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CapitaLand's enlarged size to impact future of Singapore, enable it to achieve global ambitions

Goola Warden
Goola Warden3/4/2019 07:30 AM GMT+08  • 19 min read
CapitaLand's enlarged size to impact future of Singapore, enable it to achieve global ambitions
SINGAPORE (Mar 4): Vertigo-inducing videos on CapitaLand’s website show The Crystal, a 300m-long skybridge, being hoisted 250m to sit atop four skyscrapers that make up part of Raffles City Chongqing (RCCQ). The project, comprising eight skyscrapers and
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SINGAPORE (Mar 4): Vertigo-inducing videos on CapitaLand’s website show The Crystal, a 300m-long skybridge, being hoisted 250m to sit atop four skyscrapers that make up part of Raffles City Chongqing (RCCQ). The project, comprising eight skyscrapers and designed by renowned architect Moshe Safdie, will be the latest jewel in the real estate developer’s crown when it is completed in 2H2019.

Touted as an engineering marvel, RCCQ is CapitaLand’s most ambitious project so far. It is sited at the confluence of the Yangtze and Jialing rivers in Chongqing, China’s biggest city by area and the heart of its far-reaching Belt and Road Initiative. The mixed-use development will have a sprawling shopping mall, plenty of Grade A office space, 1,400 apartments and a serviced residence and hotel. On Feb 25, the company announced the topping-out of the eighth and final skyscraper. Already, about 39% of its residential units have been sold.

The progress comes as quite a relief to Lee Chee Koon, who was recently appointed CapitaLand’s president and group CEO. “The greatest risk, in terms of development, is over,” Lee tells The Edge Singapore in an exclusive interview.

The real estate group has just reported its best set of results in 10 years. And given that CapitaLand has committed to pay out no less than 30% of its earnings, shareholders, including Temasek Holdings, which has a 40.8% stake, are to be rewarded with 12 cents per share in dividends. The company’s stock, which had been underperforming industry benchmarks, bounced 4% after the results announcement on Feb 20.

ASB acquisition

But Lee has yet another formidable challenge ahead. On Jan 14, CapitaLand announced that it planned to acquire Ascendas-Singbridge (ASB), the industrial and commercial real estate group wholly owned by Temasek, for $10.9 billion. If the acquisition takes place, CapitaLand’s enlarged size would have implications for Singapore’s Smart Nation initiative and intelligent buildings, its efforts at sustainability and the moribund local stock market.

There are questions around the deal, namely its timing, the price CapitaLand is to pay for the assets and the amount of debt it has to take on to do so. Critics of the ASB transaction have observed that the main beneficiary is Temasek, which will divest ASB into CapitaLand at book value for the assets, and at a multiple for the fund management business, for which CapitaLand books $800 million in goodwill. In return, Temasek gets $3 billion worth of CapitaLand shares at $3.50 apiece, which is a 23% discount to its net asset value (NAV) of $4.55 a share.

Lee acknowledges that there are shortcomings in the deal. But he says investors generally understand the rationale for the acquisition. “The key is how successfully we can integrate the two teams [to form] one culture, and to capitalise on the much bigger platform we can create after completion of the transaction,” he says. “I hope shareholders will support [the resolutions]. It makes sense from the numbers: ROE [return on equity] is accretive, EPS [earnings per share] is accretive. NAV is slightly dilutive, but from the value we are creating, we can more than make up for the short-term NAV dilution.”

Lee also hints at the benefits the deal will have on the broader market. ASB reportedly had plans to spin off a real estate investment trust before the transaction was announced, and this could materialise. “We want to continue to create more REIT products. If the ASB deal is approved, it will give us more products and more markets for us to contemplate new REIT listings, whether in Singapore or other jurisdictions,” Lee says.

Lee, 43, was appointed CapitaLand’s CEO on Sept 1 last year, just eight months after becoming the group’s chief investment officer (CIO) and at a time when shares in CapitaLand had been underperforming the FTSE ST Real Estate Index over a five-year period (see chart). Almost immediately after Lee became CEO, the market saw a change in the real estate group’s strategy. On Sept 18, CapitaLand announced that it had acquired a portfolio of 16 freehold multifamily properties in the US for US$835 million ($1.14 billion).

“I really want to turn CapitaLand into a global company, with a diversified, balanced portfolio between emerging and developed markets, across different asset classes,” Lee says.

Importantly, harvesting returns is a lot more predictable if the properties are -geographically diversified. “Global doesn’t mean every single market. You have to be in markets and asset classes that can contribute meaningfully to the bottom line,” Lee says.

‘Diversified real estate’ company

CapitaLand is not quite the typical Singapore developer, but terms itself a “diversified real estate” company. Typical developers normally acquire land, develop a property and sell it, and perhaps own some investment properties for recurring income. CapitaLand’s assets are investment properties — owned directly through its REITs, private-equity funds and joint ventures — as well as properties held for sale. Investment properties include retail malls, office towers, lodgings (formerly serviced residences) and integrated developments. The REITs and funds contribute fee income; in FY2018, CapitaLand reported fee income of $227.5 million, making up 4% of its total revenue of $1,624 million (+34% y-o-y).

The bulk of CapitaLand’s asset base of $64.6 billion comprises investment properties, which provide a mixture of fee income and net property income (NPI), and trading properties, currently comprising 21% of total assets. CapitaLand has also indicated a preference for its assets to be evenly split (50:50) between emerging and developed markets. As at Dec 31, the more stable developed market assets comprised 58% of total assets. About 36% of its assets are in China.

For FY2018, CapitaLand announced an ROE of 9.3%, of which 4.6% was operating profit after tax and minority interests (Patmi), 1.8% was from trading gains and 2.9% from revaluations and impairments (non-cash). In 2013, CapitaLand had set an ROE target of 8% to 12%, but consistently failed to achieve this target.

“If you look at 2014 to 2015, ROE was a bit low,” Lee acknowledges. “Not because there were problems; there were no problems. It’s just that we took on too many development projects. When you take on so many projects at one go, it will have an impact on your returns.” The group had six major projects under development in China, including RCCQ, Raffles City Changning (RCCN) and Suzhou Centre, which opened in November 2017 and is three times the size of ION Orchard. “There was no issue with the balance sheet, but we just didn’t have enough projects to sell. We have to be careful how we pace our projects,” says Lee.

China to boost bottom line

The Chaotianmen site on which RCCQ was developed was acquired from the governor of Yuzhong district. The agreement was signed in January 2012, when CapitaLand was still helmed by former CEO Liew Mun Leong. Including land cost, the total development cost of RCCQ is RMB24 billion ($4.8 billion), marginally higher than the original estimate of RMB21.1 billion.

The commercial portion of RCCQ was valued at RMB7,554 million (on a 100% basis). Three residential towers with a total of 769 units have been launched for sale, of which 71%, or a gross floor area (GFA) of 115,034 sq m, have been sold at an average price of RMB42,111 per sq m, or a total of RMB4.84 billion.

The project is jointly owned by CapitaLand and ASB. As at Dec 31, CapitaLand owned a 62.5% stake in RCCQ. Should the ASB transaction be approved by CapitaLand’s minority shareholders at an extraordinary general meeting expected to be held in the next few months, CapitaLand will own 100% of RCCQ, and could reap hefty earnings and valuation gains from the development.

Like CapitaLand’s other large Raffles City projects in China, RCCQ will open in stages. CapitaLand’s strategy is usually to open the mall — there are five storeys of retail space in RCCQ — when it is around 80% committed. Office towers can start operating at lower occupancy levels.

Two of RCCQ’s eight skyscrapers are 350m high, 25% taller than the tallest buildings in Singapore. The other six skyscrapers have a height of about 250m each. The mall and Grade A office have an area of 235,000 sq m and 150,000 sq -m -respectively. RCCQ, with a total GFA of 817,000 sq m, also houses the Ascott Raffles City Chongqing serviced residences and the InterContinental Raffles City Chongqing hotel.

As CapitaLand hands over completed units in 2H2019, including about 500 apartments, its bottom line will get a boost. For its entire residential portfolio in China, CapitaLand announced that 7,000 units valued at RMB15.6 billion are likely to be handed over from 2019 and it should be able to recognise 70% of this value this year. “We are selling [residential units] north of RMB40,000 per sq m, significantly higher than our underwritten [values]. We know that in the long run, [RCCQ] will be okay; in the last few years, residential prices in Chongqing went up quite nicely,” Lee says.

Still, while RCCQ’s valuation is to change from a project under development (PUD) to an operating property, its income stream will take a while to stabilise and contribute to the group’s NPI.

Nevertheless, Lucas Loh, president (China and investment management), allays fears that CapitaLand could be adversely affected by property curbs and excessive supply in China. Margins can be between 10% and 30%, depending on the price at which the land was obtained, and the price caps in place in various cities, Loh indicates. “Across the portfolio, if we sell based on the price caps, we still have positive margins for all our projects,” he says during a recent results briefing.

Positioning for the future

CapitaLand was formed in 2000 from the merger of DBS Land and Pidemco Land. Both companies were highly levered. Singapore’s REIT sector came about from efforts to cut CapitaLand’s debt load in 2002 through the divestment of retail properties into what is now CapitaLand Mall Trust. In 2004, CapitaLand divested a handful of office properties, including 6 Battery Road, into CapitaLand Commercial Trust. This asset recycling model has enabled CapitaLand to set up private-equity funds which, together with its REITs, have provided stable fee income.

In 2005, CapitaLand divested the iconic Raffles Hotel, along with 40 other hotels, to Colony Capital for $1.72 billion. The monies were mainly recycled into developing malls in China.

In 2010, CapitaLand doubled down on China by acquiring Orient Overseas Developments for US$2.2 billion, a move that paid off handsomely. OODL had a portfolio of seven high-quality sites, including The Paragon in Shanghai’s swanky French Concession, and Raffles City Changning, also in Shanghai. RCCN was valued at RMB11.699 billion as at Dec 31. Residential units at The Paragon fetched prices that averaged RMB125,000 per sq m. In early 2018, CapitaLand divested 20 malls in China’s third- and fourth-tier cities for $1.706 billion.

With the adverse effect of e-commerce on malls and the increasing use of technology, CapitaLand has turned its attention to developed markets, particularly outside of China.

When he was CIO, Lee studied portfolios in the US, Europe and Australia. “If you look at property cycles globally and across asset classes and if you can play in the global space, it gives you a lot more optionality to be able to deploy capital across cycles and different asset classes,” he points out.

Fitting that profile would be the portfolio in the US, as well as ASB, which has assets in Australia, Europe and India. Ascendas REIT, which CapitaLand could end up controlling, has 11% of its property value in logistics and distribution facilities in Australia. “ASB has quite a complementary portfolio because it is in asset classes we are not in, and in markets that complement nicely,” Lee says.

Indeed, some market observers have wondered whether CapitaLand might have been better off merging with Mapletree Investments, the commercial, industrial and logistics real estate company 100% owned by Temasek.

The two have often been compared, given their similar profile and footprint. However, over the past five years, Mapletree Investments has outperformed CapitaLand. In FY2018, Mapletree Investments reported Patmi of $1,958.6 million, up 39% y-o-y and significantly higher than FY2013’s Patmi of $878.2 million. CapitaLand’s Patmi in FY2018 rose 12% y-o-y to $1,762.5 million. In FY2013, CapitaLand reported Patmi of $840.2 million. However, only $764.4 million of Mapletree Investments’ FY2018 Patmi was operating Patmi compared with CapitaLand’s $872.2 million. Mapletree reported an ROE of 15.7% for FY2018 ended March 31 versus CapitaLand’s 9.3% in FY2018.

But, Mapletree Investments is not listed and has been able to work on relatively higher gearing ratios. For instance, its gearing ratio as at end-March last year stood at 0.83 times compared with CapitaLand’s 0.56 times as at end-December.

On his part, Lee maintains that he has no knowledge of any transaction involving Mapletree Investments. “We have to ask ourselves what is the complementary nature of the business and look for an entity with the best fit,” he says.

Whatever the case, a merger with ASB will create a real estate behemoth that Lee believes will help CapitaLand scale even greater heights. CapitaLand would be one of the 10 largest property fund managers by assets under management in the world, which is expected to help it attract more capital partners for its private funds. And it could set global standards for intelligent buildings and sustainable urban development.

Already, it has secured a $300 million five-year loan from DBS Bank that is linked to its listing on the Dow Jones Sustainability World Index. Interest rates can be reduced on a tiered basis, contingent on CapitaLand’s ongoing performance measured against ESG (environmental, social and governance) indicators based on -RobecoSAM’s Corporate Sustainability Assessment and a retained listing on the DJSI World.

With size, CapitaLand will also be able to scale up its US multifamily portfolio. This asset class in the US is big and liquid at US$3 trillion, which presents ample acquisition opportunities. “Because of the size of the market, we can grow, acquire more properties and find opportunities to securitise to a private-equity fund or a REIT platform,” Lee says.

“Scale is important for many reasons,” he adds. “You need it to deploy significant amounts of capital, you need it to employ the best people, to be able to negotiate with the authorities, especially when it comes to development projects.” And, a large project affects the community, jobs and environment.

Indeed, Lee is also keenly aware of longer-term considerations that an organisation as large and influential as CapitaLand has to take into account. “When I was asked to become CIO of CapitaLand in August 2017, I looked at the portfolio and business, and [I] asked: How do we position the company into the future [for] the big trends that define the world’s technologies, relating to ageing demographics and healthcare and urbanisation?” he says.

“It is not just earnings for this year or next, but for three, four, 10 years into the future,” Lee adds. “As a company, we have 14,000 staff and if you’re not prepared to shift and position the company for the future, what does it mean for the 14,000 colleagues who have a job with the company?” — With additional reporting by Chan Chao Peh

CapitaLand CEO reticent on deal with Mapletree

SINGAPORE (March 4): Lee Chee Koon, president and group CEO of CapitaLand, gave his first full interview as CEO to The Edge Singapore.

The Edge Singapore: Did you discuss deals with any other parties such as Mapletree Investments?

Lee: We have to ask ourselves what is the complementary nature of the business and look for an entity with the best fit. Whether Mapletree is in talks with Ascendas-Singbridge [ASB], I really have no idea.

What about between CapitaLand and Mapletree Investments?

It may have happened but I’m not aware. I just took over as CEO in September; as CIO, I never contemplated [such a deal].

Do you have investors asking you questions on sustainability?

There are investors who check if we are in the Dow Jones Sustainability World Index. Climate issues are real — we see ice caps melting and water levels rising, and it’s going to have a real impact. Being one of the largest real estate developers and fund managers in Asia, we have a big responsibility to play on this front.

What is the role that CapitaLand can play in our Smart Nation initiative?

In addition to facial recognition and M&E [monitoring and evaluation], we can go much further, assuming the ASB transaction takes place. It will give us a lot more exposure across different asset classes and across the island, where we can work more closely with the government to co-define what are smart buildings and what kind of difference we can make to the people who use the buildings, whether they come to the office or go shopping.

CapitaLand has not listed a real estate investment trust for a long time. What’s your view on REITs?

I am of the view that we should continue to develop REITs as a product and SGX should help to develop them. In terms of the stock market, Bloomberg reports that our market cap keeps shrinking. It’s partly the luck of the draw — we don’t have a huge hinterland. If you give me a choice, to list a REIT in a market that gives the best returns to unitholders, Singapore would be my first port of call.

Given how small your current exposure to the Singapore residential property is, are you quite nonchalant about the Singapore property market?

The Singapore residential market has a five-year sell-by period. You are constrained. There are other areas we can choose to compete in. If the constraint creates interesting opportunities, we can always choose to strike. The ASB transaction gives us a lot more optionality. If you have no options, you have to continue to look for landbank.

Deleveraging post-ASB could see CapitaLand realising higher valuation

SINGAPORE (Mar 4): Valuations are something of an art and a science. If the Ascendas-Singbridge (ASB) transaction is approved by shareholders, CapitaLand is likely to move into deleveraging mode to realise some of its valuation gains. “If we’re recycling capital, selling assets and realising portfolio gain are a good test of valuation,” says Andrew Lim, group chief financial officer of CapitaLand, during a recent results briefing.

CapitaLand announced a profit after tax and minority interests (Patmi) of $1,762.5 million in FY2018, up 12.3% y-o-y, boosting return on equity (ROE) to 9.3%, up from 8.6% a year ago. Operating Patmi eased 5.9% to $872.2 million. Revenue rose 21.3% to $5,602.4 million on account of contributions from newly acquired and operational properties in Singapore, China, Germany and the US, and higher handover of units from residential projects in China and Vietnam.

China operations

As at Dec 31, 7,000 units in China valued at RMB15.6 billion ($3.15 billion) were sold. Of these units, 70% of the sales value is expected to be handed over in FY2019. In Vietnam, the company sold 2,456 units valued at $745 million, of which 45% is likely to be handed to buyers this year.

To replenish its landbank in China, CapitaLand acquired a mixed-use site in Guangzhou Science City for RMB882 million last November, which it will develop into offices, strata offices, retail units and a serviced residence. CapitaLand holds a 75% stake in the development, with the remainder held by an unrelated third party. The development is targeted for completion by 2022. Also in November, CapitaLand, through Raffles City China Investment Partners (RCCIP) III, formed a 50:50 joint venture with GIC to acquire Shanghai’s tallest twin towers for RMB12.8 billion, to be developed into a Raffles City branded property.

Lucas Loh, president (China and investment management), says RCCIP III — which owns Raffles City Shenzhen — still has capacity to acquire another project. The other two Raffles City funds were converted into income funds. “Raffles City Hangzhou opened in 2017 and needs time to stabilise. Raffles City Changning is being stabilised,” Loh explains. “[Eventually] we will look at the capital market if timing and factors are right.”

On Feb 27, CapitaLand announced the launch of a debt fund to invest in offshore US dollar-denominated subordinated instruments for real estate in China’s first- and second-tier cities. It will focus on loans and securities of high-quality real estate covering commercial, retail, residential, logistics and industrial properties.

Following the announcement of the acquisition of ASB in January, CapitaLand said its gearing was likely to increase to 0.72 times. It stood at 0.56 times as at Dec 31. At the same time, the company will put in a debt reduction plan with a gearing target of 0.64 times by 2020.

Divestment options

In a recent report, Citi indicated that CapitaLand has several options to recycle ASB’s assets and pare debt. Citi believes the market value of ASB’s properties is closer to $6.1 billion compared with a book value of $5.3 billion. The properties are mainly business/science parks in Singapore and China, suburban offices in the US and core CBD offices in Seoul. “We expect the majority of these assets to be injected into Ascendas REIT, enhancing [CapitaLand’s] ROE profile,” Citi says.

The biggest valuation uplift for CapitaLand post-ASB is likely to be from Raffles City Chongqing and ASB Tower (the redevelopment of the former CPF Building on Robinson Road), Citi says. When completed, ASB Tower and ASB’s stake in RCCQ could be valued at $3.4 billion compared with the book value of $2.6 billion.

Elsewhere, Ascendas Hospitality Trust has the potential to be divested. Citi says “non-core” hotels could be sold to a third party, or the entire portfolio could be sold to a fund or it could merge with Ascott Residence Trust. (Saizen REIT and Creosus Retail Trust sold their entire portfolios prior to their delistings.) Interestingly, on Dec 23, 2015, Ascendas Hospitality Trust announced that it was reviewing certain options relating to a sale, but this did not materialise. Its portfolio value as at Dec 31, 2018 was $1.89 billion. In total, Citi expects ASB’s accretion to CapitaLand to be as high as 33 cents a share.

Citi’s revalued net asset value for CapitaLand is $5.97, one of the highest estimates, with the stock valued at a 44% discount, or $4.18.

Not all analysts are as positive. Credit Suisse has a “neutral” recommendation, as it sees limited near-term catalysts. It had expected dividend per share to rise to 13 cents in FY2018, but CapitaLand maintained it at 12 cents to conserve capital and reduce gearing if the ASB transaction is approved by shareholders.

In addition, Credit Suisse points out that headline ROE of 9.3% does not tell the full story. “Core ROE fell from 5.1% in FY2017 to 4.6% in FY2018, in line with five-year average,” Credit Suisse says. Core ROE uses operating Patmi instead of total Patmi, which includes revaluation gains. However, Credit Suisse says: “With CapitaLand’s net gearing expected to rise post the ASB deal, we expect a faster pace of asset recycling in 2019 versus CapitaLand’s $3 billion per annum target, with deleveraging a priority versus new acquisitions.” Credit Suisse values CapitaLand at $3.90 a share, up from a pre-results value of $3.75.

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