mil perpetual securities that is due to reset its
distribution rate on 8 Jul 2021. Usually, companies will choose to redeem
the perpetual securities and issue new ones to replace them. However, given
First Reit's financial conditions, it will likely not redeem the perpetual
securities when the distribution reset date comes. Non-redemption does not
constitute default. Furthermore, given the low interest rate environment, the
distribution rate will likely be lower after reset. The current distribution
rate is 5.68%. The distribution rate will reset to 5-year SGD Swap Offer
Rate (SOR) + 3.925%.
</p>
<p style="text-align: justify;">
Distribution on the perpetual securities is also discretionary. Non-payment
of distribution does not constitute a default. However, distributions on the
Reit units will need to be stopped. The annual distribution on the perpetual
securities is SGD3.41 mil. <br />
</p>
<p style="text-align: justify;">
The fifth risk is besides the 14 Indonesian hospitals that are subject to
lease restructuring, there are other assets whose leases are due to expire.
The lease on Sarang Hospital will expire on 4 Aug 2021. The current annual rental is USD0.7 mil. Although there is an
option to renew for another 10 years, likely it will be renewed at a lower rental
rate. The hospital was purchased for USD13.0 mil in 2011. The latest
appraised value is only USD4.6 mil in 2020, which suggests lower rental rate
going forward. First Reit has also flagged that there will be upcoming capital expenditure, and further marked down the value to USD3.1 mil.
</p>
<p style="text-align: justify;">
As mentioned in last week's blog post on
<a href="https://boringinvestor.blogspot.com/2021/01/what-siloams-financial-reports-can-tell.html">What Siloam's Financial Reports Can Tell Us About First Reit's Lease
Restructuring</a>, there is another Indonesian hospital which is leased directly to Siloam
which could be subject to lease restructuring or lower rental when the lease
expires in Dec 2025. The annual rent for this hospital is SGD4.2 mil.<br /></p>
<p style="text-align: justify;">
The sixth risk is that after the lease restructuring, the leases of the 14
Indonesian hospitals will be extended to Dec 2035. Fig. 5 below shows the
new lease expiry profile.<br />
</p>
<p style="text-align: justify;"></p>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;">
<tbody>
<tr>
<td style="text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEr4JUe-5gYRCF-J0eMBASyqJ7nxxaHRYvyYn5BB1Y_GZdUSXB99dDtTv9TZio5wJOWcnbH4MMkXZE6fIlghsYjm5I2vF5IgKLmNF6bCKuKU8TWO0_Fa2jBoXtu9y86m6Scu_yh9Kuzkc/s1575/FirstReitNewLeaseExpiry.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="750" data-original-width="1575" height="190" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEr4JUe-5gYRCF-J0eMBASyqJ7nxxaHRYvyYn5BB1Y_GZdUSXB99dDtTv9TZio5wJOWcnbH4MMkXZE6fIlghsYjm5I2vF5IgKLmNF6bCKuKU8TWO0_Fa2jBoXtu9y86m6Scu_yh9Kuzkc/w400-h190/FirstReitNewLeaseExpiry.png" width="400" /></a>
</td>
</tr>
<tr>
<td class="tr-caption" style="text-align: center;">
Fig. 5: Revised Lease Expiry Profile<br />
</td>
</tr>
</tbody>
</table>
<p></p>
<p style="text-align: justify;"> An unintended consequence of this lease extension is that there is now a
concentration of lease expiry. 66% of all leases by GFA will now expire
in Dec 2035 instead of being fairly distributed. If First Reit is not able
to buy new properties to diversify the geographical, tenant and lease expiry
concentrations, there will be another round of concern when Dec 2035 comes
near. </p>
<p style="text-align: justify;"><b>Conclusion</b></p>
<p style="text-align: justify;"> The lease restructuring is a painful exercise for existing shareholders.
However, there are silver linings in the form of higher rents through
Performance Based Rent towards the end of the 15-year leases. Nevertheless, even if the restructuring and rights
issue go through smoothly, there are still road bumps and risks down the
road for First Reit. </p>
<p style="text-align: justify;">
Should First Reit be given a second chance? I cannot advise you what you
should do, but for us, we are inclined to give it a small second chance. We
will monitor how First Reit manages the risks identified above, and if it
does well, increase the chance given to it.
</p>
<p style="text-align: justify;"><br /></p>
<p style="text-align: justify;">See related blog posts:</p>
<ul style="text-align: left;">
<li>
<a href="https://boringinvestor.blogspot.com/2021/01/what-siloams-financial-reports-can-tell.html">What Siloam's Financial Reports Can Tell Us About First Reit's Lease
Restructuring</a>
</li>
<li><a href="https://boringinvestor.blogspot.com/2014/03/a-tale-of-2-indonesian-reits.html">A Tale of 2 Indonesian REITs</a>
</li>
<li>
<a href="https://boringinvestor.blogspot.com/2013/08/the-hidden-risks-of-buy-and-leasebacks.html">The Hidden Risks of Buy-and-Leasebacks for Industrial REITs</a><br /></li>
</ul>
</div>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com6tag:blogger.com,1999:blog-6213354074634538714.post-33733057077089611322021-01-10T15:02:00.001+08:002021-01-17T22:01:31.095+08:00What Siloam's Financial Reports Can Tell Us About First Reit's Lease Restructuring<p style="text-align: justify;">On 28 Dec 2020, First Reit dropped a bombshell by announcing a major rights issue at a heavily discounted price. This caused the share price to dropped significantly. The main reason is the proposed restructuring of master leases that First Reit have with Lippo Karawaci (LPKR) and Metropolis Propertindo Utama (MPU). First Reit leases hospitals to LPKR and MPU which in turn lease them to Siloam International Hospitals. The proposed lease restructuring would reduce the Base Rent of LPKR-leased hospitals from SGD80.9 mil to SGD50.9 mil and that of MPU-leased hospitals from SGD11.3 mil to SGD5.8 mil. These represent a reduction of 37% and 49% respectively. Not only that, the rents will be paid in Indonesian Rupiah (IDR) instead of Singapore Dollar (SGD) in future. As a result of the reduced revenue, First Reit's lenders have decided to only refinance SGD260 mil out of the SGD400 mil term loan, of which the first tranche of SGD196.6 mil will mature on 1 Mar 2021.</p><p style="text-align: justify;">To sweeten the deal, the restructured master leases would include a fixed rental escalation of 4.5% per year, instead of 2 times Singapore's Consumer Price Index (CPI), but capped at 2% per year. In addition, there will a Performance Based Rent pegged at 8% of the hospitals' Gross Operating Revenue. The actual rent will be the higher of the Base Rent and Performance Based Rent. </p><p style="text-align: justify;">Siloam is listed on the Indonesia Stock Exchange, hence its financial reports are publicly available. As the Indonesian hospitals are all leased to Siloam as the end user, and we can cross check the information from Siloam's financial reports to understand better the proposed lease restructuring.</p><p style="text-align: justify;">Siloam's Annual Report for Financial Year 2019 documents the rent that Siloam pays to LPKR and MPU for the hospital leases. See Fig. 1 below. For the 14 hospitals that are subject to lease restructuring, Siloam paid a total of IDR156.8 mil to LPKR and MPU in FY2019. In contrast, the total existing and proposed commencement Base Rent paid by LPKR and MPU to First Reit is IDR997.6 mil and IDR613.1 mil respectively. The rent paid by Siloam is only 15.7% of the existing Base Rent and 25.6% of the proposed commencement Base Rent. This shows that post-restructuring, LPKR and MPU are still subsidising Siloam's rent and/or topping up First Reit's revenue. Since the hospital leases are not revenue neutral to LPKR and MPU even after lease restructuring, there is a risk that LPKR and MPU could seek another lease restructuring in future.</p><table cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgTA4USLpFFVxSJxQRu8HObAG9G3UkIp2GPgNsyU8QeBkebcIPF7jU4NWvpZO7Zg65k3MOYBvBqk7eJnM3Z079ePZWicHww_FBuOIrDBfkm_JuSUpwF4vOGCk2Scr3fAajRtxeRyUJV2Vg/s993/FirstReitRents.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="379" data-original-width="993" height="153" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgTA4USLpFFVxSJxQRu8HObAG9G3UkIp2GPgNsyU8QeBkebcIPF7jU4NWvpZO7Zg65k3MOYBvBqk7eJnM3Z079ePZWicHww_FBuOIrDBfkm_JuSUpwF4vOGCk2Scr3fAajRtxeRyUJV2Vg/w400-h153/FirstReitRents.png" width="400" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Fig. 1: Siloam's Rent to LPKR and MPU as % of Existing & Restructured Base Rents </td></tr></tbody></table><div style="text-align: justify;"><br /></div><div style="text-align: justify;">Siloam's annual report also documents the Gross Operating Revenue (GOR) generated at some of its major hospitals. <span style="text-align: justify;">See Fig. 2 below.</span><span style="text-align: justify;"> Pre-restructuring, t</span>he GOR as a percentage of existing Base Rent ranges from 7.5% to 40.7%. Post-restructuring, the GOR as a percentage of proposed commencement Base Rent ranges from 6.7% to 14.8%. For hospitals which data is available, the weighted GOR is 18.7% of existing Base Rent and 11.6% of the proposed commencement Base Rent.</div><div style="text-align: justify;"><br /></div><div style="text-align: justify;">This information also tallies with the information provided by First Reit during the investor dialogue on 7 Jan 2021. To a shareholder question, First Reit replied that the proposed Base Rent in aggregate is in the range of 10% to 15% of the GOR for LPKR-leased hospitals in FY2019.</div><div style="text-align: justify;"><br /></div><table cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody><tr><td style="text-align: justify;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgodpCetLzn14EA8lK8bbsmETL6TiqRTmGjVKtNF77LdjF983UnJe5U4Fs12MbSWDurdpz3yKmZLRiJ0idofR7SKZuDo5v-cMOITYMeluFR7a_PYB4JZxbEPJGexFh52zJTeb9IEEyBe7M/s902/FirstReitRentRevenue.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="379" data-original-width="902" height="168" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgodpCetLzn14EA8lK8bbsmETL6TiqRTmGjVKtNF77LdjF983UnJe5U4Fs12MbSWDurdpz3yKmZLRiJ0idofR7SKZuDo5v-cMOITYMeluFR7a_PYB4JZxbEPJGexFh52zJTeb9IEEyBe7M/w400-h168/FirstReitRentRevenue.png" width="400" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Fig. 2: Existing & Restructured Base Rents as % of Hospital Revenue</td></tr></tbody></table><div style="text-align: justify;"></div><p style="text-align: justify;">Under the proposed lease restructuring, the actual rent will be the higher of the Base Rent or Performance Based Rent, which is pegged to 8% of the GOR, on an asset by asset basis. Based on the financial performance of the hospitals in FY2019, a slightly higher rent could be expected from a few hospitals, namely Kebon Jeruk, Surabaya, Purwakarta and Sriwijaya. However, take note that this is based on the financial results in FY2019, which does not include the impact of COVID-19. COVID-19 has affected the hospital revenue significantly as patients defer their visits to hospitals to avoid exposure to COVID-19.</p><p style="text-align: justify;">Amid the uproar regarding the proposed lease restructuring for 14 Indonesian hospitals, one other Indonesian hospital is actually not subject to lease restructuring. The hospital is Lippo Cikarang. This hospital is leased directly from First Reit to Siloam. Siloam's annual report also shows that it is paying much higher rent on this hospital compared to those on the other 14 hospitals, i.e. there is no rent subsidy and/or top-up by LPKR and MPU. </p><p style="text-align: justify;">A check on the history of the lease of this hospital shows that the hospital was acquired by First Reit in Dec 2010. At the time of purchase, the hospital was purchased from and leased back to a subsidiary of LPKR. Some time from then till now, Siloam acquired the subsidiary. Hence, Siloam is paying rent on Lippo Cikarang directly to First Reit, unlike the other 14 hospitals.</p><p style="text-align: justify;">The key question to the lease restructuring is what are the true market rents for the Indonesian hospitals? Is it close to the rent paid on Lippo Cikarang which is comparable to the existing Base Rent of the other 14 hospitals, or close to the proposed commencement Base Rent of the 14 hospitals? If it is the former, the proposed lease restructuring is disadvantaged to First Reit as it will now receive below-market rent. If it is the latter, LPKR and MPU have been topping up the rent for First Reit's benefit and the restructuring might be more equitable to all parties, although painful for First Reit. It also suggests that Lippo Cikarang might have to undergo a lease restructuring at some time in future.</p><p style="text-align: justify;">Siloam's annual report also shows the net profit at its major hospitals. See Figs. 3 and 4 below. Take note that the net profits are based on the rents Siloam paid to LPKR and MPU and not the top-up rents paid by LPKR and MPU to First Reit.</p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjDO7b6MEeHf7VG-Tmeqfia2zJt7ynUIsIpRFMousGOQSL8nsjBICpwy33KMfdJh1LbG3DtPVEb0Mu1DO4UeQAG6-LSrfsLcoJwZ2sPkskPynDHsSsau8vv7DHJKSDVMLL2tZN29Zc9Aas/s1100/FirstReitHospitalRev1.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="498" data-original-width="1100" height="181" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjDO7b6MEeHf7VG-Tmeqfia2zJt7ynUIsIpRFMousGOQSL8nsjBICpwy33KMfdJh1LbG3DtPVEb0Mu1DO4UeQAG6-LSrfsLcoJwZ2sPkskPynDHsSsau8vv7DHJKSDVMLL2tZN29Zc9Aas/w400-h181/FirstReitHospitalRev1.png" width="400" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Fig. 3: Revenue and Profit at each Hospital (Part 1)</td></tr></tbody></table><br /><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmQAAmMEe4fDRckIwrEJ_seBBYC-xXEeJ8se9T3OyD6DwelAIWaUooDhpkC9xfTuQXyQFM0Z8X_gr9aXxhuuWgu2TouOOG4tMgI_cl4LA4ylq3lhRB7Y1dIpjgT56I0RSVqzlWmG_8uP4/s1088/FirstReitHospitalRev2.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="508" data-original-width="1088" height="186" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmQAAmMEe4fDRckIwrEJ_seBBYC-xXEeJ8se9T3OyD6DwelAIWaUooDhpkC9xfTuQXyQFM0Z8X_gr9aXxhuuWgu2TouOOG4tMgI_cl4LA4ylq3lhRB7Y1dIpjgT56I0RSVqzlWmG_8uP4/w400-h186/FirstReitHospitalRev2.png" width="400" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Fig. 4: Revenue and Profit at each Hospital (Part 2)</td></tr></tbody></table><p style="text-align: justify;">The figures show that the net profit at Lippo Cikarang is the lowest among all the major hospitals. Its net profit margin is only 1% of revenue. This is likely due to the high rent that Siloam pays to First Reit. The operating expense is 96% of the gross profit. In contrast, the same ratio for the other hospitals ranges from 38% to 81%, with a weighted average of 50%. A hospital that has similar revenue and gross profit as Lippo Cikarang is Purwakarta. The operating expense is 55% of gross profit and net profit margin is 10%. The information does suggest that the existing Base Rent might be unsustainable for LPKR, MPU and Siloam, and some lease restructuring might be necessary.</p><p style="text-align: justify;">By right, the hospitals are very secure assets to ensure Siloam fulfils its rent obligations. Termination of the leases would lead to Siloam not being able to continue its business, which is a very serious implication. However, this does not apply to LPKR and MPU, as they have other businesses besides Siloam's business. Also, using Lippo Cikarang as an example, Siloam is not making much profit from the hospital. If First Reit insists on LPKR and MPU fulfilling their rent obligations, there is some probability of them breaching the lease agreements, as there is not much profit to be made anyway. At some point in time, LPKR, MPU and Siloam will seek a restructuring of the leases to be more sustainable. This includes Lippo Cikarang, which, while not subject to lease restructuring currently, is due for lease renewal in Nov 2025.</p><p style="text-align: justify;">Another key question of this lease restructuring is whether LPKR and/or MPU will seek another restructuring if they continue to encounter financial difficulties in future, since they have already sought one now. It is very difficult to answer this question as very few persons can tell how LPKR's and MPU's businesses will perform in future. However, using Lippo Cikarang as an example, by reducing the Base Rent to a more sustainable level, there is more money left on the table to keep LPKR, MPU and Siloam from walking away.</p><p style="text-align: justify;">The proposed lease restructuring is a very painful exercise for First Reit's shareholders who have been accustomed to it paying good distributions regularly. However, based on the information gleaned from Siloam's financial reports, it suggests that the rents that First Reit collect from LPKR, MPU and Siloam might not be sustainable. Reducing them to a more sustainable level might be a more equitable outcome for all parties in the long run.</p><p style="text-align: justify;">This episode shows that investing in REITs is not a buy-and-forget activity. It also shows the importance of <a href="https://boringinvestor.blogspot.com/2017/10/know-your-customers-well.html">knowing your customers</a> well. </p><p style="text-align: justify;"><br /></p><p style="text-align: justify;">See related blog posts:</p><p style="text-align: justify;"></p><ul><li><a href="https://boringinvestor.blogspot.com/2021/01/should-first-reit-be-given-second-chance.html">Should First Reit Be Given a Second Chance?</a></li><li><a href="https://boringinvestor.blogspot.com/2014/03/a-tale-of-2-indonesian-reits.html">A Tale of 2 Indonesian REITs</a><br /></li><li><a href="https://boringinvestor.blogspot.com/2017/10/know-your-customers-well.html">Know Your Customers Well!</a></li></ul><p></p>Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com0tag:blogger.com,1999:blog-6213354074634538714.post-51336640372155063792021-01-03T01:12:00.003+08:002021-02-21T22:57:24.591+08:00Will Suntec Reit Carry Out a Rights Issue?<p style="text-align: justify;">It is the new year already, and in another 3 weeks' time, REITs will start to report their financial performance. For REITs with December as their Financial Year-end, they will also have to update their property valuations. With COVID-19 having caused significant changes to the way people live, work and shop, one of the key risks to REITs during this period is whether property values will decline significantly. This could lead to breaches in Aggregate Leverage limits, leading to rights issues at unfavourable prices.</p><p style="text-align: justify;">One of the REITs that caught my attention is Suntec Reit. It owns offices, retail spaces and part of the convention centre in Suntec City. It also owns part of One Raffles Quay, Marina Bay Financial Centre and 9 Penang Road (formerly known as Park Mall). In recent years, it has diversified into Australian properties. 2 weeks ago, it bought a 50% stake in 2 office buldings (Nova) in London. The acquisition was fully funded by debts and perpetual securities. Post-acquisition, the Aggregate Leverage limit would rise from 41.3% as at 30 Jun 2020 to 43.5%. An Extraordinary General Meeting was held on 4 Dec 2020 to seek shareholders' approval for the acqusition. One of the questions that shareholders asked was "what is the level of Aggregate Leverage Ratio (ALR) the board would be comfortable with?". Suntec Reit's reply was "the target ALR is between 40% to 45% with the appropriate interest coverage multiples". Thus, although REITs are allowed to raise their ALR to 50%, Suntec Reit would not be comforable if the ALR were to rise above 45%.<br /></p><p style="text-align: justify;">In the latest business update for 3Q2020, Suntec Reit reported that the committed occupancy for its Singapore offices dropped from 99.1% in 4Q2019 (pre-COVID) to 98.1% in 3Q2020, while that for the Singapore retail spaces dropped from 99.5% in 4Q2019 to 93.4% in 3Q2020. Footfall in Suntec City Mall is down by 53% in 3Q2020, although tenant sales are down by only 21% over the same period. The occupancy for retail spaces is more greatly affected as people work from home and as travel restrictions and safe distancing measures limit the number of exhibitions held at the convention centre. If you have not been to Suntec City for a while, you should visit the row of shops where "llao llao" is (at Level 1, near the entrance of Esplanade MRT station), to witness the impact on retail occupancy.<br /></p><p style="text-align: justify;">Over at its Australian properties, the committed occupancy for offices dropped from 97.8% in 4Q2019 to 94.0% in 3Q2020. The occupancy figure was dragged down by a new office buiding (21 Harris St) acquired in Apr 2020, although there is rent guarantee on vacant spaces for its Australian office buildings. For retail spaces, the committed occupancy dropped from 92.8% in 4Q2019 to 91.7% in 3Q2020.</p><p style="text-align: justify;">As at Dec 2019, the total value of its properties was $10,204 mil. By Jun 2020, the total value is estimated to have increased to $10,446 mil, contributed by the AUD$295 mil acquisition of 21 Harris St, but offset by a fair value loss of $66.6 mil on Suntec Singapore (convention centre). Aggregate Leverage as at end Jun before and after acquition of Nova was 41.3% and 43.5% respectively.<br /></p><p style="text-align: justify;">For 3Q2020, the URA Property Price Indices for Office and Retail Spaces
show there is a Year-on-Year decline of 8.4% and 0.7% respectively. Applying these drops in value to the Singapore offices and retail spaces, the total value of the properties would have dropped by 4.1%, leading to Aggregate Leverage increasing from 43.5% to 45.4%, which is just above the target range for Suntec Reit.</p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0XJ6E98b3SxFV5-uL4G3UoQf724_ZFoCbU2oa6-qO4n3WRVLkaYvj1o2criIQ72RbPubDZJUMjrM1PWXgwvmwa5faA5pf7oJeqGqsZz_lcFq85OeHwzccYfyq0ryLSGEzRcL68prZuzA/s599/SuntecLeverage.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="599" data-original-width="540" height="400" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0XJ6E98b3SxFV5-uL4G3UoQf724_ZFoCbU2oa6-qO4n3WRVLkaYvj1o2criIQ72RbPubDZJUMjrM1PWXgwvmwa5faA5pf7oJeqGqsZz_lcFq85OeHwzccYfyq0ryLSGEzRcL68prZuzA/w361-h400/SuntecLeverage.png" width="361" /></a></div><p style="text-align: justify;">Given that the Aggregate Leverage is above the target range of 40% to 45%, it is possible that Suntec Reit could carry out a rights issue to bring down the Aggregate Leverage to 40% or below. Lowering the Aggregate Leverage to 40% would mean raising approximately $580 mil in cash, equivalent to $0.21 per existing share (e.g. 1-for-7 rights issue at $1.44 per share).<br /></p><p style="text-align: justify;">Alternatively, since the Aggregate Leverage is only slightly above the target range, the REIT manager could opt to receive its fees in units of Suntec Reit instead of being paid in cash. It could also allow shareholders to opt for scrip dividends instead of cash dividends. This would reduce the Aggregate Leverage over time.</p><p style="text-align: justify;">In conclusion, Suntec Reit's Aggregate Leverage has been increasing prior to COVID-19. With the acquisition of Nova that is fully funded by debt, it has increased further. Any revaluation loss during the annual revaluation exercise would likely tip the Aggregate Leverage over the target range that Suntec Reit is comfortable with. To lower the Aggregate Leverage, Suntec Reit could carry out a rights issue, or allow its REIT manager and shareholders to be paid in units instead of cash for their fees/ dividends.<br /></p><p style="text-align: justify;"><br /></p><p style="text-align: justify;">See related blog posts:</p><ul style="text-align: left;"><li><a href="https://boringinvestor.blogspot.com/2020/06/things-dont-look-good-for-retail.html">Things Don't Look Good for Retail Landlords</a></li><li><a href="https://boringinvestor.blogspot.com/2021/02/will-ara-us-ht-carry-out-rights-issue.html">Will ARA US HT Carry Out a Rights Issue?</a><br /></li><li><a href="https://boringinvestor.blogspot.com/2021/01/should-first-reit-be-given-second-chance.html">Should First Reit Be Given a Second Chance?</a></li></ul>Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com0tag:blogger.com,1999:blog-6213354074634538714.post-76898731831593628812020-12-20T23:26:00.000+08:002020-12-20T23:27:05.931+08:00Possibly The Worst Time to Invest – 6 Years On<div style="text-align: justify;"></div><div style="text-align: justify;"></div><p style="text-align: justify;">This year's blog post on the same series comes out later than usual, as I wanted to see how the rest of 2020 would pan out for my passive portfolios. In fact, my plain vanilla passive portfolio has just past the 7-year mark while my spicy passive portfolio is 5.5 years old. You can read more about them in <a href="https://boringinvestor.blogspot.com/2014/02/the-passive-portfolio.html">The Passive Portfolio </a>and <a href="https://boringinvestor.blogspot.com/2015/03/the-anti-fragile-portfolios.html">The Anti-Fragile Portfolios</a>.</p><p style="text-align: justify;">In Mar this year, the unrealised profits of my 2 passive portfolios dropped by nearly half. Prior to Mar, my plain vanilla portfolio had an unrealised profit of 57.7% since inception while my spicy portfolio had unrealised profit of 54.8%. Almost half of that profit accumulated painstakingly over 5-6 years vapourised in just 1 month! Is that it, the crash that I had been waiting for in the past 5-6 years? Would stock prices revisit the lows during the Global Financial Crisis in 2007-2009? Looking back at the lost profits in Mar, I wondered if I should have rebalanced and locked in some of the profits in Feb while the Dow Jones Industrial Average reached a new high (yet again, for the past 6 years). </p><p style="text-align: justify;">No, stocks did not go into an unrelenting free fall. 5 months later, by Aug, the value of the 2 passive portfolios recovered to their highs in Feb. This time round, I carefully considered whether I should rebalance out of the equity funds into fixed income funds. But the rules that I set for rebalancing at the start of the portfolios had not been reached. The rules call for rebalancing whenever allocation to the equity portion reaches either 62% or 78% (i.e. +/-8% margin from the initial allocation of 70% to equities and 30% to fixed income). Equity allocation for the plain vanilla portfolio reached only 73% while that for the spicy portfolio reached only 77%, just a tad shy of the rebalancing trigger. In the end, I decided to stick to my original rules and not rebalance.</p><p style="text-align: justify;">The portfolios dipped slightly in Oct, but recovered after the US presidential elections in early Nov. To-date, the 2 portfolios have reached new highs. Unrealised profit on the plain vanilla portfolio is 65.2%, while that of the spicy portfolio is 62.6%. I am glad that I had not tinkered with my rebalancing rules when the portfolios recovered to their Feb highs in Aug. To-date, neither portfolio has reached the rebalancing threshold, with equity allocation for the plain vanilla portfolio at 74% and that for the spicy portfolio at 77%.</p><p style="text-align: justify;">COVID-19 is a major public health crisis, with significant economic impact on many sectors such as aviation, hospitality, tourism, retail, etc. Stock markets sold off sharply in Mar, but thanks to the massive fiscal and monetary responses from governments around the world, stock markets have recovered from their steep declines in Mar to post new highs. We are still not out of the woods yet, as vaccination from COVID-19 would take many months to complete, and there are reports of mutation of the COVID-19 virus. Nevertheless, this episode shows that we should not stop investing because we are worried of market crashes, so long as there are good defence mechanisms in the portfolios to manage them. </p><p style="text-align: justify;"><br /></p><div style="text-align: justify;">
See related blog posts:</div>
<ul><li><a href="https://boringinvestor.blogspot.com/2014/02/possibly-worst-time-to-invest.html">Possibly The Worst Time to Invest</a></li><li><a href="https://www.boringinvestor.blogspot.sg/2015/03/possible-worst-time-to-invest-year-on.html">Possible The Worst Time to Invest – A Year On</a> </li><li><a href="https://boringinvestor.blogspot.sg/2016/04/possibly-worst-time-to-invest-2-years-on.html">Possibly The Worst Time to Invest – 2 Years On</a></li><li><a href="https://boringinvestor.blogspot.sg/2017/04/possibly-worst-time-to-invest-3-years-on.html">Possibly The Worst Time to Invest – 3 Years On</a></li><li><a href="https://boringinvestor.blogspot.sg/2018/05/possibly-worst-time-to-invest-4-years-on.html">Possibly The Worst Time to Invest – 4 Years On</a></li><li><a href="https://boringinvestor.blogspot.com/2019/08/possibly-worst-time-to-invest-5-years-on.html">Possibly The Worst Time to Invest – 5 Years On</a></li></ul>Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com2tag:blogger.com,1999:blog-6213354074634538714.post-52187824320262367682020-11-15T01:53:00.003+08:002020-11-15T16:21:41.809+08:00Banks' Operating & Financial Metrics Explained<p style="text-align: justify;">Recently, the 3 local banks reported a better set of results than expected. Banks have a unique set of operating and financial metrics that are different from other industries and their financial statements cannot be analysed based on the usual metrics. This blog post attempts to explain the various metrics used in banks' financial statements. I will use DBS' financial statements as examples for the metrics, but they are applicable to the other 2 banks.</p><p style="text-align: justify;"><b>Net Interest Income</b><br /></p><p style="text-align: justify;">At the core of a bank's operations is its business of taking short-term deposits and making long-term loans. Banks charge higher interest rates for the loans and pay lower interest rates for the deposits, thereby profiting from the difference in interest rates. This difference is known as the <b>Net Interest Margin (NIM)</b>. The higher the NIM, the more profits the bank generates from its lending operations. In the last 6 months, the NIM of banks have come off steeply as the US Federal Reserve lowered interest rates sharply to stave off an impending recession caused by the COVID-19 pandemic. For DBS, its NIM has dropped from 1.86% in Dec 2019 to 1.53% in Sep 2020.<br /></p><p style="text-align: justify;">Many factors affect the NIM. One of them is the <b>Loan-to-Deposit Ratio (LDR)</b>. This ratio indicates how much deposits are lent out as loans. The higher the LDR, the more loans are made from the deposits. However, it is never a good idea to lend out 100% of the deposits, because if depositors were to withdraw money from the bank at short notices, the bank would have to find other sources of funds to replace them. These alternative sources of funds are usually more expensive than customers' deposits. Due to the COVID-19 recession, depositors have flocked back to the safety of the 3 major banks. For DBS, its LDR has dropped from 89% in Dec 2019 to 83% in Sep 2020 as it receives more deposits than it could loan out.</p><p style="text-align: justify;">Another factor is the <b>Current Account Savings Account (CASA) Ratio</b>. Banks obtain their funds from current accounts, savings accounts, fixed deposits, bank bonds, shareholder equity, etc. This ratio describes the percentage of deposits that are from current and savings accounts, which have the lowest cost of funds among all funding sources.Thus, the higher the CASA ratio, the lower the interest rate paid to depositors and the higher the NIM would be. For DBS, the CASA ratio went up from 58.9% in Dec 2019 to 69.5% in Sep 2020. This is likely due to the low interest rates offered on fixed deposits, which discourage depositors from renewing their fixed deposits. </p><p style="text-align: justify;"><b>Credit Costs</b></p><p style="text-align: justify;">Although banks profit from the Net Interest Income, there are also loans that might potentially go bad and have to be written off, which reduces the lending profits. The key metric is the <b>Non-Performing Loan (NPL) Ratio</b>. This ratio describes the percentage of loans that might potentially go bad. Note that this ratio reflects the total amount of outstanding NPLs at a snapshot in time and not new NPLs incurred during the reporting period. For DBS, the NPL ratio has largely stayed constant, from 1.5% in Dec 2019 to 1.6% in Sep 2020.</p><p style="text-align: justify;">How banks deduct losses from bad loans is by setting aside allowances in the income statement. Note that these allowances do not necessarily mean that the bad loans are
irrecoverable. If the economy recovers and the companies do well again, the bank could write-back the
past allowances made, thereby increasing the profit in future reporting periods.</p><p style="text-align: justify;">There are 2 types of allowances -- general provisions and specific provisions. <b>General Provisions (GP)</b> are for potential bad loans in the industry as a whole, while <b>Specific Provisions (SP)</b> are for bad loans of specific companies. For example, retailers are facing significant challenges from e-commerce and COVID-19. Banks might set aside more general provisions for loans to retailers. On the other hand, Robinsons' closure means that banks that are exposed to it have to set aside more specific provisions for loans to Robinsons. <br /></p><p style="text-align: justify;">In recent years, banks have adopted the <b>Expected Credit Loss (ECL)</b> model, which requires banks to estimate the expected amount of credit losses from the loans. There are 3 stages in the ECL model. ECL Stages 1 and 2 correspond to GP while ECL Stage 3 corresponds to SP. <br /></p><p style="text-align: justify;">For 3Q2020, DBS set aside $236M in GP and $318M in SP. As a percentage of total loans on an annualised basis, the SP credit cost is 0.31% or 31 basis points. The GP credit cost works out to be 23 basis points.</p><p style="text-align: justify;">Thus, for 3Q2020, DBS made NIM of 1.53%, but had to set aside credit costs of 0.31% in SP and 0.23% in GP. After deducting the credit costs, DBS made 0.99% from its lending operations.</p><p style="text-align: justify;">From another perspective, DBS' NPL ratio is 1.6%, which is close to the NIM of 1.53%. In other words, the Net Interest Income that DBS makes in 1 year is nearly sufficient to write off all the existing NPLs.<br /></p><p style="text-align: justify;"><b>Allowance Reserves</b><br /></p><p style="text-align: justify;">The GP and SP set aside in each reporting period go to the allowance reserves. When the loan eventually cannot be recovered, the loan amount is deducted from the reserves. There is no further impact on the income statement.</p><p style="text-align: justify;">There is another reserve known as <b>Regulatory Loss Allowance Reserve (RLAR)</b>. Allowances for RLAR are set aside from retained earnings instead of from the income statement, i.e. profits are not reduced by the amount set aside for RLAR, unlike GP and SP. However, there is no free lunch. When the loan eventually cannot be recovered, the loan amount is deducted from RLAR and from the income statement.</p><p style="text-align: justify;"></p><p style="text-align: justify;">Together, the GP and SP reserves and RLAR form a pool of allowance reserves to cover <b>Non-Performing Assets (NPA)</b>. NPAs are similar to NPLs, but include other NPAs in the banks' non-lending businesses, such as wealth management, brokerage, etc.. The <b>(Total Allowance & RLAR)/NPA Ratio</b> indicates the percentage of NPAs which is covered by the total allowance reserves. For DBS, this ratio is 107% in Sep 2020, which means that all NPAs are fully covered by the reserves. If this ratio is less than 100% and if all NPAs were to be irrecoverable, any shortfall will have to be deducted from the income statement. If this results in a loss, it will reduce the bank's capital, which might affect the stability and liquidity of the bank (see next section). Thus, the total allowance reserves provide a cushion for bad loans before the income statement and bank's capital are impacted. Having said the above, there is no requirement for the ratio to be above 100%, since not all NPAs will end up being irrecoverable.<br /></p><p style="text-align: justify;">Some NPAs are secured by collaterals. For these loans, banks could take over and sell the collaterals to recover the loans. Hence, there is a corresponding ratio that considers only unsecured NPAs. This is the <b>(Total Allowance & RLAR)/Unsecured NPA Ratio</b>. For DBS, this ratio is 200% in Sep 2020, which means that the allowance reserves are sufficient to cover unsecured NPAs by 2 times. The high ratio helps to cushion instances whereby the collaterals are worth less than the loan amount.<br /></p><p style="text-align: justify;"><b>Stability & Liquidity</b><br /></p><p style="text-align: justify;">Banks are systematically important to the economy and failure of a bank could lead to disastrous consequences. To guard against such scenarios, banks are required to have sufficient capital reserves to absorb loan losses. This is measured by <b>Capital Adequacy Ratios (CAR)</b>. Capital can be classified as Tier 1 or Tier 2, with Tier 1 being more reliable than Tier 2. Tier 1 capital comprises share capital and audited retained earnings, while Tier 2 capital comprises unaudited retained earnings and general loss reserves. CARs are measured by dividing the specific tier of capital over <b>Risk-Weighted Assets (RWA)</b>. Different types of loans have different risks (e.g. secured/ unsecured), and RWA considers the likelihood of the assets going bad. <br /></p><p style="text-align: justify;">The most important CAR is the <b>Common Equity Tier 1 (CET1) Ratio</b>. This ratio is most keenly watched by investors, as it has implications on the amount of dividends the bank can declare. If the CET1 ratio is too low for regulators' comfort, regulators could ask the bank to stop dividends so that earnings could be retained to build up the CET1 capital. Similarly, banks could also raise capital via rights issues.</p><p style="text-align: justify;">In Sep 2020, DBS' CET1 ratio is 13.9%, which is above the bank's target ratio of 12.5% to 13.5%. For reference, the last time DBS carried out a rights issue was in Dec 2008, at the height of the Global Financial Crisis (GFC). Its Tier 1 CAR then was 10.1%. Post-issuance, the Tier 1 CAR rose to 12.5% in Mar 2009.<br /></p><p style="text-align: justify;">The GFC saw governments stepping in to rescue major banks that were at risks of failing. Since then, regulators have introduced 2 additional measures to ensure that banks would not fail again. The <b>Liquidity Coverage Ratio (LCR)</b> measures how much High Quality Liquid Assets the bank has to meet estimated total net cash outflows over a 30-day stress scenario. The <b>Net Stable Funding Ratio (NSFR)</b> measures the amount of available stable funding relative to the amount of required stable fuinding. The LCR and NSFR measure the short-term and mid/long-term resilience of the banks respectively and must be above 100%. For DBS, the LCR and NSFR are 135% and 123% respectively in Sep 2020. </p><p style="text-align: justify;">The <b>Leverage Ratio</b> measures the amount of loans relative to the bank's equity. It is similar to the Debt-to-Equity ratio for other industries. For DBS, the leverage ratio is 6.9 times in Sep 2020. </p><p style="text-align: justify;"><b>Other Ratios</b></p><p style="text-align: justify;">Other ratios include <b>Return on Assets (ROA)</b> and <b>Return on Equity (ROE)</b>. These ratios should be familiar with investors since they also apply to other industries. Another ratio is the <b>Cost-to-Income Ratio</b>, which measures how efficient the bank is in controlling costs relative to income. Some banks also report the <b>Non-Interest Income to Total Income Ratio</b>, which measures how much income the bank generates outside its lending business. A higher ratio means that there is great diversity in the income sources.<br /></p><p style="text-align: justify;"><b>Conclusion</b></p><p style="text-align: justify;">This blog post explains the operating and financial metrics that are relevant to banks. With this information, hopefully investors will be able to understand the financial performance of banks better.</p><p style="text-align: justify;"><br /></p><p style="text-align: justify;">See related blog posts:</p><ul style="text-align: left;"><li><a href="https://boringinvestor.blogspot.com/2016/02/a-comparison-of-3-local-banks.html">A Comparison of the 3 Local Banks (2016)</a><br /></li></ul>Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com2tag:blogger.com,1999:blog-6213354074634538714.post-34720397430342083842020-06-14T00:15:00.003+08:002021-01-17T22:03:53.783+08:00Things Don't Look Good for Retail Landlords<div style="text-align: justify;">
The massive sell-down in Mar brought many REITs to rare, multi-year lows. This re-ignited my interest in REITs, as I have been out of them for many years due to their increasing debt levels and decreasing yields. However, I passed up the opportunity while I analysed what could be the impact of COVID-19 on REITs. Despite the massive government interventions, things do not look good for retail and F&B companies. And when tenants struggle, their landlords will also suffer. In this blog post, I will examine the potential impact of COVID-19 on 2 retail companies and 2 F&B companies.</div>
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Before we begin, it is good to recap what are the measures the government has taken to cushion the impact on retail and F&B companies. </div>
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<b>Wage Support</b></div>
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Through 4 extraordinary budgets, the government will provide support to wages via the Job Support Scheme (JSS). The level of wage support varies across industries. The JSS will last for 10 months. For the first 2 months, it will cover 75% of $4,600 of wages of all local employees for all companies. The 75% support level will continue if companies are not allowed to operate during the gradual lifting of Circuit Breaker, until Aug. For the remaining months, the wage support will be as shown in Fig. 1 below. </div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjXPMPdGUrXnCmbKkE4x3QDdRZ_MzIUGmi1i-9FgflkDCmq548tezag3agei9iSoP_IH8s81yWZvBMy4dXorKc-5ik9G0sZfeOUOCJ0FJ6RV0r85zZS8_6QBCg5OlYZdLYsx16wIEbT_d8/s1600/JobSupportScheme.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="658" data-original-width="1520" height="172" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjXPMPdGUrXnCmbKkE4x3QDdRZ_MzIUGmi1i-9FgflkDCmq548tezag3agei9iSoP_IH8s81yWZvBMy4dXorKc-5ik9G0sZfeOUOCJ0FJ6RV0r85zZS8_6QBCg5OlYZdLYsx16wIEbT_d8/s400/JobSupportScheme.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 1: JSS Support for Remaining Months</td></tr>
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Thus, both retail and F&B companies will get the following wage support:</div>
<ul>
<li>3 months of 75% wage support (assuming they are allowed to reopen in Jul)</li>
<li>7 months of 50% wage support </li>
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This
translates to 48% reduction in annual wage costs for FY2020 (assuming that all wages of employees are at $4,600). </div>
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<b>Rental Relief</b></div>
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In addition to wage support, the government has also implemented measures to help companies cope with rental costs. The Government will provide property tax rebates and cash grants equivalent to 2 months' rent for qualifying commercial properties and 1 month's rent for industrial and office properties for Small and Medium Enterprises (SMEs) with annual turnover of less than $100M. On top of that, the government also passed a law requiring landlords to waive 2 months' rent for commercial properties and 1 month's rents for industrial and office properties for SMEs that have seen a significant drop in their monthly revenues. The total amount of rental relief for SMEs in commercial and industrial/ office properties is summarised in Fig. 2 below.</div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiJrdLUbJulbsFvvl8yXcXdJIP1T-Qzupk2dLqKUAbXBPs7TtmmYUVDMSIpBIPQleQLN0vbvVlCZGs4H7kGFYkyv0Dg1SNt1aQZPfjNq_6IeZ1ZKxxuyGzozEojwyPeYADVtLmJkniCjQY/s1600/TenantReliefTable.jpg" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="377" data-original-width="835" height="180" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiJrdLUbJulbsFvvl8yXcXdJIP1T-Qzupk2dLqKUAbXBPs7TtmmYUVDMSIpBIPQleQLN0vbvVlCZGs4H7kGFYkyv0Dg1SNt1aQZPfjNq_6IeZ1ZKxxuyGzozEojwyPeYADVtLmJkniCjQY/s400/TenantReliefTable.jpg" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 2: Rent Relief for SMEs</td></tr>
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Thus, retail and F&B SME companies will get up to 4 months of rental relief, translating to a 33% reduction in annual rental costs for FY2020. </div>
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<b>Revenue Hit</b></div>
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COVID-19 has stopped people from shopping and dining out, either because of government-mandated lockdowns or fear of contracting the virus. It is anyone's guess how soon people will go back to their normal lifestyles after shops and F&B outlets are allowed to operate. China is the first country to exit the lockdown and provides the first glimpse of how consumers would react in a post-COVID world. Figs. 3 and 4 below from Capitaland Retail China Trust's (CRCT) investor conference in May shows that shopper traffic is only picking up gradually after the end of the lockdown. Year-on-year, total shopper traffic and tenants' sales in 1Q2020 declined by 37.6% and 42.5% respectively.</div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgRThJ6ofs1nAxbgRdHswqDZ00WsYB-VCYimzZWjcAdT85areeEf63ScQnM00rweTo0ro1iBFhDvzxBMeT3ZxbkxijiMAulznSbreZEBDy6ZCajOk8LGKcO0p2_VYszuUTGIePSOteCKCY/s1600/CovidCapitaChinaTrafficUpdate.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="900" data-original-width="1600" height="225" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgRThJ6ofs1nAxbgRdHswqDZ00WsYB-VCYimzZWjcAdT85areeEf63ScQnM00rweTo0ro1iBFhDvzxBMeT3ZxbkxijiMAulznSbreZEBDy6ZCajOk8LGKcO0p2_VYszuUTGIePSOteCKCY/s400/CovidCapitaChinaTrafficUpdate.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 3: Shopper Traffic at CRCT Malls in 1Q2020</td></tr>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEif-e_3_n03WbGoPTQToMtmrdJnLseXQ77trkNvNw1IR4ERrYA8MBPb6cpC2cAMMjGh2iBFRQdSPzlpAi1ysTuqpVQkHeOU81etfPzQqIFejVt3x_3WxJz8nYgHZ4ki2LbnbXsctHdc_ek/s1600/COVIDCapitaChinaSalesUpdate.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="900" data-original-width="1600" height="225" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEif-e_3_n03WbGoPTQToMtmrdJnLseXQ77trkNvNw1IR4ERrYA8MBPb6cpC2cAMMjGh2iBFRQdSPzlpAi1ysTuqpVQkHeOU81etfPzQqIFejVt3x_3WxJz8nYgHZ4ki2LbnbXsctHdc_ek/s400/COVIDCapitaChinaSalesUpdate.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 4: Tenants' Sales at CRCT Malls in 1Q2020</td></tr>
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For the revenue hit on retail and F&B companies, I assume the following:</div>
<ul>
<li>3 months of closure during Circuit Breaker: 0% revenue</li>
<li>2 months of gradual re-opening: 50% revenue</li>
<li>7 months of recovery: 80% revenue</li>
</ul>
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This translates to a 45% decline in annual revenue for FY2020. Will retail and F&B companies survive this kind of harsh business conditions? Let us take a look at 2 retail companies and 2 F&B companies.</div>
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<b>Retail Companies</b></div>
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<u>Company F</u> </div>
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Company F is a barely profitable retail company. In FY2019, it generated net profit of $0.2M. See Fig. 5 below for its income statement for FY2019.</div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj-Fkw3UySXRU-BbDqGQbm3MpEi7_KBlCID9LBIiSUSP3WTIRGqJ1A7zmxG0_HsexedQ6JhwNCtbmzPrMT-HNSL6MdX-PTOv92KePei2TDJv5PW15mYrML1J4Y2nPXI2CS3zonwGod5BPU/s1600/FJBen.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="532" data-original-width="830" height="256" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj-Fkw3UySXRU-BbDqGQbm3MpEi7_KBlCID9LBIiSUSP3WTIRGqJ1A7zmxG0_HsexedQ6JhwNCtbmzPrMT-HNSL6MdX-PTOv92KePei2TDJv5PW15mYrML1J4Y2nPXI2CS3zonwGod5BPU/s400/FJBen.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 5: Company F's Income Statement for FY2019</td></tr>
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It is insightful to note that of the gross profit of $64.7M, staff costs ($21.4M) take up 33% of the gross profit and rental costs ($22.3M) take up another 34% of the gross profit. In total, staff and rental costs take up 68% of gross profit. It is no wonder that the government had to act quickly to relieve the pressure of staff and rental costs on companies!</div>
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Applying the estimated declines in revenue, staff and rental costs above (plus some other assumptions for other costs), Company F might see its net profit turn from positive $0.2M to negative $5.4M. See Fig. 6 below for the computation.</div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjDUEs5mAnqhLaKeXhw_7mxjHQo7FraeFJJJDypiRqv4IRwNPTtNfZB09dda_YeDh7GCqxEUKe4hBSu622Mok4W_Sa0c-ehC1Om4gYyS2ziOPtbgQhlFSZpWV5WVCSQE7lWgTmhtYcGwI0/s1600/FJBenCovidImpact.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="579" data-original-width="372" height="400" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjDUEs5mAnqhLaKeXhw_7mxjHQo7FraeFJJJDypiRqv4IRwNPTtNfZB09dda_YeDh7GCqxEUKe4hBSu622Mok4W_Sa0c-ehC1Om4gYyS2ziOPtbgQhlFSZpWV5WVCSQE7lWgTmhtYcGwI0/s400/FJBenCovidImpact.png" width="256" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 6: Estimated Impact of COVID-19 on Company F</td></tr>
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As at end FY2019, Company F had cash of $7.8M. The estimated loss of $5.4M is equivalent to 69% of its cash and 10% of its equity.</div>
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<div style="text-align: justify;">
<u>Company C</u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Company C is a fairly profitable retail company. In FY2019, it generated net profit of $17.7M. Applying the same analysis as Company F, Company C might see its
net profit reduced from $17.7M to $9.1M. See Fig. 7 below
for the computation. Company C will likely have no problem going through the COVID-19 situation.</div>
<div style="text-align: justify;">
<br /></div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhth3qnDhUveJQp5v9RKjC8lC-ubhgIpEM4sDByoTzN-PU0YisnpVd1_VbwLR9q0z-CDWGK4bOJ_UWqOwIeik-zounKPsQFGc-uOR5Z3p74AWh75lvdBd7i6eOAEYw0atJ5qbJsTrQcVug/s1600/ChallengerCovidImpact.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="579" data-original-width="380" height="400" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhth3qnDhUveJQp5v9RKjC8lC-ubhgIpEM4sDByoTzN-PU0YisnpVd1_VbwLR9q0z-CDWGK4bOJ_UWqOwIeik-zounKPsQFGc-uOR5Z3p74AWh75lvdBd7i6eOAEYw0atJ5qbJsTrQcVug/s400/ChallengerCovidImpact.png" width="262" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 7: Estimated Impact of COVID-19 on Company C</td></tr>
</tbody></table>
<br />
<div style="text-align: justify;">
<b>F&B Companies</b></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u>Company S</u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Company S is a barely profitable F&B company. In FY2019, it generated net profit of $0.8M. See
Fig. 8 below for its income statement for FY2019.</div>
<div style="text-align: justify;">
<br /></div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3zUmgGLBZrRDo7msJj5RiopTCTzqMXZjMyrNiWTsVEN67mL99HxpWjWsg9Lus34TPGvUcUhg36ouLjTHeawFTcBKQt3RHQwuk8VmLmuK13d7iRbs3RKT50Rt_So6psWESL2X1Skt_jcA/s1600/SoupRes.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="562" data-original-width="720" height="311" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3zUmgGLBZrRDo7msJj5RiopTCTzqMXZjMyrNiWTsVEN67mL99HxpWjWsg9Lus34TPGvUcUhg36ouLjTHeawFTcBKQt3RHQwuk8VmLmuK13d7iRbs3RKT50Rt_So6psWESL2X1Skt_jcA/s400/SoupRes.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 8: Company S's Income Statement for FY2019</td></tr>
</tbody></table>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Like retail companies, staff and rental costs take up a large portion of the gross profit of F&B companies. Staff costs ($14.3M) take up 43% of gross profit and rental costs ($7.9M) take up another 24% of gross
profit. In total, staff and rental costs take up 66% of gross profit. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Applying the same analysis, Company S might see its
net profit turn from positive $0.8M to negative $2.6M. See Fig. 9 below
for the computation. The estimated loss is equivalent to 32% of its cash and 27% of its equity as at end FY2019. </div>
<div style="text-align: justify;">
<br /></div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwDlDfeuCF7CpM9hRtW-fDLF5WGgU7ehunq5yNktzAN3zA2LggR_X-__381ahMKyMM7lut1TmgoMRwpuusjkpG1HhwWxVK3GmxthWBLvKIMFD-HCEd1Nfsw_KJAWIVeQIRmLwRQacYxkM/s1600/SoupRes.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="579" data-original-width="372" height="400" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwDlDfeuCF7CpM9hRtW-fDLF5WGgU7ehunq5yNktzAN3zA2LggR_X-__381ahMKyMM7lut1TmgoMRwpuusjkpG1HhwWxVK3GmxthWBLvKIMFD-HCEd1Nfsw_KJAWIVeQIRmLwRQacYxkM/s400/SoupRes.png" width="256" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 9: Estimated Impact of COVID-19 on Company S</td></tr>
</tbody></table>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u>Company J</u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Company J is a fairly profitable retail company. In FY2019, it generated
net profit of $10.9M. Applying the same analysis as Company F, Company J
might see its
net profit reduced from $10.9M to $1.9M. See Fig. 10 below
for the computation. Company J will likely have no problem going through
the COVID-19 situation.</div>
<div style="text-align: justify;">
<br /></div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiMoGleT52mLAc0841LZkOtE4oTJMFClrbTg9_S3LELrwUJ33gjRU_VfCQ5uw_cte7dA4y2zDrPbIBbsjF1-Y8NvKIRlzp11iiBC02lkONJ8x3QsMNYZmtagIMU6YfS73x_N1NQeGSHsMQ/s1600/JumboCovidImpact.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="579" data-original-width="380" height="400" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiMoGleT52mLAc0841LZkOtE4oTJMFClrbTg9_S3LELrwUJ33gjRU_VfCQ5uw_cte7dA4y2zDrPbIBbsjF1-Y8NvKIRlzp11iiBC02lkONJ8x3QsMNYZmtagIMU6YfS73x_N1NQeGSHsMQ/s400/JumboCovidImpact.png" width="262" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 10: Estimated Impact of COVID-19 on Company J</td></tr>
</tbody></table>
<div class="separator" style="clear: both; text-align: center;">
</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<b>Conclusion</b></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
We have run through the estimated impact of COVID-19 on 2 retail and 2 F&B companies. Staff and rental costs consistently take up around 2/3 of gross profits. When there is no or poor business due to government-mandated lockdowns or fear of contracting the virus, the impact on the bottom lines of retail and F&B companies is very significant. As in all crises, stronger companies with leaner cost structures and/or significant retained earnings will be able to weather the storm while weaker ones will end up in losses, despite the extraordinary government interventions. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
The companies I analysed above are all listed companies. How about unlisted companies? Would they have stronger financials than listed companies? Some food for thoughts. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Last week, Department of Statistics released the retail and F&B sales figures for Apr 2020. Fig. 11 below shows that retail sales declined by 13.3% in Mar (before Circuit Breaker) and 40.5% in Apr (during Circuit Breaker) on a year-on-year basis. Almost all sectors were impacted, with the exception of Supermarts & Hypermarts, Mini-marts & Convenience Stores, and to some extent, Computer & Telco Equipment. </div>
<div style="text-align: justify;">
<br /></div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9S4hupxM-yh4VCleSikSaCfFdh_5GxhVf_U1LoDdXZICny-uHfLf0edJyeZMzv3iYuIHTyFPakVyZgrswTaJtMBLnhDIQ3JICUBsrE8c1OJLANwdcRTcyPUUE_mTaW8Q5R4d7sQpOgak/s1600/RetailSalesCovidImpactApr20.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="741" data-original-width="737" height="400" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9S4hupxM-yh4VCleSikSaCfFdh_5GxhVf_U1LoDdXZICny-uHfLf0edJyeZMzv3iYuIHTyFPakVyZgrswTaJtMBLnhDIQ3JICUBsrE8c1OJLANwdcRTcyPUUE_mTaW8Q5R4d7sQpOgak/s400/RetailSalesCovidImpactApr20.png" width="397" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 11: % Changes in Retail Sales</td></tr>
</tbody></table>
<br />
Fig. 12 below paints a similarly bleak picture for F&B sales, with a decline of 23.6% in Mar and 53.0% in Apr on a year-on-year basis. No F&B sector escaped the decline.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhfN8gWVPu9YNyLmI6ccoK3lcMNhNZM7x_q7S06JMOrlLKLkRc2rZRUQCOLhYEIqV6NRjdZpXtvbWZ5XmYzRH5Zg2A38ppfr53imryqSqjOutTup-Xc-qWcP2ZUCZor2F2tgXnMqv-N89g/s1600/F%2526BSalesCovidImpactApr20.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="364" data-original-width="737" height="197" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhfN8gWVPu9YNyLmI6ccoK3lcMNhNZM7x_q7S06JMOrlLKLkRc2rZRUQCOLhYEIqV6NRjdZpXtvbWZ5XmYzRH5Zg2A38ppfr53imryqSqjOutTup-Xc-qWcP2ZUCZor2F2tgXnMqv-N89g/s400/F%2526BSalesCovidImpactApr20.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 12: % Changes in F&B Sales</td></tr>
</tbody></table>
<div style="text-align: justify;">
</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Lastly, Fig. 13 below shows the tenant mix at Frasers Centrepoint Trust's Malls.</div>
<div style="text-align: justify;">
<br /></div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiJa5Sgfd4Eqr2abfQ_t9LWulC4gAnSLAqmoNTCI4ppKXZT7F3xpmujPz8JnuJ7InyfbPfJP65HMzPqOjtM3FMm02Ky4Cy8XhTvoMbd29vSeBME3wWUZtDWOs-LpX75QD9y2AIqaVrSwX0/s1600/TenantMix.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="824" data-original-width="1346" height="243" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiJa5Sgfd4Eqr2abfQ_t9LWulC4gAnSLAqmoNTCI4ppKXZT7F3xpmujPz8JnuJ7InyfbPfJP65HMzPqOjtM3FMm02Ky4Cy8XhTvoMbd29vSeBME3wWUZtDWOs-LpX75QD9y2AIqaVrSwX0/s400/TenantMix.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 13: Tenant Mix at Frasers Centrepoint Trust's Malls</td></tr>
</tbody></table>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
F&B accounts for 38% of Gross Rental Income. Fashion takes up 14% while Beauty & Health accounts for 11%. All these sectors will be impacted by COVID-19. The only sector that has a roaring business during COVID-19, Supermarts & Hypermarts, contributes only 5% of the Gross Rental Income.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
In conclusion, COVID-19 has resulted in a very challenging business environment for retail and F&B companies. When tenants struggle, landlords will also suffer. Things do not look good for retail landlords.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
P.S. I am vested in Capitaland.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
See related blog posts:</div>
<ul>
<li><a href="https://boringinvestor.blogspot.com/2020/04/not-all-hospitality-trusts-are-created.html">Not All Hospitality Trusts Are Created Equal</a> <br /></li><li><a href="https://boringinvestor.blogspot.com/2021/01/will-suntec-reit-carry-out-rights-issue.html">Will Suntec Reit Carry Out a Rights Issue?</a></li><li><a href="https://boringinvestor.blogspot.com/2021/01/should-first-reit-be-given-second-chance.html">Should First Reit Be Given a Second Chance?</a></li>
</ul>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com15tag:blogger.com,1999:blog-6213354074634538714.post-48795186720281355332020-04-05T01:24:00.001+08:002020-04-05T01:29:34.995+08:00Not All Hospitality Trusts Are Created Equal<div style="text-align: justify;">
In the past 2 months, investors have been selling off Hospitality Trusts (HTs) listed on SGX due to travel restrictions imposed by governments around the world to stem the spread of COVID-19. There are 6 HTs listed on SGX, namely:</div>
<ul>
<li>ARA US HT</li>
<li>Ascott Residence Trust</li>
<li>CDL HT</li>
<li>Eagle HT</li>
<li>Far East HT</li>
<li>Frasers HT</li>
</ul>
<div style="text-align: justify;">
While all hotels will suffer revenue decline due to the travel restrictions, not all HTs will be impacted by the same extent. One important factor affecting the impact on HTs is their operating models. Traditionally, hotels have been owned and operated by the same party, but there are increasingly more investors who wish to invest in hotels but might not have the expertise or time to manage them. Thus, hotels might be owned by one party but operated by another, with revenue-sharing agreements between them. If you buy into HTs, you are buying into the ownership of the hotels. The operating model adopted by the HT will affect how the revenue and/or profit are shared between the owners (i.e. HTs) and the operators (i.e. hotel chains like Mariott, Hilton, Accor, etc.).</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Some of the major operating models are as follow:</div>
<ul>
<li style="text-align: justify;">Owner Operated - The owner owns and operates the hotel, bears all costs and risks, and receives all profits. HTs usually do not adopt this model.</li>
<li style="text-align: justify;">Master Lease - This is the simplest model when the owner and operator are different parties. The owner leases the hotel property to the operator in return for a fixed rental fee. The operator bears all costs and risks of operating the hotel. The owner does not have any share in the profits from operating the hotel. Nevertheless, there are variants to this model in which the rental can be variable and pegged to a percentage of the hotel revenue and/or profit. </li>
<li style="text-align: justify;">Management Contract - In this model, the owner engages the operator to run the hotel. The operator receives a management fee which is pegged to a percentage of the hotel revenue and profit. The owner bears all costs and risks of operating the hotel and receives all profits after deducting the costs and management fee to the operator.</li>
<li style="text-align: justify;">Franchise - In this model, the owner runs the hotel using the franchisor's brand. The franchisor receives a franchise fee which is pegged to a percentage of the hotel
revenue. The owner bears all costs and risks of operating the
hotel and receives all profits after deducting the costs and franchise fee. A variant of this model is the owner outsources the operation of the hotel to an independent third-party operator. This arrangement is similar to a management contract, except that the third-party operator is not associated with the franchisor.</li>
</ul>
Fig. 1 below summarises the responsibilities of the owner and the operator/ franchisor in running the hotel. <br />
<ul>
</ul>
<div style="text-align: justify;">
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh39_utrWXHWI_bVekTwruAHmr_lPMyzivGkHInhhWBr6RZV-CY9Es4AMgaEVzbcJIzr8V-j9TqnxerdPgFN6rcKBvWZh3AGxChXZttylT206A4SdEbwx-5m2RHjdSmvYN8i2epLfZdljY/s1600/HotelMgtModel.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="318" data-original-width="1044" height="120" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh39_utrWXHWI_bVekTwruAHmr_lPMyzivGkHInhhWBr6RZV-CY9Es4AMgaEVzbcJIzr8V-j9TqnxerdPgFN6rcKBvWZh3AGxChXZttylT206A4SdEbwx-5m2RHjdSmvYN8i2epLfZdljY/s400/HotelMgtModel.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 1: Various Hotel Operating Models</td></tr>
</tbody></table>
<br />
Needless to say, given the severe travel disruptions currently in place, the
master lease model (especially the fixed rental model) would have the least impact to the revenue received
by the HTs. Let us look at the operating model adopted by each of the
HTs. Do note that a lot of these information are sourced from the annual reports. For HTs whose financial years end in Dec, the FY2018 annual reports are the latest ones available. <br />
<br />
<u>ARA US HT </u></div>
<div style="text-align: justify;">
<br />
ARA US HT owns 41 hotels, of which 38 carry the brand of Hyatt and 3 carry the brand of Mariott. Fig. 2 below shows the operating model adopted.<br />
<br /></div>
<div style="text-align: justify;">
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9SEJrm_A5-8FdrERe0UY1yP1neO9fZ32baSO4OVx-DgL-gxYK-jbGOEMw82CpfnspKuTKFGe3ZcmyLXJbm0-4QECvrhnO77NA4R4ZB4l1Ocv4ef_PR77lDOsUSPufYzih8T8sFHFrolU/s1600/ARAModel.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="793" data-original-width="876" height="361" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9SEJrm_A5-8FdrERe0UY1yP1neO9fZ32baSO4OVx-DgL-gxYK-jbGOEMw82CpfnspKuTKFGe3ZcmyLXJbm0-4QECvrhnO77NA4R4ZB4l1Ocv4ef_PR77lDOsUSPufYzih8T8sFHFrolU/s400/ARAModel.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 2: ARA HT's Operating Model</td></tr>
</tbody></table>
<br />
The figure shows that all of ARA US HT's hotels are franchised by Hyatt and Mariott and operated by independent third-party operators. <br />
<br />
As explained in the section above, under the franchise model, all costs and risks are borne by ARA US HT, which is not a good thing during the current COVID-19 situation.<br />
<br />
<u>Ascott Residence Trust (ART)</u><br />
<br />
ART owns 87 hotels and serviced residences. It recently merged with Ascendas HT to form the largest HT in Asia Pacific. ART adopts a combination of master leases and management contracts. Fig. 3 below shows the breakdown of gross profit from the various operating models in 4Q2019.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3cwCEPbdpoe9cHcr3ia98P9Q7MCLkdkT10apCTbYDUzdbOs_N23FJb5yX566fH6819KyEW2f_TPxojcKAvKuc40y7sXkYGFXheebPMpjfPZYUHwknM6tX-lH_61R8RBsQ7_L8kiRcetc/s1600/AscottModel.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="542" data-original-width="1242" height="173" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3cwCEPbdpoe9cHcr3ia98P9Q7MCLkdkT10apCTbYDUzdbOs_N23FJb5yX566fH6819KyEW2f_TPxojcKAvKuc40y7sXkYGFXheebPMpjfPZYUHwknM6tX-lH_61R8RBsQ7_L8kiRcetc/s400/AscottModel.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 3: Breakdown of ART's Gross Profit in 4Q2019</td></tr>
</tbody></table>
<br />
25% of the gross profit comes from master leases, while another 13% comes from management contracts with minimum guaranteed income.<br />
<br />
Notwithstanding the above, there are fixed and variable rent
components in the leases. ART disclosed that its operating lease
receivable within 1 year of FY2018 is $70.3M. This is based on
the fixed rent component in the leases. This amount represents only 14% of both the
gross rental income and total revenue
(rental and other income) in FY2018. In the worst case scenario whereby there is only fixed rental income, ART could see its revenue
dropping by 86%.<br />
<br />
<u>CDL HT</u><br />
<br />
CDL HT owns 16 hotels, 2 resorts and 1 retail mall across 8 countries. It has a combination of master leases, management contracts and owner-operated hotel. Fig. 4 below shows the operating model.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEixHhhEQylTXcNfr_-ZvGTAMwbMj4DZGFMNvtjG_Tc0pL13KGHP1Wko_tL5lcYswYu-w3-SZcHflf95yWwYpkkDoGaDO9WxG1ZDt9am-CTiGQQauXBA6G9BAy-7rqXXW4bFJsFg4gNJLsg/s1600/CDLHTModel.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="730" data-original-width="1216" height="240" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEixHhhEQylTXcNfr_-ZvGTAMwbMj4DZGFMNvtjG_Tc0pL13KGHP1Wko_tL5lcYswYu-w3-SZcHflf95yWwYpkkDoGaDO9WxG1ZDt9am-CTiGQQauXBA6G9BAy-7rqXXW4bFJsFg4gNJLsg/s400/CDLHTModel.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 4: CDL HT's Operating Model</td></tr>
</tbody></table>
<br />
Of the 19 properties, 13 are under master leases, 4 are under management contracts and 2 are owner-operated.<br />
<div class="separator" style="clear: both; text-align: center;">
</div>
<div class="separator" style="clear: both; text-align: center;">
</div>
<div class="separator" style="clear: both; text-align: center;">
</div>
<br />
Although master leases form the majority of the hotels, they have fixed and variable rent components. Fig. 5 below compares the minimum and actual rental income received in FY2018. <br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiffYjHmaCAimoZJ-1ZDy3vGZ3N1IbXhYK5isT4iFB7456E1N6aJo_9sbErZhtu0mzHd40reRjkv1gQCQ7vM6-pvPDC7pKNCNrGSSS2T5iAIfeu9pTTjAO2W5qqm-FuKbHlHppBwQ4UaOY/s1600/CDLHTMinRental.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="785" data-original-width="1082" height="290" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiffYjHmaCAimoZJ-1ZDy3vGZ3N1IbXhYK5isT4iFB7456E1N6aJo_9sbErZhtu0mzHd40reRjkv1gQCQ7vM6-pvPDC7pKNCNrGSSS2T5iAIfeu9pTTjAO2W5qqm-FuKbHlHppBwQ4UaOY/s400/CDLHTMinRental.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 5: Minimum & Actual Rental Income for Master Leases</td></tr>
</tbody></table>
<div class="separator" style="clear: both; text-align: center;">
</div>
<br />
In total, the minimum rental income from all master-leased hotels forms only 49% of the actual rental
income received in FY2018. As a percentage of total revenue, the minimum rental income constitutes only 35%. In the worst case scenario whereby there is only minimum rental income, CDL HT could see its revenue
dropping by 65%.<br />
<br />
Thus, although the majority of CDL HT's hotels are under master leases, the variable rent component in these master leases reduces the stability of income received by CDL HT in situations like COVID-19.<br />
<br />
<u>Eagle HT</u><br />
<br />
Eagle HT was listed on SGX recently. It owns 18 hotels in US, most of which carry the brands of IHG, Mariott and Hilton. The operating model appears similar to that of ARA US HT, i.e. franchise model.<br />
<br />
<u>Far East HT</u><br />
<br />
Far East HT owns 9 hotels and 4 serviced residences in Singapore. Fig. 6 below shows the operating model adopted.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYPoOdFBIML3OcdV0nh6fOVGgnxuiCqSS1SB156SMIogixOCCsPh1rXOpDh22INrH9LkPk6g53CHhmeSn_bEwTOfl6nldDqSEoqKnpZHlTFvIfDDJjStAqGCTqXiWBWrvlpFDW6x2lbmI/s1600/FarEastHTModel.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="690" data-original-width="682" height="400" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYPoOdFBIML3OcdV0nh6fOVGgnxuiCqSS1SB156SMIogixOCCsPh1rXOpDh22INrH9LkPk6g53CHhmeSn_bEwTOfl6nldDqSEoqKnpZHlTFvIfDDJjStAqGCTqXiWBWrvlpFDW6x2lbmI/s400/FarEastHTModel.png" width="395" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 6: Far East HT's Operating Model</td></tr>
</tbody></table>
<br />
All their hotel and serviced residence properties are master leased to its sponsor, Far East Organisation and its related subsidiaries. Although Far East HT did not disclose the fixed and variable rent components of the master leases, it disclosed that its operating lease receivable within 1 year of FY2018 is $85.1M. This is based on the fixed rent in the master leases. This amount represents 93% of the rental income received from master leases and 75% of total revenue in FY2018. In the worst case scenario whereby there is only fixed rental income, Far East HT could see its revenue dropping by 25%.<br />
<br />
<u>Frasers HT</u><br />
<br />
Frasers HT owns 9 hotels and 6 serviced residences in 6 countries. 14 of the properties are under master leases and 1 is under management contract. Like all HTs, the master leases have fixed and variable rent components. Fig. 7 below shows the minimum and actual rental income received in FY2019.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEigW_RBHUEJxAj7-zw66v89kYKi0T2oRa0BqkOXLjb-CyQIkKStIIJrM_NbTrXAaJukbwviZp_eO5ndU7LcGVitkjzvi6olzBNF4gwSKdgNoL-yoUHl825kL65ZrX9-HKqauYliFEMDw3g/s1600/FrasersHTMinRental.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="785" data-original-width="1082" height="290" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEigW_RBHUEJxAj7-zw66v89kYKi0T2oRa0BqkOXLjb-CyQIkKStIIJrM_NbTrXAaJukbwviZp_eO5ndU7LcGVitkjzvi6olzBNF4gwSKdgNoL-yoUHl825kL65ZrX9-HKqauYliFEMDw3g/s400/FrasersHTMinRental.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 7: Minimum & Actual Rental Income for Master Leases</td></tr>
</tbody></table>
<br />
In total, the minimum rental income forms only 49% of the rental income received from master leases and 38% of total revenue in FY2019. In the worst case scenario whereby there is only minimum rental income, revenue can fall by 62%. <br />
<br />
<u>Conclusion</u><br />
<br />
The table below summarises the operating models adopted by the various HTs listed on SGX. For HTs with master leases, the table also shows the minimum rental income from master leases as a percentage of their total revenue.<br />
<br />
<table border="0" cellpadding="0" cellspacing="0" style="width: 580px;"><colgroup><col style="mso-width-alt: 4754; mso-width-source: userset; width: 98pt;" width="130"></col>
<col style="mso-width-alt: 10605; mso-width-source: userset; width: 218pt;" width="290"></col>
<col style="mso-width-alt: 5851; mso-width-source: userset; width: 120pt;" width="160"></col>
</colgroup><tbody>
<tr height="40" style="height: 30.0pt;">
<td class="xl67" height="40" style="height: 30.0pt; width: 98pt;" width="130"><b>Hospitality
Trust</b></td>
<td class="xl67" style="width: 218pt;" width="290"><b>Operating Models</b></td>
<td class="xl68" style="width: 120pt;" width="160"><b>Min. Lease Rental <br />as % of
Revenue</b></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">ARA US HT</td>
<td>Franchises</td>
<td class="xl65">Not Applicable</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">ART</td>
<td>Leases, Mgt Contracts</td>
<td class="xl66">14%</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">CDL HT</td>
<td>Leases, Mgt Contracts & Owner-Operated</td>
<td class="xl66">35%</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">Eagle HT</td>
<td>Franchises</td>
<td class="xl65">Not Applicable</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">Far East HT</td>
<td>Leases</td>
<td class="xl66">75%</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">Frasers HT</td>
<td>Leases, Mgt Contracts</td>
<td class="xl66">38%</td>
</tr>
</tbody></table>
<br />
Like most REITs, HTs have been well-liked by dividend investors. However, as this blog post shows, the revenue received by HTs is highly variable, depending on the operating model adopted. In theory, master leases provide the greatest stability compared to management contracts and franchises. However, most master leases of HTs have fixed and variable rent components. The higher the variable rent component, the more variable is the revenue stream. Dividend investors should really consider whether HTs should form part of their portfolios.<br />
<br />
Although the segregation of roles and responsibilities between the owner (i.e. HT) and the operator through the various operating models splits the risks between them, it is ultimately a zero-sum game. When the hospitality industry faces a severe downturn like the current COVID-19 situation, neither the owner nor the operator wins. Even when the owner is relatively shielded at the expense of the operator via master leases with fixed rentals, investors need to check the credit risks of the operator. If the operator cannot pay the fixed rentals, the owner will also lose. Investors in hotel companies and HTs can only pray that the COVID-19 crisis is resolved quickly.<br />
<br />
<br />
See related blog posts:<br />
<ul>
<li><a href="https://boringinvestor.blogspot.sg/2017/11/some-hotels-could-be-very-valuable.html">Some Hotels Could Be Very Valuable!</a></li>
<li><a href="https://boringinvestor.blogspot.sg/2017/11/will-gl-rise-like-mandarin-oriental.html">Will GL Rise Like Mandarin Oriental?</a></li>
</ul>
</div>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com14tag:blogger.com,1999:blog-6213354074634538714.post-39035144962364473562019-09-08T23:42:00.001+08:002019-09-09T23:38:33.911+08:00Burnout<div style="text-align: justify;">
How time flies. It has been exactly 7 years since I started this blog. It has not been a continuous process, though, as I stopped blogging for exactly a year from Jun last year to Jun this year. The cause? Burnout.</div>
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<br /></div>
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For 5 over years, I have tried to blog at least once a week. It gives readers continuity, as they know that I am always around. This is especially important during times of market stress, as readers know that I do not talk about investments only during good times and leave them in the lurch during bad times. Also, they only need to check my blog once and only once a week. The inspiration for a weekly blog came from a current affairs blog that I regularly visited in the past -- www.littlespeck.com, which is now no longer updated as the author has passed away. I liked the regularity of his week blog, which provided updates on a sufficiently regular basis but is not too frequent to follow. I thought too that I could achieve the same kind of regularity, but alas, trying to think up an idea, research about it, organise the thoughts and write it out, and then repeating the cycle 52 times a year proved too much to bear and I burned out.</div>
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<br /></div>
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It was not just blogging that I stopped. Almost everything connected to personal finance stopped. I stopped tracking my expenses, which I had done for the past 24 years. I also stopped monitoring the performance of my portfolio, which I had done for the past 20 years. Naturally, since I stopped blogging, I also stopped thinking about specific stocks and bonds.</div>
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During this 1-year hibernation, I wondered whether my blog has added clarity to investment issues or simply contributed to the noise. Individually, each blog might have very good reasons for their recommendations, but because different blogs have different opinions on even the same topic, to a person who is trying to search for some clarity on the internet, he might end up being more confused after reading these blogs than before he started. Nevertheless, my wife consoled me that I have done my best to value-add to the investing community. There will be some readers who would appreciate the unique opinions that I have.</div>
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Although I stopped thinking about specific stocks and bonds, I was still keeping up with financial news and there were issues that bothered me and made me want to blog about them. Such issues include the restructuring of Hyflux and DBS Vickers' plans to move the retail stock trading into the bank. Although upset, I did not have the time and energy to restart my blog. </div>
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<br /></div>
<div style="text-align: justify;">
The issue that finally made me restart my blog was the IPO of Astrea V bonds in Jun. Coincidentally, my last posts before I stopped blogging were on the Astrea IV bonds. In my second-to-last post, I had blogged that I would not be applying for the Astrea IV bonds, although I corrected my initial thinking in my last post of 2018 and acknowledged that the Astrea IV bonds had sufficient safeguards. Fast forward to 1 year later, I decided to apply for the Astrea V bonds and I thought I should come out and reiterate my thoughts about the Astrea bonds before I applied for them. See <a href="https://boringinvestor.blogspot.com/2019/06/astrea-v-385-bonds-understanding-what.html">Astrea V 3.85% Bonds – Understanding What You Are Buying Into</a> for more info.</div>
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<br /></div>
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Once I restarted, the inertia was overcome and it became easier to continue blogging again. Nevertheless, I am conscious of the demands of a weekly blog and I would only be blogging whenever time permits and when ideas come to me. It is more sustainable this way. </div>
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<br /></div>
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During the 1-year hibernation, although there were issues that made me want to restart blogging, there was also an incident that made me felt that all these years of blogging had been wasted. In Jan this year, I attended the Astrea Investor Day. During the Question & Answer session, one participant asked "could we have more of Astrea bonds?". This was despite the ongoing debacle of the Hyflux preference shares and perpetual capital securities. While I acknowledge that the Astrea bonds have safeguards to protect retail investors, I do not think that they are sure-win investments. Is it a case of the bonds having no risks at all, or that particular participant being blissfully ignorant of the risks? After coming back from hibernation, I wrote a series of posts on the Astrea/ Private Equity (PE) bonds. They can be found <a href="https://boringinvestor.blogspot.com/search/label/Private%20Equity%20Bonds">here</a>. Readers can read and gauge for themselves whether the Astrea/ PE bonds are really risk-free or not.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
That question really hurts. It hurts much more than if someone were to criticise my blog posts. For so many years, I have been blogging and keeping the blog free for all so that it could add value to the investment community and make a small difference to the world. That question just proved that it was probably my wishful thinking and my blog never really made much of a difference. It made me wonder whether I should still continue blogging. So, please, do not let me hear such questions again. It really hurts. </div>
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<br /></div>
<div style="text-align: justify;">
Finally, for readers who have been regularly reading and supporting this blog, I thank all of you for your time and sharing of your views. </div>
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<br /></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
See related blog posts:</div>
<ul>
<li>Where it all began: <a href="http://boringinvestor.blogspot.sg/2012/09/the-beginning-of-end.html">The Beginning of the End</a></li>
<li>1st blog birthday: <a href="http://boringinvestor.blogspot.sg/2014/04/a-years-worth-of-blog-posts.html">A Year's Worth of Blog Posts</a></li>
<li>2nd blog birthday: <a href="http://boringinvestor.blogspot.sg/2015/04/about-blogging-and-investing.html">About Blogging and Investing</a></li>
<li>3rd blog birthday: <a href="http://boringinvestor.blogspot.sg/2016/04/the-value-of-boring-investor-blog.html">The Value of (The) Boring Investor Blog</a> </li>
<li>4th blog birthday: <a href="http://boringinvestor.blogspot.sg/2017/04/i-didnt-let-my-alma-mater-down.html">I Didn't Let My Alma Mater Down</a></li>
<li>5th blog birthday: <a href="https://boringinvestor.blogspot.com/2018/04/how-long-can-boring-investor-blog.html">How Long Can (The) Boring Investor Blog Continue?</a></li>
</ul>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com8tag:blogger.com,1999:blog-6213354074634538714.post-2164419014198876112019-08-18T11:09:00.002+08:002020-12-20T23:41:40.515+08:00Possibly The Worst Time to Invest – 5 Years On<div style="text-align: justify;">
US-China trade wars, Hong Kong protests, US yield curve inversion, etc. You probably would be thinking now is a bad time to invest. I had the same feelings 5.5 years ago in Dec 2013, when the Dow Jones Industrial Average was then near an all-time high and interest rates near an all-time low. You can read more about it in <a href="https://boringinvestor.blogspot.com/2014/02/possibly-worst-time-to-invest.html">Possibly The Worst Time to Invest</a>. Nevertheless, I still went ahead to initiate a plain vanilla passive portfolio comprising 70% in global equities and 30% in global bonds. In 2015, I also added a more spicy passive portfolio comprising 70% in US equities and 30% in Asian bonds. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Each year, I would blog about whether that decision in Dec 2013 turned out to be correct or not. Each year, the blog post would say the passive portfolios were up and there is inherent defence mechanism to manage the fearsome stock market crashes through portfolio rebalancing. These once-a-year blog posts on this series almost sound like a broken record.</div>
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<br /></div>
<div style="text-align: justify;">
This year, the plain vanilla portfolio is up by 39.5% since inception 5.5 years ago, while the spicy portfolio is up by 34.7% since inception 4 years ago. You can read about last year's figures in <a href="https://boringinvestor.blogspot.com/2018/05/possibly-worst-time-to-invest-4-years-on.html">Possibly The Worst Time to Invest – 4 Years On</a>.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Each year, there are bound to be events that worry us and stop us from investing. But each year, the stock market would somehow manage to shrug off the worrisome events and continue its upwards march, reaching new highs which previously seemed unimaginable along the way. A couple of years later, would you still remember the events that stopped you from investing? Do you still remember the taper tantrum in 2013, the threat of Grexit and yuan devaluation in 2015, the shock Brexit vote and US presidential election in 2016? Some of these events have faded from memory, and some people might wonder what was the fuss that stopped anyone from investing in 2013/ 2015/ 2016, etc. But when these events were playing out, the mood was cautious and the stock markets were falling. A couple of years from now, would most people still remember the US-China trade wars, Hong
Kong protests and US yield curve inversion that are causing the stock markets to drop currently?</div>
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<br /></div>
<div style="text-align: justify;">
There will be a time when the stock market crash really arrives. But no one can predict reliably when it will arrive. The best way to deal with it is not to stop investing, but to have a good defence mechanism in place while investing. </div>
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<br /></div>
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<br /></div>
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See related blog posts:</div>
<ul>
<li><a href="https://boringinvestor.blogspot.com/2014/02/possibly-worst-time-to-invest.html">Possibly The Worst Time to Invest</a> <br /></li>
<li><a href="https://boringinvestor.blogspot.com/2015/03/possible-worst-time-to-invest-year-on.html">Possible The Worst Time to Invest – A Year On</a></li>
<li><a href="https://boringinvestor.blogspot.com/2016/04/possibly-worst-time-to-invest-2-years-on.html">Possibly The Worst Time to Invest – 2 Years On</a></li>
<li><a href="https://boringinvestor.blogspot.com/2017/04/possibly-worst-time-to-invest-3-years-on.html">Possibly The Worst Time to Invest – 3 Years On</a></li>
<li><a href="https://boringinvestor.blogspot.com/2018/05/possibly-worst-time-to-invest-4-years-on.html">Possibly The Worst Time to Invest – 4 Years On</a></li>
<li><a href="https://boringinvestor.blogspot.com/2020/12/possibly-worst-time-to-invest-6-years-on.html">Possibly The Worst Time to Invest – 6 Years On</a></li>
</ul>Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com4tag:blogger.com,1999:blog-6213354074634538714.post-76896383430453429522019-08-12T12:16:00.000+08:002019-08-12T12:18:20.096+08:00Effects of New Accounting Rule on Leases<div style="text-align: justify;">
Did you notice that in recent quarters, companies have been reporting better EBITDA (Earnings before Interest, Tax, Depreciation & Amortisation) and Free Cashflow figures? Do not be happy too soon, as the improvements could merely be due to a change in accounting rule for leases.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Before this year, companies that lease properties, equipment, etc. could choose to treat the leases as operating leases if they meet certain conditions and expense the rents as they fall due. There are no assets and liabilities on the balance sheet associated with these operating leases. This poses a problem when comparing against companies that own the properties and/or equipment. In reality, is a company that leases property very different from another that owns a leasehold property? In terms of the rights to use the property, the differences are small, but financially, the differences can be quite significant. On the balance sheet, such property-owning companies would have more assets and probably more loans to fund these assets. On the income statement, these companies would not have to pay any rent but would have higher depreciation and probably higher interest expenses.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Starting from this year, all companies have to adopt the Singapore Financial Reporting Standards (International) SFRS(I) 16 on Leases, which standardise the way companies report leases on their financial statements. Companies can no longer choose to treat their leases as operating leases and expense the rents. Companies have to treat their leases as financial leases and include the asset as a Right-of-Use (ROU) asset and a corresponding lease liability on the balance sheet. The lease liability is the present value of all future lease payments. At the start of the lease period, both the ROU asset and lease liability must match and balance out each other.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Companies only have the rights to use the ROU asset for the duration of the lease. Hence, at the end of the lease period, both the ROU asset and lease liability have to be reduced to zero. ROU asset is reduced to zero through depreciation. Lease liability is reduced to zero through amortisation. This is similar to loan repayment, in which the remaining loan amount each year is increased slightly by the interest expense, but reduced by a larger amount by the loan repayment. Both depreciation and amortisation affect the income and cashflow statements. It would be clearer to illustrate the changes using a company's actual financial statements.<br />
<br />
The example used here is Hour Glass, which is a watch retailer that leases properties to operate its shops. Its business is generally stable, making year-to-year comparison valid. Furthermore, it separates out ROU assets and depreciation while most companies combine
them with Property, Plant and Equipment (PPE), hence, allowing a clearer view of the effects of SFRS(I)
16. Companies should be encouraged to adopt the same practice.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u>Balance Sheet</u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Fig. 1 below shows the balance sheet for Hour Glass in 1Q2019. </div>
<div style="text-align: justify;">
<br /></div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh0tnJMozY3YVE1BOfGubib_Pi-4RFQt2bs4bpJuKrjd_HUxf2VACzuNx-nS3WzS4tALL-SGjwpEbFs3cdRz-1YHOAJb5vUJC_ZaPXhFdDeX-xJzFcRZpg7bro_W0AUL8i6SBdI_WecT_c/s1600/HrGlassBalSheetHighlight.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="900" data-original-width="578" height="640" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh0tnJMozY3YVE1BOfGubib_Pi-4RFQt2bs4bpJuKrjd_HUxf2VACzuNx-nS3WzS4tALL-SGjwpEbFs3cdRz-1YHOAJb5vUJC_ZaPXhFdDeX-xJzFcRZpg7bro_W0AUL8i6SBdI_WecT_c/s640/HrGlassBalSheetHighlight.png" width="408" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 1: Balance Sheet</td></tr>
</tbody></table>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Hour Glass adopted SFRS(I) 16 starting from this Financial Year (FY), which began in Apr 2019. It added ROU assets of $113.8M and corresponding lease liabilities of $116.1M. The ROU assets are nearly twice as much as Property, Plant and Equipment (PPE) which amounts to $58.7M. This shows that the value of rental properties could be as much as or even more significant than the leasehold properties that the companies own. Note that not all companies report ROU assets separately; some companies report them together with PPE.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u>Income Statement</u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Fig. 2 below shows the income statement for 1Q2019.</div>
<div style="text-align: justify;">
<br /></div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjZ5c0zEd4UOBerlHSkeXr5tE8kigloWmjma3bUfVF9jXZXOkxrVbV3kBPYxAkUuZF-Mnvrnz4ACAmYSpN6RFLq_tq7gi2aB3jydGL8iSCCYKf3fMkUgqbd-lI8Hf8pA2k2IFSBxI2JQAs/s1600/HrGlassIncomeHighlight.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="900" data-original-width="1116" height="321" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjZ5c0zEd4UOBerlHSkeXr5tE8kigloWmjma3bUfVF9jXZXOkxrVbV3kBPYxAkUuZF-Mnvrnz4ACAmYSpN6RFLq_tq7gi2aB3jydGL8iSCCYKf3fMkUgqbd-lI8Hf8pA2k2IFSBxI2JQAs/s400/HrGlassIncomeHighlight.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 2: Balance Sheet</td></tr>
</tbody></table>
<div style="text-align: justify;">
</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
On the income statement, rental expenses are reduced significantly from $7.6M in 1Q2018 to $1.2M in 1Q2019. On the other hand, there is additional depreciation of $6.9M on the ROU assets. Finance cost is also higher by $0.5M to account for the interest expense incurred on the lease liabilities. Assuming all other factors remain constant, the net effect of these factors due to adoption of SFRS(I) 16 is a reduction of $1.1M in operating profit for Hour Glass in 1Q2019.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
However, if you compute EBITDA, EBITDA computation excludes depreciation and interest, among others. Changes in depreciation and interest do not affect EBITDA. Hence, only the change in rental expenses affects EBITDA. Holding all other factors constant, EBITDA would have increased by $6.4M in 1Q2019. In 1Q2018, Hour Glass' EBITDA was $19.2M. The change in accounting rule for leases has increased Hour Glass' EBITDA by 33%!</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u>Cashflow Statement</u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Fig. 3 below shows the cashflow statement for 1Q2019.</div>
<div style="text-align: justify;">
<br /></div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjUX7-6jlxIW2D3_0ZCXTta90StFr_XSonH94dx4I2JUDLTgmSo-WCw7lKPuF_-wDtE8q0u4U8C9IItcUQ3fqElMaoinKy6FcLBDnJ8oSNB6W2kaceuWrVvP6f9AYWpckh6Z0J_37OVPF8/s1600/HrGlassCashflowHighlight.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="900" data-original-width="768" height="640" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjUX7-6jlxIW2D3_0ZCXTta90StFr_XSonH94dx4I2JUDLTgmSo-WCw7lKPuF_-wDtE8q0u4U8C9IItcUQ3fqElMaoinKy6FcLBDnJ8oSNB6W2kaceuWrVvP6f9AYWpckh6Z0J_37OVPF8/s640/HrGlassCashflowHighlight.png" width="545" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 3: Cashflow Statement</td></tr>
</tbody></table>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
For Cashflow from Operations (CFO), depreciation from ROU assets is added back to the operating profit. For Cashflow from Financing (CFF), payment of lease liabilities, i.e. rental expenses, is included. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Previously, rental expenses would have been deducted when computing the operating profit which is used as the starting point to compute the CFO. The rental expenses have been mostly replaced by depreciation of ROU assets, but in computing the CFO, the depreciation of ROU assets is added back. Hence, the net effect is an increase in CFO, by an amount equivalent to the payment of lease liabilities, which is now moved to CFF. Holding all other factors constant, the net effect is an increase in CFO by $6.1M, or 53% from 1Q2018!</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Free Cashflow (FCF) is generally computed as CFO minus capex. Since CFO increased by $6.1M, FCF would have increased by an equivalent amount. Assuming no change in capex, FCF for Hour Glass in 1Q2019 would have increased by 68% simply from a change in accounting rule!</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u>Conclusion</u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
The above discussion summarises the key changes arising from the change in accounting rule for leases. There are other changes required to reconcile the balance sheet items for each company. For more details, readers are advised to read the companies' financial statments. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Also note that all the improvements in EBITDA and FCF compared to the previous FY mentioned above are also because companies do not have to restate the financial statements for the previous FY. Effectively, the financial statements for this FY are not comparable to that of the previous FY. Do not be too happy when you see an increase in EBITDA and FCF figures this year!</div>
<div style="text-align: justify;">
</div>
<div style="text-align: justify;">
</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
P.S. I am vested in Hour Glass.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
See related blog posts:</div>
<ul>
<li><a href="http://boringinvestor.blogspot.com/2016/05/understanding-accounting-for-joint.html">Understanding the Accounting for Joint Ventures</a></li>
<li><a href="http://boringinvestor.blogspot.com/2016/07/understanding-shipbuilders-balance.html">Understanding Shipbuilders' Balance Sheets</a></li>
<li><a href="http://boringinvestor.blogspot.com/2017/10/accounting-for-hyfluxs-water-treatment.html">The Accounting for Hyflux's Water Treatment Plants</a></li>
</ul>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com6tag:blogger.com,1999:blog-6213354074634538714.post-7350946981058865222019-07-28T16:41:00.000+08:002019-07-28T16:41:30.965+08:00Does SIA's 3.03% Bond Have Sufficient Margin of Safety?<div style="text-align: justify;">
Following up from last week's blog post on <a href="http://boringinvestor.blogspot.com/2019/07/will-temasek-bail-out-sia-bondholders.html">Will Temasek Bail Out SIA Bondholders In Event of Default?</a>, here is the analysis on SIA's 5-year 3.03% bond based on Benjamin Graham's criteria as described in <a href="http://boringinvestor.blogspot.com/2014/01/the-lost-art-of-bond-investment.html">The Lost Art of Bond Investment</a>. Surprisingly, the bond is not as strong as I initially thought based on a simple Debt-to-Equity ratio check. Below are the computation of the earnings coverage
and stock value ratio based on SIA's
latest financial statements for Financial Year 18/19 ending in Mar 2019.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u>Earnings Coverage</u></div>
<div style="text-align: justify;">
<div style="text-align: justify;">
</div>
<table border="0" cellpadding="0" cellspacing="0" style="width: 535px;"><colgroup><col style="mso-width-alt: 14006; mso-width-source: userset; width: 287pt;" width="383"></col>
<col style="mso-width-alt: 5558; mso-width-source: userset; width: 114pt;" width="152"></col>
</colgroup><tbody>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt; width: 287pt;" width="383">Profit before tax</td>
<td class="xl65" style="width: 114pt;" width="152">= $868.6M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">Adjusted for:</td>
<td class="xl65"><br /></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">- Deduct: Share of profits from joint ventures</td>
<td class="xl65">= $23.2M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">- Add: Share of losses from associates</td>
<td class="xl65">= $97.4M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">- Add: Rental on leased aircraft</td>
<td class="xl65">= $679.7M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">- Add: Finance cost</td>
<td class="xl65">= $116.1M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><b>Total earnings available for covering
fixed charges</b></td>
<td class="xl65"><b>= $1,738.6M</b></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><br /></td>
<td class="xl65"><br /></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">Current finance cost</td>
<td class="xl65">= $116.1M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">Adjusted for:</td>
<td class="xl65"><br /></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">- Add: Rental on leased aircraft</td>
<td class="xl65">= $679.7M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">- Add: Interest for $600M @ 3.16% MTN 007 series</td>
<td class="xl65">= 3.16% x $600M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><br /></td>
<td class="xl65">= $19.0M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">- Add: Interest for $750M @ 3.03% MTN 001 series</td>
<td class="xl65">= 3.03% x $750M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><br /></td>
<td class="xl65">= $22.7M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><b>Total finance cost</b></td>
<td class="xl65"><b>= $837.5M</b><b> </b></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><br /></td>
<td class="xl65"><br /></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><b>Earning Coverage</b></td>
<td class="xl65"><b>= $1,738.6M / $837.5M</b></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><b><br /></b></td>
<td class="xl65"><b>= 2.08</b><strike><b> </b></strike></td>
</tr>
</tbody></table>
<br />
Several adjustments were made to compute the total earnings available for covering fixed charges and total finance cost. The more unusual adjustment in SIA's case involves adding the rental of leased aircraft to both figures. This is because SIA leases aircraft in addition to buying them. The leases range from 6 to 12 years and cannot be cancelled, although there are options for early termination for up to 2 years before the original lease expiry. The leased aircraft do not appear on the balance sheet.<br />
<br />
On the other hand, for aircraft that SIA owns by borrowing money from the banks, the aircraft appear as a asset and the loan appears as a liability on the balance sheet. On the income statement, there is no rental required, but SIA incurs depreciation and interest on the loan.<br />
<br />
Hence, for the leased aircraft, even though SIA does not incur a finance cost, the rental is effectively a fixed charge that SIA has to cover, as the leases cannot be cancelled and SIA needs the aircraft to continue its operations. A similar adjustment needs to be made for the balance sheet, as discussed in the section later.<br />
<br />
The current finance cost is also adjusted for interest on a $600M 3.16% Medium Term Note (MTN) issued on 26 Oct 2018 and the $750M 3.03% bond issued on 29 Mar 2019 which is the subject of this blog post. Although both bonds already appear on the balance sheet as at 31 Mar 2019, their first interest payments will only be made in FY19/20, Hence, their interest payments need to be added to compute the actual finance cost.<br />
<br />
Based on the above adjusted figures, the earnings coverage is computed to be 2.08 times, which is
below the minimum average earnings coverage of 3 times for industrial companies.</div>
<br />
<u>Stock Value Ratio</u><br />
<br />
<div style="text-align: justify;">
<table border="0" cellpadding="0" cellspacing="0" style="width: 423px;"><colgroup><col style="mso-width-alt: 9398; mso-width-source: userset; width: 193pt;" width="257"></col>
<col style="mso-width-alt: 6070; mso-width-source: userset; width: 125pt;" width="166"></col>
</colgroup><tbody>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt; width: 193pt;" width="257">No. of shares</td>
<td class="xl65" style="width: 125pt;" width="166">= 1,199.9M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">Share price</td>
<td class="xl65">= $9.62</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><b>Market value of shares</b></td>
<td class="xl65"><b>= $11,542.6M</b></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><br /></td>
<td class="xl65"><br /></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">Current borrowings</td>
<td class="xl65">= $6,654.4M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">Adjusted for:</td>
<td class="xl65"><br /></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;">- Add: Liability for rental aircraft</td>
<td class="xl65">= $2,200.0M</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><b>Total borrowings</b></td>
<td class="xl65"><b>= $8,854.4M</b></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><br /></td>
<td class="xl65"><br /></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><b>Stock value ratio</b></td>
<td class="xl65"><b>= $11,542.6M / $8,854.4M</b></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td height="20" style="height: 15.0pt;"><b><br /></b></td>
<td class="xl65"><b>= 1.30 </b></td>
</tr>
</tbody></table>
</div>
<div style="text-align: justify;">
<br />
<div style="text-align: justify;">
As mentioned above, adjustments need to be made to the balance sheet for the rental aircraft. The rental aircraft is effectively an asset for SIA. Correspondingly, there should be a liability to account for the loan that SIA would have borrowed to purchase the aircraft outright. In fact, International Financial Reporting Standard (IFRS) 16 on Leases came into effective starting from Jan 2019 that requires companies like SIA to account for leased assets on their balance sheets. SIA has disclosed in its Annual Report that the assets will be increased by $1.7B while liabilities will be increased by $2.2B. <br />
<br />
Considering the $2.2B increase in total borrowings, the
stock value ratio is computed to be 1.30, which is higher than the minimum stock value ratio
of 1.0 for industrial companies.</div>
</div>
<div style="text-align: justify;">
<br />
<u>Quantitative Assessment</u></div>
<div style="text-align: justify;">
<br />
Thus, based on the above figures, SIA's 5-year 3.03% bond does not meet the earnings coverage criterion but meets the stock value ratio criterion. Based on
Benjamin Graham's criteria, the bond does not have sufficient margin of
safety.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u>Other Considerations</u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
As mention in my blog post on <a href="http://boringinvestor.blogspot.com/2019/07/will-temasek-bail-out-sia-bondholders.html">Will Temasek Bail Out SIA Bondholders In Event of Default?</a> last week, I believe Temasek will come to the rescue of SIA bondholders in the event that SIA could not pay interest and/or redeem the bond.<br />
<br />
P.S. I am vested in SIA's 3.03% bond.<br />
<br />
<br />
See related blog posts:<br />
<ul>
<li><a href="http://boringinvestor.blogspot.sg/2014/01/the-lost-art-of-bond-investment.html">The Lost Art of Bond Investment</a></li>
<li><a href="http://boringinvestor.blogspot.sg/2015/11/is-benjamin-grahams-art-of-bond.html" style="text-align: justify;">Is Benjamin Graham's Art of Bond Investment Outdated?</a></li>
<li><a href="http://boringinvestor.blogspot.com/2019/07/will-temasek-bail-out-sia-bondholders.html">Will Temasek Bail Out SIA Bondholders In Event of Default?</a></li>
</ul>
</div>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com0tag:blogger.com,1999:blog-6213354074634538714.post-21367437988964304432019-07-21T14:31:00.000+08:002019-07-28T16:43:01.574+08:00Will Temasek Bail Out SIA Bondholders In Event of Default?<div style="text-align: justify;">
As regular readers would know, I stopped blogging for a year. I did not just stopped blogging; I also stopped monitoring performance of my portfolio and analysing shares and bonds in detail. So when SIA launched its retail 3.03% bond in Mar this year, I did not analyse it in detail as I would typically do using Benjamin Graham's method (see <a href="http://boringinvestor.blogspot.sg/2014/01/the-lost-art-of-bond-investment.html" target="_blank">The Lost Art of Bond Investment</a> for details) and simply bought it. I took a glance at its financial statements, carried out a simple Debt-to-Equity check and concluded that its debt obligations were not too excessive. Most importantly, I relied upon the assumption that SIA's parent, Temasek, would bail out bondholders in full in event of a default. This was not the only time that I relied on similar assumptions when buying bonds. I did the same when I bought Fraser Property's 3.65% bond (see <a href="http://boringinvestor.blogspot.sg/2015/11/does-fcls-365-bond-have-sufficient.html">Does FCL's 3.65% Bond Have Sufficient Margin of Safety?</a> for more info).</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Now that I am back to blogging (and thinking about financial issues), it is worth diving deeper to examine whether the assumption is rock solid and could be relied upon. Do note that this is not entirely a hypothetical question, as the airlines industry is a highly competitive one. Bankruptcies are not uncommon. Past examples include American Airlines, Delta Airways, Northwest Airlines, etc. going into Chapter 11 protection. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
So, will Temasek come to the rescue of bondholders in the event SIA defaults on the bond? To answer this question, we need to first understand the background of SIA and Temasek. So, the first question is: will Temasek rescue SIA? The answer must be a resounding yes. SIA is the national airline and the pride of the nation. When our political leaders go overseas for conferences, they fly with SIA. It is difficult to imagine our political leaders flying on some other countries' national airlines. Thus, yes, Temasek will come to the rescue of SIA.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
However, rescuing SIA the company is not the same as rescuing SIA bondholders. While SIA the company is a strategic national asset, SIA bondholders (and shareholders) are not. Furthermore, the ultimate shareholders of Temasek are Singaporeans. Bailing out SIA and its bondholders with Temasek's money is akin to using taxpayers' money to do so. It will be politically difficult to use taxpayers' money to bail out bondholders in full. The most likely scenario is that the settlement with bondholders will be at arm's length basis on normal commercial terms, i.e. the outcome would be similar to another company that is not owned by Temasek. In other words, bondholders will suffer some capital losses. This is not unlike the case of Hyflux preference shares and perpetual capital securities. Thus, from this perspective, SIA bondholders should not expect Temasek to bail them out in full.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
On the other hand, SIA is not the only company that Temasek owns. Temasek owns a lot of companies in its portfolio. Temasek has triple-A ratings from both Moody's and S&P. Not all the companies in its portfolio has similar ratings based on their own merits. When companies with lower ratings borrow money, lenders take into consideration the fact that the company is majority owned by Temasek and offer a lower interest rate compared to a company that does not have Temasek as its backing. In the event that Temasek does not step in to bail out bondholders in full, credit markets will take note and will not offer lower interest rates to Temasek-owned companies in future. Each company has to pay an interest rate that is commensurate with its own credit rating. In other words, Temasek will have to bear higher interest payments across most of its subsidiaries. This long-term economic cost might outweigh the short-term political cost and prompt Temasek to bail out bondholders in its subsidiaries in full.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Finally, we should also note that Temasek, although it does not play an active role in day-to-day management of the subsidiaries' operations, is not a sleeping partner either. Long before trouble happens and hits the headlines, Temasek would have done something to avert it. For example, Tiger Airways, SIA's budget airline, had been losing money for 4 out of 6 years since its listing on SGX in Jan 2010. It carried out 3 rights issues over the same period. It also issued a 2% perpetual capital convertible securities (PCCS) in Apr 2013. If the trend were to continue, Tiger Airways would probably have failed and defaulted on the PCCS. In Nov 2015, SIA announced that it would take over Tiger Airways. It also redeemed all outstanding PCCS upon successful takeover of the company.</div>
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In conclusion, I had been lazy in analysing the SIA 3.03% bond when I bought it. But I guess I still can rely on the assumption that Temasek would step in and bail bondholders out in the event of default by SIA. Nevertheless, I should do my homework and analyse whether the SIA bond has sufficient margin of safety according to Benjamin Graham's method.</div>
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See related blog posts:</div>
<ul>
<li><a href="http://boringinvestor.blogspot.sg/2014/01/the-lost-art-of-bond-investment.html" target="_blank">The Lost Art of Bond Investment</a></li>
<li><a href="http://boringinvestor.blogspot.com/2019/07/does-sias-303-bond-have-sufficient.html">Does SIA's 3.03% Bond Have Sufficient Margin of Safety?</a></li>
<li><a href="http://boringinvestor.blogspot.sg/2015/11/does-fcls-365-bond-have-sufficient.html">Does FCL's 3.65% Bond Have Sufficient Margin of Safety?</a></li>
</ul>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com2tag:blogger.com,1999:blog-6213354074634538714.post-9542185571158024532019-07-07T01:31:00.000+08:002019-07-07T11:28:13.468+08:00Are Private Equity Bonds Better Than Corporate Bonds?<div style="text-align: justify;">
When Astrea V 3.85% bond was launched, some investors remarked that it is better than some of the recently issued corporate bonds, such as SIA 3.03% bonds. What are the differences between Private Equity (PE) bonds and corporate bonds, and are PE bonds really better than corporate bonds?</div>
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It is difficult to compare Astrea bonds with, say, SIA bonds, since their nature of business are different. To make the comparison between PE bonds and corporate bonds more meaningful, let us consider a hypothetical bond issued by Azalea Asset Management, which is the sponsor of the Astrea III/IV/V bonds. Fig. 1 below shows the corporate structure of Azalea.</div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDHJEskYl4gLxX8-HTg1QeYBQnAd9d7pHbwAGgi_M_p9dySBp9-RLXSyouafSB4t7joCHpNjpQvbYaYOW-JOicfF06zp8ZobjA5yuzZicZOQ2_2pcUIxjf7b-thSRv1ZvABUuuClYB0wM/s1600/AzaleaGroup.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="508" data-original-width="868" height="233" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDHJEskYl4gLxX8-HTg1QeYBQnAd9d7pHbwAGgi_M_p9dySBp9-RLXSyouafSB4t7joCHpNjpQvbYaYOW-JOicfF06zp8ZobjA5yuzZicZOQ2_2pcUIxjf7b-thSRv1ZvABUuuClYB0wM/s400/AzaleaGroup.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 1: Azalea Corporate Structure</td></tr>
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The assets of Azalea are the 3 Astrea companies issuing the Astrea III/IV/V bonds and owning the underlying portfolios of PE funds. Azalea probably has some other income-generating assets, such as the investment management company shown in Fig. 1 above, plus some other unlisted PE funds. Thus, the nature of business of Azalea and Astrea III/IV/V companies are similar. What would be the differences between the hypothetical Azalea corporate bond and Astrea III/IV/V PE bonds? Note that the PE bonds are not limited to the Class A-1 bonds which are open to retail investors. There are also Class A-2, B and C bonds. </div>
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The first key difference would be the security of the bonds over the assets. Astrea PE bonds are secured against the PE funds in the respective Astrea companies, whereas Azalea corporate bond would be unsecured. In the hypothetical scenario where the Astrea PE bonds default, Astrea bondholders could force the respective Astrea companies to liquidate their PE funds and return money to the bondholders. However, in the event that the liquidation proceeds are insufficient to redeem the bonds, bondholders have no recourse to Azalea, or to the other Astrea companies. For example, if Astrea III bonds were to default, Astrea III bondholders have no rights to the assets of Azalea, Astrea IV and Astrea V companies. The assets of each company are ring-fenced and could only be used to service the bonds issued by the respective company.</div>
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Similarly, in the hypothetical scenario where the Azalea corporate bond defaults, Azalea bondholders have no claims over the PE funds held in the 3 Astrea companies. Nevertheless, they could force Azalea to sell off the Astrea companies together with their portfolio of PE funds and PE bonds. However, they could not force Azalea to break up the Astrea companies, sell off their PE funds, redeem the Astrea PE bonds, and return excess cash to Azalea to pay off the corporate bondholders (Note: it might be possible to do so for other project/ asset-level bonds, but the terms of Astrea PE bonds do not allow for early liquidation of assets and redemption of bonds). In other words, regardless of what happens to Azalea, Astrea PE bondholders will not be affected. </div>
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So does it mean that Astrea PE bonds, which are secured against the PE funds of the respective Astrea companies, are better than Azalea corporate bonds which are unsecured? Not necessarily. The key factor is the quality of the assets that are securing the bonds. If the assets are of high quality, the PE bonds have good collaterals. Conversely, if the assets are of low quality, the collaterals would be useless. Remember, Astrea PE bondholders have no recourse to Azalea and the other Astrea companies. They can only count on the assets in their respective Astrea companies to pay interest and redeem the bonds. </div>
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Although Azalea corporate bond is unsecured, if the Astrea companies are generating good cashflows for Azalea, it does not matter whether the bond is secured or not. In a hypothetical scenario where one of the Astrea companies have poor assets whereas the other Astrea companies have good assets, it might be better to hold the unsecured Azalea corporate bond than the secured but troubled Astrea PE bond. So, quality of assets is key in determining whether secured or unsecured bonds are better.</div>
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The second difference is that Azalea could have other income-generating
assets and businesses besides the 3 Astrea companies. In Fig. 1 above,
it has an investment management subsidiary to manage the investments in
PE funds for the Astrea companies in return for a fee. It could
also have other PE funds that are outside the Astrea companies. So, for
Azalea corporate bonds, there could be other sources of operating
cashflows, whereas for Astrea PE bonds, the only source of cashflows is
the PE funds in the respective Astrea companies. <br />
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The third difference is that besides receiving cashflows from the Astrea companies to redeem the Azalea corporate bond, Azalea could refinance the bond through bank borrowings, new corporate bonds, shareholder loans from Temasek, or even private share placements and IPO! Being a corporate bond, there are many avenues to refinance it. Astrea PE bonds do not have such avenues. To reiterate, Astrea PE bondholders can only count on the assets in the respective Astrea companies. If the assets are good, PE bondholders will get the promised returns. If the assets are poor, they will suffer some losses.</div>
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Having said the above, being able to borrow money is a double-edged sword. While borrowings could help to refinance the Azalea corporate bond, Azalea could also run the risk of borrowing too much money and jeopardise its ability to pay interest to and/or redeem the Azalea corporate bond if banks decide that Azalea's credit risk is too high. For the Astrea PE bonds, such risks have been mitigated. The terms of Astrea PE bonds prohibit the Astrea companies to borrow money other than to issue the different classes of bonds at inception, as well as to meet capital calls and cover bond interest payment shortfalls. The last 2 conditions are actually safeguards for the PE bondholders (see <a href="http://boringinvestor.blogspot.com/2018/06/understanding-safeguards-of-astrea-iv.html">Understanding the Safeguards of Astrea IV 4.35% Bonds</a> for more info).</div>
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In conclusion, PE bonds are not necessarily better or worse than corporate bonds. The key words are: quality of assets securing the PE bonds. This is unlike preference shares and perpetual capital securities, which are inherently inferior to stocks and bonds (see <a href="http://boringinvestor.blogspot.com/2016/05/prefs-and-perps-are-generally-inferior.html">Prefs and Perps are Generally Inferior to Stocks and Bonds as an Investment Form</a> for more info). </div>
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See related blog posts:</div>
<ul>
<li><a href="http://boringinvestor.blogspot.com/2016/05/prefs-and-perps-are-generally-inferior.html">Prefs and Perps are Generally Inferior to Stocks and Bonds as an Investment Form</a> </li>
<li><a href="http://boringinvestor.blogspot.com/2018/06/understanding-safeguards-of-astrea-iv.html">Understanding the Safeguards of Astrea IV 4.35% Bonds</a> </li>
<li><a href="http://boringinvestor.blogspot.com/2019/06/astrea-v-385-bonds-understanding-what.html">Astrea V 3.85% Bonds – Understanding What You Are Buying Into</a></li>
</ul>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com0tag:blogger.com,1999:blog-6213354074634538714.post-31874314331877940752019-06-30T02:12:00.000+08:002019-06-30T11:37:33.939+08:00A Shrinking Balance Sheet for Bonds in Mature PE Funds<div style="text-align: justify;">
In another few more days, the Class A-1 bonds of Astrea III, the first wholesale Private Equity (PE) bond listed in Singapore, will be redeemed as scheduled. What could we learn from the 3-year existence of this bond, which could provide some useful insights on the behaviour of Astrea IV and V bonds?</div>
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Astrea III publishes annual reports, which document the cashflows received, performance of its underlying PE investments, outlook for PE investments as well as the usual income statements and balance sheets. In the 3 years of its existence, the cashflows of Astrea III from its investments in PE funds are shown in Fig. 1 below.</div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhWOglGsf-am3dFEK2QY3aeHLYOxSTK9hpvY0EZ5vwBkRUMH0GzqMrY0UOKhSY5LapeLNz73N0z3AQuiZrBPNnAY682hCl8PbTW-amgF8ZuO3ziVzvZWNPp8mRzMqktbIgDSDDcAYhVxX8/s1600/A3Cashflow.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="610" data-original-width="936" height="260" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhWOglGsf-am3dFEK2QY3aeHLYOxSTK9hpvY0EZ5vwBkRUMH0GzqMrY0UOKhSY5LapeLNz73N0z3AQuiZrBPNnAY682hCl8PbTW-amgF8ZuO3ziVzvZWNPp8mRzMqktbIgDSDDcAYhVxX8/s400/A3Cashflow.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 1: 3-Year Cashflows of Astrea III</td></tr>
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Over the 3 years, Astrea III has received total distributions of USD952M, capital calls of USD176M, resulting in net distributions of USD776M. At inception, the weighted average age of the PE funds which Astrea III invested into is 6 years. The cashflows are typical of investments in mature PE funds, as shown in Fig. 2 below.</div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhs_ffwa00uPGOFIaScnkKKWgOhULapmAsPuhwLq29-2hV-VTNKXVu7G_XRcnlaVPTUpTHBggaIzsUhEssx2eDG_YGp24xmZmx2nEXLD-8DJHau63QX5_68d6IU1303wqClE85qGt_AjR0/s1600/AstreaBondLifespan.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="584" data-original-width="1092" height="213" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhs_ffwa00uPGOFIaScnkKKWgOhULapmAsPuhwLq29-2hV-VTNKXVu7G_XRcnlaVPTUpTHBggaIzsUhEssx2eDG_YGp24xmZmx2nEXLD-8DJHau63QX5_68d6IU1303wqClE85qGt_AjR0/s400/AstreaBondLifespan.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 2: Typical Cashflows of PE Investments</td></tr>
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Moving forward, Astrea III will likely see less distributions, as indicated in Fig. 2. Already, the investments made by the underlying PE funds into companies are showing signs of ageing, as shown in Fig. 3.</div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjjZ8zyJQF217v5gUzyHcXgu0QYD6TN0XK2_zRZx_9wkEi5TAWk9XVWX5hLbsgHs9HsqnyPkuCnxOr0qLgSCKo2k9sZzY55qKSo9Hebj6myhNYXQhu5ZGGNHqcobj0Xk-BobYKc62UHnPw/s1600/A3HoldPeriod.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="610" data-original-width="936" height="260" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjjZ8zyJQF217v5gUzyHcXgu0QYD6TN0XK2_zRZx_9wkEi5TAWk9XVWX5hLbsgHs9HsqnyPkuCnxOr0qLgSCKo2k9sZzY55qKSo9Hebj6myhNYXQhu5ZGGNHqcobj0Xk-BobYKc62UHnPw/s400/A3HoldPeriod.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 3: Holding Period of Underlying PE Investments</td></tr>
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The average holding period of the underlying PE funds' investments into companies has increased from 4.0 years in 2016, to 4.5 years in 2017 and 5.2 years in 2018. There are 2 opposing reasons why PE funds hold onto their investments for longer than usual -- it could be to extract more value from a good company, or it could be the company could not deliver as promised and the PE fund has difficulty selling it for a good price. If it is the first reason, it is a good thing for PE bond investors. But if it is the second reason, PE bond investors will have reasons to be worried.</div>
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What happened to the distributions received by Astrea III over the 3 years? Fig. 4 below shows the balance sheet for the Financial Years ending in Mar 2017, 2018 and 2019.</div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgOZBavAc7nBTnhWtIRtIwcNzj0OH84LMgPtLuHcU6BntdWZeUpB3dlIfddtF8NNB3d8OEw5z3sb2mHU2UHacRZL35DVGWre7kR57xOI5syiM0kQFEbt05i0pLRCj1erqci4dExqsfrceU/s1600/A3BalSheetWithRes.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="780" data-original-width="1280" height="243" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgOZBavAc7nBTnhWtIRtIwcNzj0OH84LMgPtLuHcU6BntdWZeUpB3dlIfddtF8NNB3d8OEw5z3sb2mHU2UHacRZL35DVGWre7kR57xOI5syiM0kQFEbt05i0pLRCj1erqci4dExqsfrceU/s400/A3BalSheetWithRes.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 4: Astrea III's Balance Sheets</td></tr>
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The first thing to notice is the investments in PE funds (yellow bar) have been shrinking, from USD1,070M in 2017 to USD904M in 2018 and finally to USD739M in 2019. This is due to the net distributions of USD568M from the PE funds from 2017 till 2019, offset by fair value gains (i.e. capital gains) in the PE funds of USD236M over the same period. </div>
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A portion of the net distributions went to increase the cash account (grey bar), which increased from $203M in 2017 to around USD340M in both 2018 and 2019. Another portion went to pay interest of USD21M to bondholders in 2018 and 2019. The remaining distributions were used to pay the sponsor in the form of repayment of shareholder loans and dividends to shareholder. From 2017 till 2019, a total of USD385M was paid to the sponsor/ shareholder. As a result, the sponsor equity (orange bar) has been shrinking.</div>
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Because of the distributions and payments to sponsor, the asset base has been shrinking. On the other hand, there is relatively little cashflow used to pay down the bonds (blue bar), as they have not matured. If the trend continues, bond holders might end up holding onto a shrinking asset base of ageing PE funds with declining distributions while the sponsor gets all its capital back (see <a href="http://boringinvestor.blogspot.com/2019/06/where-do-astrea-bonds-stand-along-pe.html">Where Do Astrea Bonds Stand Along PE Fund Lifecycle?</a> for more info on PE lifecycle and its impact on cashflows). By the time the bonds mature, there might be little cashflows left to redeem the bonds. Remember, once the cash leaves Astrea III by way of repayment of shareholder loans and/or dividend to shareholder, bond holders have no recourse to the sponsor, Azalea, or Temasek.<br />
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Thus, one key risk for bond investors in mature PE funds is when the fund is in the midst of the harvesting period, the sponsor gets most of the money while bond investors get only the interest payment. When the harvesting dries up, bond investors do not get sufficient cashflows to redeem the bonds while the sponsor already gets all its capital back.<br />
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Fortunately for Class A (A-1 and A-2) bond holders of Astrea III, there are safeguards in place to ensure that the above scenario does not happen. Every 6 months, Astrea III has to set aside some cash in reserves accounts which can only be used to redeem the Class A bonds. The reserves accounts totalled USD161M, USD224M and USD258M in 2017, 2018 and 2019 respectively. These reserves accounts are sufficient to redeem the Class A-1 bonds which will mature in the next few days. The total amount of Class A-1 bonds is SGD228M (approximately USD170M).<br />
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Another safeguard that Astrea III put in place is the Loan-to-Value (LTV) ratio should not exceed certain thresholds ranging from 20% to 45%. If these thresholds were exceeded, Astrea III has to divert more cashflows to the reserves accounts. Based on Fig. 4, the LTV ratio of Astrea III is 27%, 18% and 24% in 2017, 2018 and 2019 respectively.<br />
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Had there been no such safeguards to set aside cash during the harvesting period, the balance sheet would have been worse for bondholders. Fig. 5 below shows the balance sheet had the reserves accounts been paid out to sponsor.<br />
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgno4s-RoUKWRwMackhUYkMu4v-D61bWfispio1hlZv42auC8spJJolGAY3qOroRQxpKxnS9ZB67WcmKa4gcBrgQJsvQo_8nVVXu6MUVbuD7J3rzZKg_4BOfQ_OC5AghV7So5ZAClfQdQY/s1600/A3BalSheetNoRes.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="780" data-original-width="1280" height="243" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgno4s-RoUKWRwMackhUYkMu4v-D61bWfispio1hlZv42auC8spJJolGAY3qOroRQxpKxnS9ZB67WcmKa4gcBrgQJsvQo_8nVVXu6MUVbuD7J3rzZKg_4BOfQ_OC5AghV7So5ZAClfQdQY/s400/A3BalSheetNoRes.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 5: Balance Sheet of Astrea III Excluding Reserves Accounts</td></tr>
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The LTV ratios would have been 42%, 43% and 58% in 2017, 2018 and 2019 respectively. In particular, bond holders would end up being a larger supplier of capital than the sponsor while still not getting the bulk of the distributions from the PE investments!<br />
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In conclusion, if you are a bond investor in mature PE funds, be prepared to see a shrinking asset base while most of the distributions go to the sponsor. Make sure you have safeguards in place to ensure that a portion of the distributions are set aside for the sole purpose of redeeming the bonds!</div>
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See related blog posts:<br />
<ul>
<li><a href="http://boringinvestor.blogspot.com/2019/06/where-do-astrea-bonds-stand-along-pe.html">Where Do Astrea Bonds Stand Along PE Fund Lifecycle?</a></li>
<li><a href="http://boringinvestor.blogspot.com/2019/06/astrea-v-385-bonds-understanding-what.html">Astrea V 3.85% Bonds – Understanding What You Are Buying Into</a> </li>
<li><a href="http://boringinvestor.blogspot.com/2018/06/understanding-safeguards-of-astrea-iv.html">Understanding the Safeguards of Astrea IV 4.35% Bonds</a></li>
</ul>
</div>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com0tag:blogger.com,1999:blog-6213354074634538714.post-405412358834571452019-06-23T01:42:00.002+08:002019-06-30T11:33:05.731+08:00Where Do Astrea Bonds Stand Along PE Fund Lifecycle?<div style="text-align: justify;">
Now that the allocation for Astrea V 3.85% bonds is released, everyone can go back to their regular activities and forget about it. However, if you, like myself, hope to get a piece of the equity portion of Private Equity (PE) investments one day, then we should continue to learn and understand more about PE. Today's discussion is on the typical lifecycle of a PE fund and where do the 3 Astrea bonds stand along the lifecycle. This has major implications on the risks of the bonds, as we shall discuss later.</div>
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A PE fund usually has a lifecycle of around 10 years and comprises 4 phases. These 4 phases usually overlap. See Fig. 1 below (source: <a href="https://thedvsgroup.com/the-ultimate-guide-to-private-equity/">The Ultimate Guide to Private Equity</a>). </div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWF27gDMQMNVqtkTMLAEEGib6LdLsl-oqQjnrTrzusKvR62GlLdVuId8ya5UgingbaJ2u-zWNqG7t2vLJUETzn6oraGokxjv9BdUlxA0EBm2siw0VayIhgX1XcnLsF0Ryz5fF7Tc6NBz0/s1600/PELifecycle.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="280" data-original-width="720" height="155" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWF27gDMQMNVqtkTMLAEEGib6LdLsl-oqQjnrTrzusKvR62GlLdVuId8ya5UgingbaJ2u-zWNqG7t2vLJUETzn6oraGokxjv9BdUlxA0EBm2siw0VayIhgX1XcnLsF0Ryz5fF7Tc6NBz0/s400/PELifecycle.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 1: Lifecycle of PE Fund</td></tr>
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In the first phase, the General Partner (GP) who runs the PE fund, will source for new investors and get their commitment to provide capital as and when needed to invest into promising companies. When capital commitments reach the target fund size, the fund will close. </div>
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In the second phase, the GP will source for promising companies to invest into. This is usually called the Investment Period, as the fund is busy investing into companies. During this phase, the fund can invest in any new companies so long as they satisfy the criteria in the investment mandate.</div>
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After buying into the companies, the fund will work with the companies' management to enhance their operations such that they can achieve a higher valuation than what the fund paid for. The typical duration that a fund holds onto a company is about 5 years, but could exceed 10 years for an under-performing company.</div>
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When the time is ripe, the fund will seek to exit the company, either by IPO, sale to another company, or even sale to another PE fund. This is known as the Harvesting phase. During this period, the PE fund is not allowed to invest in new companies, but is allowed to invest additional money into existing companies, known as follow-on investments. </div>
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Finally, before the stated lifespan of the fund is up, the GP has to exit all remaining companies, return all proceeds to investors and dissolve the fund. The 10-year lifespan is not a fixed timeline, as GPs can request for extensions of 1-2 years so that they do not need to carry out a fire sale of the remaining companies. </div>
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Based on the above lifecycle of a PE fund, investors of the PE fund (known as Limited Partners) will contribute capital in the early years of the fund before receiving distributions in the later years when the PE fund exits its investments. The cumulative cash inflow over the lifecycle of the PE fund resembles a J-Curve. See Fig. 2 below.</div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiYvX14VvvQX7zeyZ4DxdKlRv8j93m4LOG9Fbsk6ETOzLjA8VXukYKQgEhRwFiuCZVfHEtrvcdvNcKtYgOdcU1vU7i8OhAWvaRuQUf0KcX0vI442kCTdbufTXIV5dOk7t5LfC_bPrHFZfQ/s1600/PEJCurve.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="520" data-original-width="820" height="252" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiYvX14VvvQX7zeyZ4DxdKlRv8j93m4LOG9Fbsk6ETOzLjA8VXukYKQgEhRwFiuCZVfHEtrvcdvNcKtYgOdcU1vU7i8OhAWvaRuQUf0KcX0vI442kCTdbufTXIV5dOk7t5LfC_bPrHFZfQ/s400/PEJCurve.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 2: PE J-Curve</td></tr>
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For an investor in a PE fund, where the fund is along its lifespan matters. In the early years, there is significant capital outlay as the PE fund invests into new companies. There are also significant risks in streamlining the company for greater efficiency. In addition, the company might struggle under the usually significant debt load placed upon it by the PE fund. Not all of the companies will prosper and make money for the PE fund. </div>
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In the closing years of the PE fund, although there is no further capital outlay, the cash distribution from the PE fund is declining as it exits more and more companies. Also, whatever companies remaining in the PE fund might be under-performing and might not be worth much. If a company is attractive to other buyers, it probably would have been sold before the 10-year lifespan of the PE fund is up and not get left behind in the fund.</div>
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Thus, if the PE J-Curve shown in Fig. 2 is accurate, the sweet spot is around the 5th year of the PE fund. In addition, exits should be timed before the 10-year lifespan is up.</div>
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In Jun 2016, Azalea first introduced PE bonds to the market with Astrea III bonds. 2 years later, it launched Astrea IV bonds and just last week, it launched Astrea V bonds. The weighted average age of funds at the time of launch and scheduled call date of the 3 Astrea Class A-1 bonds are as follow.</div>
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<table border="0" cellpadding="0" cellspacing="0" style="margin-left: auto; margin-right: auto; text-align: left; width: 340px;"><colgroup><col style="mso-width-alt: 2633; mso-width-source: userset; width: 54pt;" width="72"></col>
<col style="mso-width-alt: 4242; mso-width-source: userset; width: 87pt;" width="116"></col>
<col style="mso-width-alt: 5558; mso-width-source: userset; width: 114pt;" width="152"></col>
</colgroup><tbody>
<tr height="20" style="height: 15.0pt;">
<td class="xl66" height="20" style="height: 15pt; text-align: center; width: 54pt;" width="72"><b>Bond</b></td>
<td class="xl66" style="text-align: center; width: 87pt;" width="116"><b>Wt Age of Fund</b></td>
<td class="xl66" style="text-align: center; width: 114pt;" width="152"><b>Scheduled Call (Yrs)</b></td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td class="xl65" height="20" style="height: 15pt; text-align: center;">Astrea III</td>
<td class="xl65" style="text-align: center;">6</td>
<td class="xl65" style="text-align: center;">3</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td class="xl65" height="20" style="height: 15pt; text-align: center;">Astrea IV</td>
<td class="xl65" style="text-align: center;">7</td>
<td class="xl65" style="text-align: center;">5</td>
</tr>
<tr height="20" style="height: 15.0pt;">
<td class="xl65" height="20" style="height: 15pt; text-align: center;">Astrea V</td>
<td class="xl65" style="text-align: center;">5.4</td>
<td class="xl65" style="text-align: center;">5</td>
</tr>
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<span id="goog_1918356865"></span><span id="goog_1918356866"></span>Their lifespans superimposed onto the PE J-Curve are shown in Fig. 3 below.</div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh7xza0tpZvSz6i6QwNtL_n3ohYbtipGP0Nd05PJU2SC8EPRB_6CnmlkIB3g37lRS-1QmN4YIMSipO2wWZcyJ1BIJ7XjQVwr6gm-EdZfmHqk7PdVWmXwlJiXnZvQ7c0NZrUrxHT7uou1Pg/s1600/AstreaBondLifespan.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="584" data-original-width="1092" height="213" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh7xza0tpZvSz6i6QwNtL_n3ohYbtipGP0Nd05PJU2SC8EPRB_6CnmlkIB3g37lRS-1QmN4YIMSipO2wWZcyJ1BIJ7XjQVwr6gm-EdZfmHqk7PdVWmXwlJiXnZvQ7c0NZrUrxHT7uou1Pg/s400/AstreaBondLifespan.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 3: Lifespan of Astrea Bonds Relative to PE Fund Lifecycle</td></tr>
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Astrea III bonds (blue line) will last from the 6th to 9th year of the underlying PE funds that Astrea III invested into. This is the sweet spot that we discussed earlier -- enter around the 5th year and exit before the 10th year. It is probably the safest of the 3 Astrea bonds. In fact, it has just been announced that this bond would be redeemed as scheduled in 2 weeks' time.<br />
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Astrea IV bonds (purple line) will last from the 7th to 12th year of the underlying PE funds. The PE funds are generating a lot of cash currently, with total net distributions (after deducting capital calls) of USD243M in Astrea IV's first year of existence. This is equivalent to 22% of its portfolio value at the time of IPO. However, as shown in Fig. 3, the amount of distributions is expected to decline moving forward.<br />
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Astrea V bonds (brown line) will last from the 5th to 10th year of the underlying PE funds. Compared to Astrea IV bonds, there is a little more risks initially, as the companies in the PE funds are less mature and less ready to be exited. Furthermore, there are higher capital calls expected. But if these risks in the initial years can be overcome, Astrea V bonds will have less risks towards the end compared to Astrea IV bonds, as cashflows towards the tail-end would not have declined as much.<br />
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When you look at the risks of Astrea IV and Astrea V bonds, some of the safeguards that Azalea put in place for the bonds start to make a lot of sense. Let's talk about Astrea V bonds first, as it is simpler. As mentioned, one of the key risks for it is higher capital calls. This is mitigated by the capital call facility that allows Astrea V to borrow money from the banks to meet the capital calls.<br />
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For Astrea IV bonds, the key risk is not receiving sufficient distributions towards the tail-end to redeem the bonds in full. Although there is liquidity facility to meet interest payments in the event of shortfalls in distributions, there is no equivalent liquidity facility that Astrea IV can borrow from to redeem the bonds. Money to redeem the bonds can only come from the distributions from the underlying PE funds. However, towards the tail-end, such distributions are declining and might not be sufficient to redeem the SGD242M bonds in full.<br />
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In fact, it would be unfair to bondholders if it were to happen, considering that in the initial years of the bond, the underlying PE funds are generating a lot of cash, most of which are passed through to the sponsor. For the first year of Astrea IV, out of total net distributions of USD243M, all classes of bondholders (Class A-1, A-2 and B) were paid only USD26M in interest. Other expenses during the same period totalled USD7M. If there were no safeguards in place, the remaining USD210M (equivalent to 86% of net distribution of USD243M) and another USD15M in existing cash would flow to the sponsor. This money can leave Astrea IV as dividends to shareholder and repayment of shareholder loans instead of being retained within Astrea IV. Once the money leaves Astrea IV, bondholders have no recourse to Azalea as the shareholder/ sponsor to redeem the bonds in full. Recall that the bond is not guaranteed by either Azalea, or its parent, Temasek?<br />
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To prevent this scenario from happening, Azalea has put in place a safeguard that part of the distributions have to be set aside in reserves accounts for the sole purpose of redeeming the bonds. For the first year of Astrea IV, a total of USD80M has been set aside. Hence, the distributions flowing to the sponsor is reduced from USD225M to USD145M. This ensures that there will be sufficient cash to redeem the bonds when they mature, even though distributions from the underlying PE funds are declining.<br />
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In conclusion, PE bonds are not a simple matter of buy-and-forget. Investors need to understand where they stand along the lifecycle of PE funds and also what investor protection they have. Azalea has done a good job protecting investors from losses, but investors still need to protect themselves by learning more about PE investments. <br />
<br />
<br />
See related blog posts:<br />
<ul>
<li><a href="http://boringinvestor.blogspot.com/2019/06/a-shrinking-balance-sheet-for-bonds-in.html">A Shrinking Balance Sheet for Bonds in Mature PE Funds</a></li>
<li><a href="http://boringinvestor.blogspot.com/2019/06/astrea-v-385-bonds-understanding-what.html">Astrea V 3.85% Bonds – Understanding What You Are Buying Into</a> </li>
<li><a href="http://boringinvestor.blogspot.com/2018/06/understanding-safeguards-of-astrea-iv.html">Understanding the Safeguards of Astrea IV 4.35% Bonds</a></li>
</ul>
</div>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com2tag:blogger.com,1999:blog-6213354074634538714.post-60807515416863848462019-06-16T01:00:00.000+08:002019-06-30T11:39:56.447+08:00Astrea V 3.85% Bonds – Understanding What You Are Buying Into<div style="text-align: justify;">
It has been exactly a year since I last blogged. My last blog post was on Astrea IV 4.35% bonds. Coincidentally, Astrea's management, Azalea, has recently launched the IPO for Astrea V 3.85% bonds. One year has passed. What do I think about Astrea bonds?</div>
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If you read last year's blog post on <a href="http://boringinvestor.blogspot.com/2018/06/would-i-invest-in-astrea-iv-435-bonds.html">Would I Invest in Astrea IV 4.35% Bonds?</a>, you would know that I was not too keen on Astrea IV 4.35% bonds. A large part of the reasons had to do with Private Equity (PE) bonds being a new asset class and there was too little time to properly analyse whether it would be a good investment. Given the time constraint, I relied on whatever understanding I had about fund of funds and leveraged buyout funds and concluded that I would not be applying for the IPO.<br />
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A week later, after the IPO had closed, I had more time to look at the structure of the Astrea IV bond and acknowledged that it could be a safe one, but only because of all the credit enhancement safeguards put in place. See <a href="http://boringinvestor.blogspot.com/2018/06/understanding-safeguards-of-astrea-iv.html">Understanding the Safeguards of Astrea IV 4.35% Bonds</a> for more info.<br />
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Thus, when the IPO for Astrea V 3.85% bonds was launched this week, the first thing I checked was whether it has similar safeguards as Astrea IV 4.35% bonds. It has. Still, it is necessary to re-iterate that being PE bonds, Astrea bonds are not traditional bonds and it is important to understand the risks of the underlying assets. Below is a summary of the risks that I am aware of.<br />
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<u>Understated Loan-to-Value Ratio in Fund of Funds</u></div>
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Astrea V bonds invest in 38 PE funds run by independent PE fund managers. Its stated Loan-to-Value (LTV) ratio for the Class A bonds (comprising Class A-1 and Class A-2 bonds which have equal seniority) is 34.8%. This means that for Class A bonds to start losing money, the value of the underlying investments has to drop by 65.2%. However, the underlying PE funds have their own debts and these debts are not considered when computing the LTV ratio of 34.8% for Astrea V bonds. The true LTV ratio after considering the debts in the underlying PE funds (i.e. look-though basis) is likely to be much higher. This ratio matters. See <a href="http://boringinvestor.blogspot.com/2018/06/would-i-invest-in-astrea-iv-435-bonds.html">Would I Invest in Astrea IV 4.35% Bonds?</a> for an example.<br />
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<u>High Leverage Used by Buyout Funds</u><br />
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80% of the Astrea V investments are in buyout funds. As discussed in <a href="http://boringinvestor.blogspot.com/2018/06/would-i-invest-in-astrea-iv-435-bonds.html">Would I Invest in Astrea IV 4.35% Bonds?</a>, buyout funds use a lot of debts when acquiring companies. Typical debts is in the region of 6-7 times Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA). High debts at the underlying PE funds, couple with a Fund of Fund structure, underestimates the true, look-through LTV ratio of the Astrea bonds.<br />
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<u>Assurance of Net Asset Value</u><br />
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Astrea V has a portfolio value of USD1,342M. This is an important figure that is used to compute the LTV ratio. After the debacle of the Hyflux preference shares and perpetual securities, it became clear that asset values should not be taken at face value. Hyflux's main asset, Tuaspring Integrated Water and Power Project, which has a stated Net Asset Value (NAV) of $902M as at end of Financial Year 2017, could not be sold at close to book value. Given that PE investments are illiquid assets, what is the assurance that the portfolio value of Astrea V is really as stated?<br />
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This question was posted during the Astrea Investor Day in Jan 2019 and during the public roadshow on Astrea V bonds conducted with SGX Academy on Saturday. Azalea's management replied that the NAV of PE funds is checked by reputable auditors. In addition, there are secondary markets where PE funds are traded. The value at which they are traded is close to the NAV reported by the PE fund managers. Furthermore, when the PE investments are disposed of, Azalea cross-checks the sale value against the reported NAV. In most cases, the sale value exceeds the reported NAV.<br />
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<u>PE in a Potential Bubble</u><br />
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PE investments have generated better returns than public equities in the last 20 years. This has resulted in a lot of funds flowing into PE investments, and increased competition between PE fund managers to find good deals. This has led to assets being purchased at higher prices. At the same time, the debts used by buyout funds to acquire companies has been on the rise. At some point in time, the PE boom will probably end, potentially leading to falls in NAV. See Bain & Company's report on <a href="https://www.bain.com/insights/year-in-review-global-private-equity-report-2019/">Private Equity: Still Booming, but Is the Cycle Near Its End?</a> for more info.<br />
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At Saturday's roadshow, Azalea replied that this is also a good time for selling assets in the PE funds that Astrea V has already invested in, which will result in cashflows coming back to the Astrea bonds. Furthermore, as most of the PE fund managers have a lot of experience running PE funds, they believe that the PE fund managers will be able to navigate the environment.<br />
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While I agree that this is a good time for selling assets in PE funds, this also means that the high asset prices are reflected in the portfolio value of Astrea's investments. In the event that asset prices correct, Astrea's portfolio value will also decline. This will lead to a rise in the LTV ratio, but there is a safeguard in place if the LTV ratio exceeds 50%. <br />
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<u>Conclusion</u><br />
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Although I believe Astrea IV and V bonds to be fairly safe for retail investors, I cannot emphasize enough that the reason this is so is because of the credit enhancement safeguards that Azalea painstakingly put in place. Also, for investors interested to buy Astrea bonds, please understand what you are buying into.<br />
<br />
<br />
See related blog posts:<br />
<ul>
<li><a href="http://boringinvestor.blogspot.com/2018/06/would-i-invest-in-astrea-iv-435-bonds.html">Would I Invest in Astrea IV 4.35% Bonds?</a></li>
<li><a href="http://boringinvestor.blogspot.com/2018/06/understanding-safeguards-of-astrea-iv.html">Understanding the Safeguards of Astrea IV 4.35% Bonds</a></li>
<li><a href="http://boringinvestor.blogspot.com/2019/06/a-shrinking-balance-sheet-for-bonds-in.html">A Shrinking Balance Sheet for Bonds in Mature PE Funds</a></li>
</ul>
</div>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com6tag:blogger.com,1999:blog-6213354074634538714.post-66348659738416841772018-06-17T23:06:00.000+08:002019-06-30T11:37:18.961+08:00Understanding the Safeguards of Astrea IV 4.35% Bonds<div style="text-align: justify;">
Astrea IV 4.35% bonds are unusual retail bonds as they are backed by Private Equity (PE). There are 5 safeguards put in place by the issuer to ensure that cashflows from PE investments are adequate to meet the obligations of the bond. These are:</div>
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<ul>
<li>Reserves Accounts</li>
<li>Sponsor Sharing</li>
<li>Maximum Loan-to-Value (LTV) Ratio</li>
<li>Liquidity Facilities</li>
<li>Capital Call Facilities</li>
</ul>
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To understand why these safeguards are important and necessary, let us consider a hypothetical scenario in which I wish to issue Boring Investor bonds to retail investors to raise capital to invest in public equities listed on the SGX. Cashflows for the bonds would come from sale of equity investments and dividends from investee companies. </div>
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Generally, the Straits Times Index (STI) generates annualised returns of 7% in capital appreciation and 3% in dividends on average. To entice investors to my Boring Investor bonds, I would probably have to pay interest rate of 5% on the bonds. The first question that comes to mind is how do I ensure that I could meet the 5% interest obligations on the Boring Investor bonds on a sustainable basis when I could only receive 3% dividends from the equity investments? There are several things I can do, as described below. </div>
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<u>Maximum Loan-to-Value (LTV) Ratio</u></div>
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Supposed I intend to invest $1M in the SGX equities. At a dividend rate of 3%, the maximum dividends I could get from the equities annually is only $30K. Based on the bond interest rate of 5%, the maximum amount of Boring Investor bonds I could issue is $30K / 5%, or $600K. The maximum Loan-to-Value (LTV) ratio that can be supported by dividends on a sustainable basis is only 60%. Thus, by setting a maximum cap on the LTV ratio, I can better ensure that bond holders are paid on time.</div>
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<u>Liquidity Facilities</u></div>
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There will be times when the economy is not doing well and the investee companies have to cut dividends. When this happens, I might not get sufficient dividends from the equity investments to pay interest to bond holders. I will need to borrow money temporarily from the banks to pay the bond interest.</div>
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<u>Capital Call Facilities</u></div>
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There will also be times when some companies need to issue rights issues to raise money. Given that most the funds raised from the Boring Investor bonds have been invested in the SGX equities, I might not have sufficient funds to subscribe to the rights issues and buy additional shares in the companies at a bargain. To guard against this, I can set up a credit line with the banks to temporarily borrow money to subscribe to the rights issues.</div>
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<u>Reserves Accounts</u></div>
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Given the unpredictable nature of the cashflows from dividends and sale of equity investments, it is prudent to set up a sinking fund to save some excess cashflows after paying the bond interest and other necessary expenses. The amount to be set aside for the sinking fund each year is a pre-determined amount, but it is only set aside if excess cashflows are available. The sinking fund will be topped up until there are sufficient funds to redeem the Boring Investor bonds in full. This would increase the likelihood that the bonds could be redeemed in full when they mature.</div>
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<u>Sponsor Sharing</u></div>
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Generally, after meeting all the obligations mentioned above, any remaining cashflows would belong to the sponsor shareholder. However, as an additional gesture of goodwill, I can share the remaining cashflows 50:50 with bond holders if certain performance threshold is met by a certain date. The cashflows shared with bond holders would be used to top up the sinking fund mentioned above, if it is not full yet. </div>
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<u>Conclusion</u></div>
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As you can see above, cashflows from equity investments (more so for PE investments and PE funds) are unpredictable, irregular and discretionary whereas interest and principal repayment obligations of bonds are fixed and mandatory. There is a need for some of the above-mentioned safeguards (known as credit enhancements) to ensure that bond obligations can be met when they fall due. If there were no credit enhancements, and the fixed and mandatory bond obligations were solely funded by the irregular and discretionary cashflows from equity investments, defaults on the bonds would likely happen at some point in time. </div>
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Thus, the Astrea IV 4.35% bonds are safe mainly because of the safeguards put in place. It is not a bond, but a structured bond. The credit ratings for Astrea IV 4.35% bonds are expected to be "A(sf)", with "sf" denoting structured finance. To avoid confusion with traditional bonds, it is best to refer to the Astrea IV 4.35% bonds as structured bonds, just like we differentiate structured deposits from fixed deposits. </div>
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Did I invest in Astrea IV 4.35% bonds? No, I did not. I prefer to invest in traditional bonds in which the underlying cashflows are sufficient to meet the bond obligations without any credit enhancements. </div>
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See related blog posts:</div>
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</div>
<ul>
<li><a href="https://boringinvestor.blogspot.com/2018/06/would-i-invest-in-astrea-iv-435-bonds.html">Would I Invest in Astrea IV 4.35% Bonds?</a></li>
<li><a href="http://boringinvestor.blogspot.com/2019/06/astrea-v-385-bonds-understanding-what.html">Astrea V 3.85% Bonds – Understanding What You Are Buying Into</a> </li>
<li><a href="http://boringinvestor.blogspot.com/2019/06/a-shrinking-balance-sheet-for-bonds-in.html">A Shrinking Balance Sheet for Bonds in Mature PE Funds</a></li>
</ul>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com8tag:blogger.com,1999:blog-6213354074634538714.post-11115118452308110492018-06-11T00:42:00.000+08:002019-07-07T01:37:25.753+08:00Would I Invest in Astrea IV 4.35% Bonds?<div style="text-align: justify;">
Recently, Temasek launched a Private Equity (PE) bond for retail investors known as Astrea IV 4.35% bond. It is the first PE bond open to retail investors. Would I invest my money in this bond?</div>
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First of all, let us understand what this bond is all about. This bond is issued by Astrea IV Pte Ltd, an indirect wholly owned subsidiary of Temasek, to hold a portfolio of PE investments. The investments are managed by 27 General Partners in 36 PE funds and invested in 596 companies. 86.1% of these funds are invested in buyouts, with 12.3% in growth equity and 1.6% in private debt. </div>
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Buyout funds are funds that privatise publicly listed companies, cut the excesses in the companies and streamline their operations to make them more efficient, and seek to exit the companies by selling them or listing them again. An example is Amtek Engineering, which was delisted from SGX in 2007 after being bought out by a PE fund, and was relisted as Interplex Holdings in 2010. And the story did not end there. Interplex Holdings itself was delisted in 2016 after being bought out by another PE fund.</div>
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The issuer, Astrea IV, has 3 classes of bonds, as follow:</div>
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<ul>
<li style="text-align: justify;">Class A-1 - SGD242M 4.35% senior bonds that are open to retail investors and which are the subject of this post.</li>
<li style="text-align: justify;">Class A-2 - USD210M senior bonds open only to Institutional and/or Accredited Investors. Class A-2 bonds have the same seniority as Class A-1 bonds.</li>
<li style="text-align: justify;">Class B - USD110M bonds junior bonds open only to Institutional and/or Accredited Investors. </li>
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The structure of the bonds is such that Class A bonds have priority to interest payments and bond redemption. In addition, it can borrow money from banks to make interest payments in the event that there are insufficient cashflows to do so. Moreover, its Loan-to-Value (LTV) ratio is capped at 50% of the portfolio value. If this threshold is crossed, it will have to cut debt levels. Furthermore, Class A bonds are senior to Class B bonds and shareholder equity. For Class A bonds to lose money, the portfolio that Astrea IV invests in must lose at least 64.4% of its value. So, it is quite safe, isn't it? </div>
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First of all, you need to recognise that Astrea IV, the company that you are investing into by buying the retail bond, is essentially a fund of funds. Although its LTV is capped at 50%, this is only at the Astrea IV level. The funds that Astrea IV invests into could have their own borrowings and these are not counted in the 50% LTV cap. After accounting for these borrowings at the lower levels (i.e. look-through basis), the leverage could be much higher. As a hypothetical example, Company A could have shareholder equity of $50M and bonds of $50M. Using this $100M, Company A invests into Company B. Company B borrows another $100M. Company B invests the $200M into a property. How much of the investment in the property is funded by equity and borrowings? The answer is $50M in equity and $150M in borrowings. Thus, even though the LTV at Company A's level is only 50%, on a look-through basis, the LTV is 75%! Does LTV on a look-through basis matter? For Company A's equity to be wiped out completely and its bonds to start losing money, the property's value only need to fall by 25% ($50M equity out of $200M asset value). So, LTV on a look-through basis does matter!</div>
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Secondly, most of the money are invested in buyout funds. Buyouts are usually highly leveraged operations. In the process of buying out companies, they take on large debts and usually pay a premium to acquire a 100% stake in the companies. After successfully acquiring the companies (which are usually cashflow-rich companies), they extract most of the cash from the companies to pay down their own debts. They also streamline the operations of the companies and load them with debts, such that the companies become more conscious about cutting costs and direct most of their cashflows to paring down the debts loaded onto them. Thus, the high returns of buyout funds are partly due to making the companies more efficient and partly due to the leverage employed. As an example, when 3G Capital teamed up with Berkshire Hathaway to buy Heinz for USD23.3B in 2013, they only forked out USD4.4B in capital each. The remaining was borrowed. (Note: Berkshire Hathaway also bought USD8B of preferred stocks paying 9% interest. I will leave it to readers to decide whether to classify this USD8B as equity or debt.)</div>
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Thus, in conclusion, Astrea IV is essentially a fund of leveraged buyout funds. I will not be investing in these bonds, even if its 4.35% coupon looks attractive.</div>
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See related blog posts:</div>
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</div>
<ul>
<li><a href="http://boringinvestor.blogspot.com/2019/07/are-private-equity-bonds-better-than.html">Are Private Equity Bonds Better Than Corporate Bonds?</a> </li>
<li><a href="https://boringinvestor.blogspot.com/2018/06/understanding-safeguards-of-astrea-iv.html">Understanding the Safeguards of Astrea IV 4.35% Bonds</a></li>
<li><a href="http://boringinvestor.blogspot.com/2019/06/astrea-v-385-bonds-understanding-what.html">Astrea V 3.85% Bonds – Understanding What You Are Buying Into</a> </li>
</ul>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com4tag:blogger.com,1999:blog-6213354074634538714.post-24377072102271206782018-05-27T21:24:00.003+08:002020-12-20T23:42:56.514+08:00Possibly The Worst Time to Invest – 4 Years On<div style="text-align: justify;">
This once-a-year post probably sounds like a broken record, but 4 years after I thought it was a bad time to invest (due to record high Dow Jones Industrial Average and record low interest rates then), the DJIA has not crashed yet, despite a series of corrections along the way, with the most recent one in Feb. I have 2 passive portfolios invested in index funds and adopting the portfolio rebalancing strategy. The plain vanilla portfolio has 70% in global equities and 30% in global bonds since Dec 2013, while the spicy portfolio has 70% in US equities and 30% in Asian bonds progressively built up over 2015. </div>
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To-date, the plain vanilla portfolio is up by 31.4% while the spicy portfolio is up by 24.2% since they were started approximately 4.5 years and 2.5 years ago. Needlessly to say, had I worried about the high stock prices and low interest rates back then and not started the 2 portfolios, I would not be sitting on such paper gains. </div>
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I am tempted to allocate more money from my active investments to the 2 passive portfolios, considering that all it takes is to monitor occasionally whether the relative allocation between the equities and bonds has moved significantly away from the initial allocation of 70% stocks and 30% bonds and rebalance them when it happens. In contrast, active investment requires a lot of hard work. I need to read the financial statements and annual reports, attend Annual General Meetings, understand pricing strategy and competitors' activities, etc. to understand how well the business is doing. Just take a look at M1, a stock that I blogged about recently. I spent no less than 6 posts (and another 3 posts on its competitors) to describe the various aspects of M1. Even then, there are probably still a lot of areas about M1 that I do not understand. Furthermore, the size of my M1 position is only 1/3 that of the 2 passive portfolios!</div>
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So, would I be worried if I were to invest more into the 2 passive portfolios and the crash finally happens? Obviously, I would be quite upset if it were to happen, but I would attribute it more to bad timing. One way to mitigate this risk is to spread out the investment, similar to what I did when I initiated the spicy portfolio. The plain vanilla portfolio was a lump-sum investment in Dec 2013, but the spicy portfolio was built up over 12 months in 2015. Furthermore, the rebalancing strategy will ensure that if stocks were to crash significantly, the bonds would be sold to buy more of the now cheaper stocks. There is inherent defence mechanism in the portfolio rebalancing strategy.</div>
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This time next year, I am not sure if I will be happy or upset over my 2 passive portfolios (which depends on whether the crash happens or not), but likely, it will be business as usual.</div>
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See related blog posts:</div>
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</div>
<ul>
<li><a href="https://boringinvestor.blogspot.com/2014/02/possibly-worst-time-to-invest.html">Possibly The Worst Time to Invest</a> <br /></li>
<li><a href="https://boringinvestor.blogspot.com/2015/03/possible-worst-time-to-invest-year-on.html">Possible The Worst Time to Invest – A Year On</a></li>
<li><a href="https://boringinvestor.blogspot.com/2016/04/possibly-worst-time-to-invest-2-years-on.html">Possibly The Worst Time to Invest – 2 Years On</a></li>
<li><a href="https://boringinvestor.blogspot.com/2017/04/possibly-worst-time-to-invest-3-years-on.html">Possibly The Worst Time to Invest – 3 Years On</a></li>
<li><a href="https://boringinvestor.blogspot.com/2019/08/possibly-worst-time-to-invest-5-years-on.html">Possibly The Worst Time to Invest – 5 Years On</a></li>
<li><a href="https://boringinvestor.blogspot.com/2020/12/possibly-worst-time-to-invest-6-years-on.html">Possibly The Worst Time to Invest – 6 Years On</a></li>
</ul>Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com4tag:blogger.com,1999:blog-6213354074634538714.post-84140879286434461712018-05-21T00:20:00.002+08:002018-05-21T00:21:03.271+08:00Who Moved Starhub's Cheese?<div style="text-align: justify;">
Starhub has been facing declining profitability in the last few years. It even had to cut its 20-cent annual dividend last year, a dividend which it had held steady for 7 years. Why did Starhub face declining profitability and who moved Starhub's cheese? To discuss these questions, we need to first understand what were Starhub's competitive advantages in the past and how have they changed.</div>
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<u>Starhub's Moats</u></div>
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Traditionally, compared to its 2 rivals, Starhub has the advantage of using its cable network infrastructure to deliver both cable TV and cable broadband services, thus enabling it to spread out the cost of operating the infrastructure over a larger number of customers.</div>
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In addition, compared to M1, which until recent years only offered mobile services, Starhub (and also Singtel) has the hubbing strategy which offers customers discounts if they sign up for 3 services, namely, mobile line, home broadband and Pay TV. The discounts range from 5% to 30% for different services. Thus, if a customer needs mobile lines, home broadband and Pay TV, he would find it attractive to sign up all services with Starhub (or Singtel) and enjoy the hubbing discounts. This hubbing strategy has allowed Starhub and Singtel to gain market share relative to M1 in the post-paid mobile services market. See Fig. 1 below for the changes in market share of the 3 telcos and the percentage of households who are members of Starhub's Hub Club.</div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWKb3AZeZKgfZFqeW6mr6G1CH2-ebYgtU49GgKWmKKpoo36ccjY8QuLpstmD0hoFYFxgyzmTTu9aI9-vTPmhTvzwilLJEnyaqPy0FDbzI8Rpxan_bRXGy5mWEVXk8kcjj-yqugZV08a6I/s1600/TelcoMobileMktShare.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="516" data-original-width="792" height="260" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWKb3AZeZKgfZFqeW6mr6G1CH2-ebYgtU49GgKWmKKpoo36ccjY8QuLpstmD0hoFYFxgyzmTTu9aI9-vTPmhTvzwilLJEnyaqPy0FDbzI8Rpxan_bRXGy5mWEVXk8kcjj-yqugZV08a6I/s400/TelcoMobileMktShare.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 1: Post-Paid Mobile Service Market Share</td></tr>
</tbody></table>
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Hence, for a long time, Starhub had been enjoying a moat which seemed impregnable. </div>
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<u>Cable Broadband</u></div>
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The first crack in Starhub's hitherto impregnable moat is cable broadband. In 2010, the Next Generation Nationwide Broadband Network (NGNBN) started operations. Instead of only Starhub and Singtel being able to offer home broadband via their cable and ADSL networks respectively, the market was suddenly opened up to many other companies, including M1, MyRepublic, ViewQwest, etc. With more competitors, prices of home broadband dropped. In addition, as more customers switch from cable broadband to fibre broadband, there are less customers to spread the cost of operating the cable network infrastructure. See Fig. 2 below for the declining number of cable broadband customers. </div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjCuzqVKTzVPXabOJCxSzns2-xv_UuhtopzgnzENKZB7IRsf6ksHnaVgTWJriZO5eJuSb8z8nqPUfT5ZxkKvmsCTiKFNcuo_nqKdI2TQjWg29cv2QlHw1u9rhhFnM4bb6hqVZ-84BWFgt0/s1600/StarhubBroadband17.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="508" data-original-width="780" height="260" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjCuzqVKTzVPXabOJCxSzns2-xv_UuhtopzgnzENKZB7IRsf6ksHnaVgTWJriZO5eJuSb8z8nqPUfT5ZxkKvmsCTiKFNcuo_nqKdI2TQjWg29cv2QlHw1u9rhhFnM4bb6hqVZ-84BWFgt0/s400/StarhubBroadband17.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 2: Proportion of Cable and Fibre Broadband Customers</td></tr>
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Although Starhub's cable broadband market share declined, its hubbing strategy is still intact. Customers who need mobile lines, Pay TV and home broadband, regardless whether it is cable or fibre broadband, would still find it attractive to sign up with Starhub to enjoy the discounts. Nevertheless, it should be noted that M1 is now able to offer a hubbing strategy for customers to sign up mobile lines and fibre broadband. Customers who do not need Pay TV would enjoy hubbing discounts with M1 but not Starhub and Singtel.</div>
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<u>Pay TV</u></div>
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With faster and more reliable broadband speed comes the ability to watch videos online. Furthermore, online viewers are not restricted to watching video on the TV; they could watch it anywhere and on the move. This has resulted in cord-cutting by Pay TV subscribers, and this trend is not limited to Singapore alone. </div>
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In Jan 2016, Netflix entered the Singapore market, offering not only a cheaper way of watching movies but also bringing in popular exclusive original content. See <a href="http://boringinvestor.blogspot.sg/2017/03/is-pay-tv-still-reliable-cash-cow.html">Is Pay TV Still A Reliable Cash Cow?</a> for more information. Since then, the decline in the number of Pay TV subscribers at both Starhub and Singtel has accelerated, despite the retention power of their hubbing strategies. See Fig. 3 below for the number of Pay TV subscribers. </div>
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQVkPtk_J_-IsTqkr4vlGJSzWLconfCnrOCA-uZr2xJXYLiT0UtT3eI3nwJCBdPhauj7QHGvAdDPZw6RW1VTxxAnOTTfvCDMx4C20OIqJZopxbyvW7UdUMSA2EiYPigKpOsBB7t-20hwc/s1600/TelcoPayTVMktShare.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="516" data-original-width="792" height="260" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQVkPtk_J_-IsTqkr4vlGJSzWLconfCnrOCA-uZr2xJXYLiT0UtT3eI3nwJCBdPhauj7QHGvAdDPZw6RW1VTxxAnOTTfvCDMx4C20OIqJZopxbyvW7UdUMSA2EiYPigKpOsBB7t-20hwc/s400/TelcoPayTVMktShare.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 3: No. of Pay TV Subscribers at Starhub and Singtel</td></tr>
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With the decline in Pay TV subscribers, there is further reduction in the number of customers to spread the cost of operating the cable network infrastructure. The traditional competitive advantage that Starhub has in the cable TV network infrastructure is irreversibly gone.</div>
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Furthermore, the proportion of households on Starhub's Hub Club has also declined. See Fig. 1 above. Thus, with the onslaught of streaming video on demand, even Starhub's hubbing strategy is no longer as impregnable. If anything, the hubbing advantage has tilted towards M1 which requires only 2 services instead of 3 services for Starhub and Singtel.</div>
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<u>Mobile Services</u></div>
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Mobile Services is the largest segment of all 3 telcos. In the last few years, it has faced many headwinds. The traditional money generator for telcos, Short Message Service (SMS), has now been superseded by messaging apps like WhatsApp, WeChat, etc. Likewise, voice is also seeing a decline as it is being replaced by WhatsApp calls, Skype, etc. Only data is seeing increasing demand. But even in this area, competition has increased. In 2016, M1 launched data upsize plans that allow subscribers to increase their data bundles with a slight increase in monthly fees. This has the effect of reducing the excess data charges that subscribers pay when they exceed their data bundles. See <a href="http://boringinvestor.blogspot.sg/2017/02/impact-of-data-upsize-plans-on-telcos.html">Impact of Data Upsize Plans on Telcos</a> for more information.</div>
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Also in 2016 and again in recent months, new virtual telcos known as Mobile Virtual Network Operators (MVNOs) have sprung up. These MVNOs buy network capacity from traditional telcos and resell to retail customers. They cater to niche customer segments and usually dangle attractive offers, such as Circles.Life's $20-for-20GB of data, ZeroMobile's Unlimited Everything and Zero1's unlimited data for $29.99. See <a href="https://boringinvestor.blogspot.sg/2018/04/will-mvnos-cannibalise-telcos-business.html">Will MVNOs Cannibalise Telcos' Business?</a></div>
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In addition, there have been other disruptions to the telco industry, such as the SIM-only plans, which attract customers who do not need to change their phones every 2 years. These plans reduce the revenue but are value accretive at the EBITDA level. See <a href="https://boringinvestor.blogspot.sg/2018/03/will-sim-only-plans-cannibalise-regular.html">Will SIM-Only Plans Cannibalise Regular Telco Plans?</a> for more information. Finally, there is also the fourth telco which is scheduled to start operations in Jan next year. See <a href="http://boringinvestor.blogspot.sg/2018/04/where-art-thou-tpg.html">Where Art Thou, TPG?</a></div>
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<u>Conclusion</u></div>
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In conclusion, Starhub is facing headwinds in many business segments. The party that is moving Starhub's cheese is not a single actor. Many actors have been moving Starhub's cheese. </div>
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P.S. I am vested in M1, Netlink Trust and Singtel.</div>
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See related blog posts:</div>
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<ul>
<li><a href="https://boringinvestor.blogspot.sg/2018/03/is-starhubs-dividend-of-16-cents.html">Is Starhub's Dividend of 16 Cents Sustainable?</a></li>
<li><a href="http://boringinvestor.blogspot.sg/2017/03/challenging-times-ahead-for-starhubs.html">Challenging Times Ahead for Starhub's Dividends</a></li>
<li><a href="http://boringinvestor.blogspot.sg/2017/03/is-pay-tv-still-reliable-cash-cow.html">Is Pay TV Still A Reliable Cash Cow?</a></li>
</ul>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com0tag:blogger.com,1999:blog-6213354074634538714.post-79714620036700564552018-05-14T00:43:00.000+08:002018-05-14T22:18:30.541+08:00A Satisfied M1 Investor<div style="text-align: justify;">
I started investing in M1 in Jan last year. At that time, it was to take advantage of the crash in telco stocks due to fear of the fourth telco. Since then, I have added to my positions several times. My current position is now 5 times the initial one. This is because despite all the headwinds that telcos face, from SIM-only plans, data upsize plans, Mobile Virtual Network Operators (MVNOs) to the fourth telco, M1 has performed admirably. Below is a summary of what I like about M1.</div>
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<u>SIM-Only Plans</u></div>
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When M1 launched SIM-only plans in Jul 2015, I had not invested in telco stocks yet. But my initial thoughts were that SIM-only plans would lead to a drop in revenue and a smaller drop in profitability, as SIM-only plans would lead to some subscribers downgrading from the more expensive regular telco plans with handphone subsidies to the SIM-only plans. See <a href="http://boringinvestor.blogspot.sg/2017/01/impact-of-sim-only-plans-on-telcos.html">Impact of SIM-Only Plans on Telcos</a>. As it turns out, although SIM-only plans indeed led to a drop in revenue, they are value-accretive at the EBITDA level, as they attract new customers in addition to existing subscribers who downgrade. An analogy would be the regular telco plans are like full-service airlines while SIM-only plans are like budget airlines. Although SIM-only plans cannibalise regular telco plans, they also create new demand of their own. See <a href="https://boringinvestor.blogspot.sg/2018/03/will-sim-only-plans-cannibalise-regular.html">Will SIM-Only Plans Cannibalise Regular Telco Plans?</a> for more information. The popularity of SIM-only plans (together with Circles.Life) has led to strong growth in M1's post-paid customer base. See Fig. 1 below for the growth rate (note: M1's post-paid customer base includes that of Circles.Life, the MVNO that works with it).</div>
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<br /></div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjXgVXY8VGlEz0FK60ZVZH5kCPdgcluq9liJBL_zKACbEAtnX0pa8LakMT1_B8TGBcwLkeXkbPisJDLB1IEVSeSxpG3aY1XeqzFABSwh3eyz7FT5Yf7hGuNS-vHmmMNjGY_pvBg6VB3oHM/s1600/M1CustGrowth17.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="508" data-original-width="780" height="260" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjXgVXY8VGlEz0FK60ZVZH5kCPdgcluq9liJBL_zKACbEAtnX0pa8LakMT1_B8TGBcwLkeXkbPisJDLB1IEVSeSxpG3aY1XeqzFABSwh3eyz7FT5Yf7hGuNS-vHmmMNjGY_pvBg6VB3oHM/s400/M1CustGrowth17.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 1: Changes in M1's Post-Paid Customers</td></tr>
</tbody></table>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
In this aspect, I have to acknowledge that M1 knows what it is doing and is doing better than I thought.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u>Data Upsize Plans</u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
This is another initiative that M1 started in Mar 2016 before I became a shareholder. Again, I believed that this would lead to lower profitability, as subscribers who used to exceed their data bundles and pay excess data charges of as high as $10.70/GB now need to pay only $5.90 per month to upsize their data bundles. See <a href="http://boringinvestor.blogspot.sg/2017/02/impact-of-data-upsize-plans-on-telcos.html">Impact of Data Upsize Plans on Telcos</a>. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
This time, I am not wrong about the impact on revenue and profitability, but M1 has bigger plans. Instead of stopping at 3 levels of upsize, M1 launched big data plans in Aug 2017, including an unlimited data plan. The big data plans are clearly ahead of competition, which is quite unusual since all telcos will try to match each other. See <a href="https://boringinvestor.blogspot.sg/2018/04/no-competition-for-m1s-big-data-plans.html">No Competition for M1's Big Data Plans</a> for more information. M1's prices are comparatively lower than that of the other 2 telcos, so much so that I feel that M1 did not maximise profits by pricing them closer to the competition (but also see the section on Narrowband Internet of Things).</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u>Mobile Virtual Network Operators (MVNOs)</u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Long before the recent spate of MVNOs like Zero Mobile, Zero1 and MyRepublic, M1 had already worked with a MVNO called Circles.Life in May 2016 to roll out mobile services to niche segments of customers that M1 did not cater for. Since MVNOs have to buy network capacity from traditional telcos, they will never be able to offer a better deal than traditional telcos on a sustainable basis. So, MVNOs are a way of getting some extra revenue from niche market segments without taking the risks.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
I would like to say that the collaboration with Circles.Life has been a successful one. Customer numbers have been increasing as shown in Fig. 1 above. Furthermore, Singtel and Starhub have recently been copying M1 in working with MVNOs as TPG's timeline for setting up operations in Singapore by Dec 2018 approaches. As they say, imitation is the best form of flattery. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
I might be wrong in this aspect, but I somehow suspect that M1 learnt something useful from Circles.Life's operations. Customers of Circles.Life use an app known as CirclesCare to manage their plans, including activating additional services on-demand. See <a href="https://pages.circles.life/circlescare-app/">CirclesCare features</a>. M1's app has similar features, which saves customers' time from not having to call the customer service line and reduces the no. of staff they need to service customers. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u>Narrowband Internet of Things (NB-IoT)</u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
NB-IoT is a new 4.5G network designed for machine-to-machine communications to facilitate Internet-of-Things (IoT). Like most other new services, M1 is the first telco to roll out this new service in Aug 2017. There are some advantages in being the first mover and the lowest cost provider in big data, but it is still a fairly new service and not many companies are ready to launch IoT devices, so it is worth watching whether this new service will bring in good revenue for M1. <br />
<br />
In an earlier section on data upsize plans, I mentioned that although M1 has a cost advantage in big data, it has not taken advantage of it to maximise profits. This might be because M1 is trying to attract more companies to use its NB-IoT services. Once on board, M1 could upsell to customers its data analytics services to derive better value. Furthermore, compared to traditional 4G services that cater to individuals, NB-IoT has higher switching costs and hence, customers are less likely to switch to a different telco. See <a href="http://boringinvestor.blogspot.sg/2018/05/nb-iot-next-frontier-for-telcos.html">NB-IoT – The Next Frontier for Telcos</a> for more information. Thus, I am willing to accept that M1 has priced its big data plans lower than necessary to capture this new market segment.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u>Overall</u></div>
<div style="text-align: justify;">
<br />
M1 is the smallest telco in Singapore. Perhaps cognisant of its small size, it has always been willing to try out new things. It is the first telco to launch 3G mobile services in Feb 2005, mobile broadband in Dec 2006, fibre broadband in Sep 2010, 4G mobile services in Sep 2012, 4.5G mobile services in Dec 2014, etc. Nevertheless, despite being the first to deliver, it has always come in last in terms of market share. Yet, it knows that if it is not the first to deliver, it will not only come in last, but also become irrelevant, given that it had no Pay TV, cable/DSL broadband and analogue/digital voice businesses (before the Next Generation Nationwide Broadband Network came on board and disrupted the playing field). To stay relevant and survive, M1 has to constantly innovate. Innovations are in M1's DNA.<br />
<br />
The innovations mentioned in earlier sections represent a desire to disrupt itself and competitors to stay ahead of the competition. Contrary to conventional wisdom, the disruptions in the telco industry in recent years did not come from the fourth telco; they came from M1 (and Singtel to a smaller extent). All these disruptions have also made the fourth telco fairly irrelevant, even if TPG were to start operations in Dec 2018 as scheduled. M1 has established a clear lead in big data (for now) and a toehold in NB-IoT. Perhaps this time round, it would not come in last among the 3 telcos.<br />
<br />
On my investment in M1, despite averaging down 4 times, I am still sitting on a small paper loss. Nevertheless, the actions that M1 took make me confident that it is a matter of time before the market recognises M1 is a technology disruptor rather than the disrupted and the share price recovers to my cost price. I am satisfied with my investment in M1.<br />
<br />
P.S. I am vested in M1, Netlink Trust and Singtel.<br />
<br />
<br />
See related blog posts:<br />
<ul>
<li><a href="https://boringinvestor.blogspot.sg/2018/04/no-competition-for-m1s-big-data-plans.html">No Competition for M1's Big Data Plans</a></li>
<li><a href="http://boringinvestor.blogspot.sg/2018/05/nb-iot-next-frontier-for-telcos.html">NB-IoT – The Next Frontier for Telcos</a></li>
<li><a href="http://boringinvestor.blogspot.sg/2017/02/do-telco-investors-need-to-fear-fourth.html">Do Telco Investors Need to Fear the Fourth Telco?</a></li>
</ul>
</div>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com2tag:blogger.com,1999:blog-6213354074634538714.post-27142563940472561672018-05-07T23:58:00.000+08:002018-05-14T21:51:51.361+08:00NB-IoT – The Next Frontier for Telcos<div style="text-align: justify;">
NB-IoT sounds like the name of a robot, but it stands for Narrowband Internet of Things. You probably have heard of Internet of Things (IoT), in which every device is collecting data and connected to the internet. As an example of the benefits of IoT, an IoT fridge can keep track of the groceries stored inside. If any grocery were to run low, it can place an order for fresh groceries to be delivered to your home automatically. You do not need to worry about groceries running low any more. It is an exciting future, isn't it? For the IoT fridge to be able to place orders online, it needs to be connected to the internet, either through WiFi at home or the telco network. Herein comes the NB-IoT. It is a 4.5G telco network that caters for machines instead of humans. NB-IoT is not the only telco network that machines can get connected to the internet, neither will it be the final telco network, but for now, it is a feasible network that enables IoT to take off.</div>
<div style="text-align: justify;">
<br />
M1 is the first telco to launch NB-IoT in Aug 2017. This is followed by Singtel in Feb 2018. Starhub's roll-out is still in progress, together with its enhancement of the 4G peak speed from 400Mbps to 1Gbps. How is the NB-IoT network going to play out for telcos?<br />
<br />
Unlike the 4G networks that cater for human-to-human communications, there is an inherent advantage that incumbent telcos have in NB-IoT networks, which is switching cost. It is easy for 5 million people in Singapore to replace the SIM cards of their 8 million handphones to that of a different telco, but it is not easy for, say, an utility company to replace the SIM cards of the smart power meters in 1 million homes. To do so, they have to incur much manpower and transport costs to visit these smart power meters. Thus, if the differences in monthly subscription costs from other telcos are not too much, customers are unlikely to switch to a different telco. First-movers will have some advantages. Having said that, NB-IoT is still fairly new and not many companies are ready to launch NB-IoT devices now.<br />
<br />
In the area of data costs, M1 seems to have an edge for now. If you read last week's post on <a href="http://boringinvestor.blogspot.sg/2018/04/no-competition-for-m1s-big-data-plans.html">No Competition for M1's Big Data Plans</a>, it appears that M1 has a cost advantage over the other 2 telcos on big data.<br />
<br />
Although NB-IoT holds promises with millions of devices to be connected up, I am still not particularly excited over telcos' prospects. The key question I have is that is the NB-IoT service that telcos provide a dumb pipe or a smart pipe? If it is a dumb pipe, any telcos could have provided the connectivity and price competition would be present. However, if it is a smart pipe, telcos would be able to hold off the competition and derive better value from NB-IoT.</div>
<div style="text-align: justify;">
<br />
Let us consider M1's collaboration with Otto Waste Systems and SmartCity Solutions to implement an intelligent waste management system based on NB-IoT. The sensors used to determine whether the bins are full is provided by Otto Waste Systems, while the centralised management system to monitor which bins need to be cleaned is provided by SmartCity Solutions. M1 provides the NB-IoT connectivity and the data analytics to determine the distribution of bins and the frequency of collection. Based on this description, M1's pipe is a half-dumb pipe. They could derive some additional value from the provision of data analytics, but M1 is not the only telco that has such data analytics capabilities. Otto Waste Systems and SmartCity Solutions could have worked with any other telcos and still not suffer a drop in the quality of service. <br />
<br />
In conclusion, NB-IoT is the next frontier for telcos. Unlike 4G networks, telcos can better hold on to their customers because of high switching costs. They probably also can derive more value from the provision of data analytics to their customers, but some levels of price competition among telcos will still be around. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
P.S. I am vested in M1, Netlink Trust and Singtel.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
See related blog posts:</div>
<div style="text-align: justify;">
<ul>
<li><a href="http://boringinvestor.blogspot.sg/2018/04/no-competition-for-m1s-big-data-plans.html">No Competition for M1's Big Data Plans</a></li>
<li><a href="http://boringinvestor.blogspot.sg/2017/02/can-telcos-stop-decline.html">Can Telcos Stop the Decline in Profitability?</a></li>
<li><a href="https://boringinvestor.blogspot.sg/2018/05/a-satisfied-m1-investor.html">A Satisfied M1 Investor</a></li>
</ul>
</div>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com2tag:blogger.com,1999:blog-6213354074634538714.post-22847178081750141322018-04-29T23:30:00.000+08:002018-05-08T00:01:22.167+08:00No Competition for M1's Big Data Plans<div style="text-align: justify;">
Usually, the 3 local telcos are very competitive. Whenever 1 launches a new service, the other 2 will follow quickly. However, for the new big data plans that M1 launched in Aug 2017, the follow-ups have been fairly feeble. Starhub launched its unlimited weekend data plans immediately, but that came with additional monthly subscription fees of $5.10. Only Singtel came up with something close, offering a Data X Infinity add-on for unlimited data for additional $39.99 per month 2 weeks later. However, that add-on only applies to higher mobile plans. Let us look at the offerings from each telco.<br />
<br />
Do note that M1's big data plans do not come with much talktime and SMS. All the big data plans (except for the most expensive one) have only 100 mins of talktime and 100 SMS. For extra talktime, there are add-ons that range from $5 (for extra 200 mins) to $15 (for unlimited talktime). These big data plans do not replace M1's more traditional mobile plans that have a balance of talktime, SMS and data. For Singtel and Starhub, there are no new mobile plans that are equivalent to M1's big data plans. They are just enhancing their existing mobile plans to add more data. Thus, the comparison below is not a like-for-like comparison. However, for users who use a lot of data, this comparison is relevant.</div>
<br />
<div style="text-align: center;">
</div>
<table border="0" cellpadding="0" cellspacing="0" style="margin-left: auto; margin-right: auto; text-align: left; width: 533px;"><colgroup><col style="mso-width-alt: 4096; mso-width-source: userset; width: 96pt;" width="128"></col>
<col span="5" style="mso-width-alt: 2585; mso-width-source: userset; width: 61pt;" width="81"></col>
</colgroup><tbody>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt; width: 96pt;" width="128"><b>M1 Plans</b></td>
<td style="text-align: center; width: 61pt;" width="81"><b><br /></b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>mySIM 40</b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>mySIM 70</b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>mySIM 90</b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>mySIM 118</b></td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">Monthly Cost</td>
<td style="text-align: center;"><br /></td>
<td class="xl68" style="text-align: center;">$40.00</td>
<td class="xl68" style="text-align: center;">$70.00</td>
<td class="xl68" style="text-align: center;">$90.00</td>
<td class="xl68" style="text-align: center;">$118.00</td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">Data (GB)</td>
<td style="text-align: center;"><br /></td>
<td class="xl66" style="text-align: center;">5</td>
<td class="xl66" style="text-align: center;">15</td>
<td class="xl66" style="text-align: center;">30</td>
<td class="xl67" style="text-align: center;">Unlimited</td>
</tr>
</tbody></table>
<br />
<table border="0" cellpadding="0" cellspacing="0" style="margin-left: auto; margin-right: auto; text-align: left; width: 533px;"><colgroup><col style="mso-width-alt: 4096; mso-width-source: userset; width: 96pt;" width="128"></col>
<col span="5" style="mso-width-alt: 2585; mso-width-source: userset; width: 61pt;" width="81"></col>
</colgroup><tbody>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt; width: 96pt;" width="128"><b>Singtel Plans</b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>Combo 1</b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>Combo 2</b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>Combo 3</b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>Combo 6</b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>Combo 12</b></td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">Monthly Cost</td>
<td class="xl67" style="text-align: center;">$27.90</td>
<td class="xl67" style="text-align: center;">$42.90</td>
<td class="xl68" style="text-align: center;">$68.90</td>
<td class="xl69" style="text-align: center;">$95.90</td>
<td class="xl67" style="text-align: center;">$239.90</td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">Data (GB)</td>
<td class="xl66" style="text-align: center;">0.1</td>
<td class="xl66" style="text-align: center;">2</td>
<td class="xl66" style="text-align: center;">3</td>
<td class="xl66" style="text-align: center;">6</td>
<td class="xl66" style="text-align: center;">12</td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt; width: 96pt;" width="128">Data X2
Cost</td>
<td class="xl68" style="text-align: center; width: 61pt;" width="81">-</td>
<td class="xl68" style="text-align: center; width: 61pt;" width="81">$48.80</td>
<td class="xl68" style="text-align: center; width: 61pt;" width="81">$74.80</td>
<td class="xl68" style="text-align: center; width: 61pt;" width="81">$101.80</td>
<td class="xl68" style="text-align: center; width: 61pt;" width="81">$245.80</td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">Data X2 (GB)</td>
<td class="xl66" style="text-align: center;">-</td>
<td class="xl66" style="text-align: center;">4</td>
<td class="xl66" style="text-align: center;">6</td>
<td class="xl66" style="text-align: center;">12</td>
<td class="xl66" style="text-align: center;">24</td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">Data X3 Cost</td>
<td class="xl68" style="text-align: center;">-</td>
<td class="xl68" style="text-align: center;">$52.80</td>
<td class="xl68" style="text-align: center;">$78.80</td>
<td class="xl68" style="text-align: center;">$105.80</td>
<td class="xl68" style="text-align: center;">$249.80</td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">Data X3 (GB)</td>
<td class="xl66" style="text-align: center;">-</td>
<td class="xl66" style="text-align: center;">6</td>
<td class="xl66" style="text-align: center;">9</td>
<td class="xl66" style="text-align: center;">18</td>
<td class="xl66" style="text-align: center;">36</td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">X Infinity Cost</td>
<td class="xl67" style="text-align: center;">-</td>
<td class="xl67" style="text-align: center;">-</td>
<td class="xl67" style="text-align: center;">$108.80</td>
<td class="xl67" style="text-align: center;">$135.80</td>
<td class="xl67" style="text-align: center;">$279.80</td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">X Infinity Data</td>
<td style="text-align: center;">-</td>
<td style="text-align: center;">-</td>
<td class="xl66" style="text-align: center;">Unlimited</td>
<td class="xl66" style="text-align: center;">Unlimited</td>
<td class="xl66" style="text-align: center;">Unlimited</td>
</tr>
</tbody></table>
<br />
<table border="0" cellpadding="0" cellspacing="0" style="margin-left: auto; margin-right: auto; text-align: left; width: 533px;"><colgroup><col style="mso-width-alt: 4096; mso-width-source: userset; width: 96pt;" width="128"></col>
<col span="5" style="mso-width-alt: 2585; mso-width-source: userset; width: 61pt;" width="81"></col>
</colgroup><tbody>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt; width: 96pt;" width="128"><b>Starhub Plans</b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>XS</b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>S</b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>M</b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>L</b></td>
<td class="xl66" style="text-align: center; width: 61pt;" width="81"><b>XL</b></td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">Monthly Cost</td>
<td class="xl68" style="text-align: center;">$48.00</td>
<td class="xl68" style="text-align: center;">$68.00</td>
<td class="xl68" style="text-align: center;">$88.00</td>
<td class="xl67" style="text-align: center;">$108.00</td>
<td class="xl68" style="text-align: center;">$238.00</td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">Data (GB)</td>
<td class="xl66" style="text-align: center;">3</td>
<td class="xl66" style="text-align: center;">4</td>
<td class="xl66" style="text-align: center;">5</td>
<td class="xl66" style="text-align: center;">8</td>
<td class="xl66" style="text-align: center;">12</td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt; width: 96pt;" width="128">Plus 3
Cost</td>
<td class="xl67" style="text-align: center; width: 61pt;" width="81">$54.00</td>
<td class="xl67" style="text-align: center; width: 61pt;" width="81">$74.00</td>
<td class="xl67" style="text-align: center; width: 61pt;" width="81">$94.00</td>
<td class="xl67" style="text-align: center; width: 61pt;" width="81">$114.00</td>
<td class="xl67" style="text-align: center; width: 61pt;" width="81">$244.00</td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">Plus 3 Data (GB)</td>
<td class="xl66" style="text-align: center;">6</td>
<td class="xl66" style="text-align: center;">7</td>
<td class="xl66" style="text-align: center;">8</td>
<td class="xl66" style="text-align: center;">11</td>
<td class="xl66" style="text-align: center;">15</td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">DataJump Cost</td>
<td style="text-align: center;">-</td>
<td class="xl67" style="text-align: center;">$78.00</td>
<td class="xl67" style="text-align: center;">$98.00</td>
<td class="xl67" style="text-align: center;">$118.00</td>
<td class="xl67" style="text-align: center;">$248.00</td>
</tr>
<tr height="18" style="height: 13.8pt;">
<td class="xl65" height="18" style="height: 13.8pt;">DataJump Data (GB)</td>
<td class="xl66" style="text-align: center;">-</td>
<td class="xl66" style="text-align: center;">9</td>
<td class="xl66" style="text-align: center;">15</td>
<td class="xl66" style="text-align: center;">23</td>
<td class="xl66" style="text-align: center;">32</td>
</tr>
</tbody></table>
<br />
<div style="text-align: justify;">
At the low end of the spectrum, M1's plan for 5GB costs only $40 per month. Singtel's Combo 2 Plan with Data X2 add-on costs $48.80 (for 4GB) while Starhub's XS plan with Plus 3 add-on costs $54 (for 6GB). There is simply no competition at this end of the spectrum.<br />
<br />
At the middle of the spectrum, M1's plan for 15GB costs $70. Singtel's Combo 6 plan with Data X2 add-on costs $101.80 (for 12GB) while Starhub's M plan with DataJump add-on costs $98 (for 15GB). Again, no competition.<br />
<br />
At the high end with unlimited data, M1's plan costs $118. Singtel's Combo 3 plan with Data X Infinity add-on costs $108.80. Starhub has no credible response here. Although Starhub's plans offer unlimited data during weekends, they are not comparable to M1's and Singtel's unlimited data plans that are unlimited any time of the week. Thus, at this end of the spectrum, only Singtel is able to beat M1.<br />
<br />
The figure below shows that subscribers are consuming more and more data. The average usage for M1 subscribers has risen from 3.2GB in 1Q2015 to 4.5GB in 1Q2018. The no. of subscribers who exceed their primary data bundle is also on the rise, from 20% in 1Q2015 to 29% in 1Q2018. If this trend continues, and if the other 2 telcos do not start offering similar big data plans in the near term, M1 might grab a bigger share of the mobile services market.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjZfqL_-XR8E5cUxxwHKZKWw6gms3PzBDrvRB-7y-c_JvPy9s5jDZs5AgOEK9hH1OgMxCH-Lxj5y7af6HOGBdxw6HttZ5TmNMav5fUrsC_QkCikyGACcvm74o6um1_Z_9_l5-VqqoUktzU/s1600/M1DataUsage17.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="508" data-original-width="780" height="260" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjZfqL_-XR8E5cUxxwHKZKWw6gms3PzBDrvRB-7y-c_JvPy9s5jDZs5AgOEK9hH1OgMxCH-Lxj5y7af6HOGBdxw6HttZ5TmNMav5fUrsC_QkCikyGACcvm74o6um1_Z_9_l5-VqqoUktzU/s400/M1DataUsage17.png" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fig. 1: M1's data usage trend</td></tr>
</tbody></table>
<br />
P.S. I am vested in M1, Netlink Trust and Singtel.<br />
<br />
<br />
See related blog posts:<br />
<ul>
<li><a href="http://boringinvestor.blogspot.sg/2017/02/impact-of-data-upsize-plans-on-telcos.html" style="text-align: justify;">Impact of Data Upsize Plans on Telcos</a></li>
<li><a href="https://boringinvestor.blogspot.sg/2018/04/will-mvnos-cannibalise-telcos-business.html" style="text-align: justify;">Will MVNOs Cannibalise Telcos' Business?</a></li>
<li><a href="https://boringinvestor.blogspot.sg/2018/05/nb-iot-next-frontier-for-telcos.html">NB-IoT – The Next Frontier for Telcos</a></li>
</ul>
</div>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com0tag:blogger.com,1999:blog-6213354074634538714.post-89116095994370429552018-04-23T00:30:00.000+08:002018-05-14T21:53:38.595+08:00Do M1's Acquisitions Make Sense?<div style="text-align: justify;">
It is a well known fact that competition among telcos has been heating up in the last couple of years. All 3 telcos have been finding new sources of revenue outside their traditional telco businesses. They have been busy acquiring companies, such as Singtel's acquisition of Turn for USD310M in Feb 2017 and Starhub's acquisition of D'Crypt for up to SGD122M in Dec 2017. In comparison, M1's acquisitions have been very small. So far, their acquisitions are as follow:</div>
<ul>
<li style="text-align: justify;">Aug 2016 - SGD3.0M for a 30% stake in Octopus Retail Management, which
provides Point-of-Sales (POS) solutions for retailers and Food
& Beverages (F&B) outlets. </li>
<li style="text-align: justify;">Oct 2017 - SGD2.45M additional investment in Kliq, which provides digital mobile remittance service. </li>
<li style="text-align: justify;">Apr 2018 - SGD3.0M for a 25% stake in Trakomatic, which provides
Business-to-Business video analytics solutions to retailers.</li>
</ul>
<div style="text-align: justify;">
<br />
Do these acquisitions have synergy with M1's existing businesses? Let us look at them one by one.</div>
<div style="text-align: justify;">
<br />
<u>Octopus - Point-of-Sales</u><br />
<br />
The POS solution is provided by <a href="https://www.octopuspos.com/">Octopus Retail Management</a>. This is an independently run business and not marketed together with M1's other services. As such, there is no synergy with M1's existing businesses. In fact, M1 has another <a href="https://www.m1.com.sg/business/mobile/solution/mpos">mobile POS solution</a> that is developed independently! To be fair, M1's in-house mPOS solution only facilitates payment transactions whereas Octopus' POS solution covers inventory tracking and customer loyalty programmes.<br />
<br />
It is a bit difficult to see how this acquisition ties in with M1's overall business strategy. For FY2017, this associate lost $0.29M for M1. <br />
<br /></div>
<div style="text-align: justify;">
<u>Kliq - Digital Mobile Remittance Service</u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Though Kliq, M1 provides remittance service to 9 Asian countries such as Bangladesh, India, Philippines, etc. Users have to M1 customers. Payment for the remittance is made through AXS machines (which accept ATM, credit and debit cards), m-AXS mobile app (which accepts internet banking, credit and debit cards) and at M1 shops at IMM and Paragon (which accept cash). <br />
<br />
Although users have to be M1 customers, there is no integration with other M1 services. Users cannot pay for their remittance through their M1 monthly bills or their pre-paid stored value accounts. Furthermore, M1's share of the telco market is only 24.0%; by limiting the service to only M1 customers, they are effectively reaching out only to a small group of potential users. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
I cannot see how this business ties in with M1's overall business strategy. Perhaps, someone from the remittance industry can see how it makes sense. In Oct 2017, M1 announced that it jointly invested an additional $5.02M in Kliq with Merchantrade Asia Sdn Bhd, thereby diluting its stake from 100% to 51%. Merchantrade is 20% owned by Axiata, one of M1's controlling shareholders. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u>Trakomatic - Video Analytics Solution</u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<a href="https://www.trakomatic.com/">Trakomatic</a> provides video analytics solutions to businesses to understand the movement and profiles of customers in their stores. The solutions can leverage on existing cameras and sensors that stores already have. This can complement M1's own data analytics solution, which analyses and provides similar information from the telco data of its customers. Trakomatic can provide information of customers within the store while M1 can provide information of potential customers in the vicinity of the store. Taken together, the data analytics created by M1 and Trakomatic will be more comprehensive and more valuable to businesses.<br />
<br />
<u>Conclusion</u></div>
<div style="text-align: justify;">
<br />
So far, M1 has acquired small stakes in 3 companies for a total of less than $10M. Among these 3 companies, 2 of them do not seem to complement its existing telco businesses very well. The more exciting acquisition is Trakomatic, which complements its data analytics business. M1 should be very careful about acquisitions, as its debts have been steadily climbing from $250M in Dec 2013 to $450M in Dec 2017.<br />
<br />
P.S. I am vested in M1. <br />
<br />
<br />
See related blog posts:<br />
<ul>
<li><a href="http://boringinvestor.blogspot.sg/2017/02/can-telcos-stop-decline.html" style="text-align: justify;">Can Telcos Stop the Decline in Profitability?</a></li>
<li><a href="http://boringinvestor.blogspot.sg/2017/02/do-telco-investors-need-to-fear-fourth.html">Do Telco Investors Need to Fear the Fourth Telco?</a></li>
<li><a href="https://boringinvestor.blogspot.sg/2018/05/a-satisfied-m1-investor.html">A Satisfied M1 Investor</a></li>
</ul>
</div>
Lee Chin Waihttp://www.blogger.com/profile/10250390011842795509noreply@blogger.com2