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Temasek the obvious winner from CapitaLand's restructuring

Jeffrey Tan
Jeffrey Tan4/1/2021 07:00 AM GMT+08  • 8 min read
Temasek the obvious winner from CapitaLand's restructuring
If CapitaLand's restructuring exercise goes through, not all shareholders will benefit equally.
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CapitaLand’s proposed restructuring has been heralded as a move that will unlock value for shareholders. The new entity, according to group CEO Lee Chee Koon, will possess a “unique and distinct advantage” over its global peers.

Most analysts agree, adding that the move is positive for other reasons too. Yet if it goes through, not all shareholders will benefit equally. Under the restructuring exercise, CapitaLand will divide its businesses into two entities.

The company will place its property development business under CapitaLand Development (CD), which will be fully owned by CapitaLand. The company, in turn, will be taken private by CLA Real Estate Holdings, an indirect wholly owned subsidiary of Temasek Holdings.

CapitaLand Investment Management (CLIM), on the other hand, will house CapitaLand’s fund management and lodging businesses. These are likely to comprise the company’s holdings in several REITs, business trusts and private funds, as well as its serviced residence and hotel assets. CLIM will be listed on the Singapore Exchange.

CapitaLand intends to undertake the restructuring exercise through a scheme of arrangement. The company will distribute roughly 48% of shares in CLIM to all its shareholders, excluding CLA. This will make it the largest shareholder of CLIM with a 51.8% stake.

For every share held in CapitaLand, shareholders will receive one CLIM share valued at $2.823, between 0.155 and 0.143 CICT units valued at $0.328, and cash of $0.951. The cash portion excludes CapitaLand’s dividend per share (DPS) of 9 cents. Overall, the implied value per share for CapitaLand’s shareholders is $4.102.

As a result, the company will distribute in specie 6% of units in CapitaLand Integrated Commercial Trust (CICT) to shareholders, excluding CLA. This will dilute its current 28.9% stake in CICT to 22.9%.

Upon the completion of the restructuring exercise, CLIM would have $115 billion in assets under management (AUM), making it the largest real estate investment manager (REIM) in Asia and the third-largest listed REIM globally. CLIM’s funds under management (FUM) would stand at $78 billion.

According to Lee — who will helm CLIM — CapitaLand has always aspired to be a globally competitive real estate manager. “Our business model is very simple. It revolves all around the concept of value — find value, add value, and unlock value. And stay disciplined in capital management and execution,” he said at a joint media and analyst briefing on March 22.

OCBC Investment Research has highlighted several benefits with CLIM. The latter would generate more recurring income streams and could fetch a higher valuation than the traditional property development business. It would also be less susceptible to property cooling measures, which the brokerage believes tend to be more targeted at the residential sector.

Nevertheless, the potential unlocked value may come at the expense of a diminished bottom line. By dividing CapitaLand’s businesses into two entities, CLIM’s ebit margin would likely be inferior compared to CD’s.

For FY2020 ended Dec 31, CapitaLand’s development business had generated total turnover of $5.61 billion and ebit of $697.9 million. This translates to an ebit margin of 12%. In contrast, the company’s fund management and lodging businesses had registered total revenue of $919.4 million and loss before interest and tax of $466.4 million.

Granted, CapitaLand’s fund management and lodging businesses had suffered the brunt of Covid-19, no thanks to the restrictive measures to curb the spread of the virus. But the collective performance of both businesses prior to the pandemic is still below that of the development business.

For FY2019, the company’s development business had generated total turnover of $4.72 billion and ebit of $4.37 billion. This translates to an ebit margin of 92%. In contrast, its fund management and lodging businesses had registered total revenue of $1.51 billion and ebit of $734.6 million. This translates to an ebit margin of 53.4%.

As a whole, CapitaLand’s FY2020 and FY2019 ebit margins were 3.5% and 81.3%, respectively.

Valuable development business

Of course, the past performances of CapitaLand’s businesses are no guarantee to their future performances. Yet it is evident that the company’s development business is highly profitable.

The main reason for that is the $6 billion acquisition of Ascendas-Singbridge (ASB) from Temasek Holdings in 2019. The transaction was immediately accretive to the development business’ top and bottom lines. It also provided the company with an immediate scale in business park, industrial and logistics assets to capture high-growth tech-driven opportunities, such as e-commerce.

Notably, the acquisition had catapulted CapitaLand India into its own strategic business unit. CapitaLand India’s ongoing developments include 17.9 million sq ft of business park space in Bangalore, Chennai, Gurgaon, Hyderabad and Pune.

Another 7.5 million sq ft through forward purchases are under construction. This includes IT parks in Mumbai and Hyderabad, a seventh warehouse at Arshiya Free Trade Warehousing Zone near Navi Mumbai, and BlueRidge 3, an IT/ITES Special Economic Zone (SEZ) development in Hinjawadi Phase 1 in Pune by Ascendas India Trust (a-iTrust). The developments in India could be a pipeline for a-iTrust in which case they could be earmarked for either CLIM or directly offered to a-iTrust.

In China, the ASB acquisition had enabled CapitaLand China to gain access to large tracts of land and development opportunities. For instance, CapitaLand signed a collaborative agreement with the Guangzhou Development District Administrative Committee (GDD) in 2019. Under the agreement, the company will develop the second phase of China-Singapore Guangzhou Knowledge City (CSGKC), a state-level bilateral collaboration project between Singapore and China.

The second phase of CSGKC follows the development of the southern start-up area by ASB, through a joint-venture company with GDD. CapitaLand will not only participate in the development of business parks through the same joint venture company, but also commercial properties and residential projects. A circular to be issued in 3Q2021 will detail which properties are likely to be placed in CLIM.

The company’s development business had also enjoyed strong operational growth from CapitaLand China’s residential projects. In 2H2020, CapitaLand China handed over 5,372 residential units to home buyers. This came mainly from La Riva in Guangzhou, Jing’an One in Shanghai, Century Park (East) in Chengdu, La Botanica in Xi’an and Raffles City Residences in Chongqing. Including 652 units handed over in 1H 2020, CapitaLand China delivered a total of 6,024 units in FY2020, compared to 5,390 units in FY2019.

Temasek will have its cake and eat it too

The winner from the proposed restructuring exercise would obviously be Temasek. The state investment firm stands to enjoy stronger ebit margins from CD, without getting diluted by the weaker ebit margins from the fund management and lodging businesses.

Yet if the fund management and lodging businesses were to outperform upon a faster recovery post Covid-19, Temasek would also enjoy the lift in CLIM through its controlling stake in the latter. In other words, the state investment firm would have its cake and eat it too. Minority shareholders of CLIM, on the other hand, would enjoy only the gains from the fund management and lodging businesses.

The restructuring exercise — in favour of Temasek — is understandable from the state investment firm’s perspective. Temasek has in recent years been increasingly relied upon to contribute to Singapore’s national coffers.

In 2016, Temasek was included under the so-called Net Investment Returns (NIR) framework, which allows the government to spend up to half of its expected long-term returns. It was a major change from the previous Net Investment Income framework, under which the government could spend only investment income comprising dividends and interest.

The government introduced the NIR framework to enhance revenues and ensure a fair balance between the needs of current and future generations. This was in anticipation of significantly higher public spending needs, especially as Singapore’s population ages and its economy copes with significant changes.

However, investing in assets that can generate attractive returns can be challenging for Temasek amid an ultra-low interest rate environment and volatile financial markets. This is on top of unresolved tensions between the US and China and the push towards sustainability.

To ensure that Temasek can meet its NIR obligations, the state investment firm has been pivoting towards new economy sector investments. These include renewable energy, biotechnology, medtech and food technology. Temasek has also been increasing its exposure to early stage, unlisted assets to capture better long-term return. And of course, Temasek will squeeze more value from its existing portfolio of companies, such as CapitaLand.

Shares of CapitaLand have so far this year gained about 15% to close at $3.77. That translates to an 8.8% upside potential from the implied consideration of $4.102. Ultimately, CapitaLand’s minority shareholders will need to weigh between receiving a premium now for shares in an entity that may have low margins ahead versus holding on to undervalued shares in the company albeit with better margins.

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