Developer profile: CapitaLand faces up to fundamentals

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By:
Chris Wright
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Once a property paragon, Singapore’s CapitaLand has been confronted with fundamental questions about the viability of its business model. Will the complex structure that has served it so well ultimately diminish the company’s standing in Asian property? Chris Wright reports.

It was all going so well. A little over a year ago, CapitaLand was announcing its first-half results for 2007: S$1.5 billion ($986 million) profit after tax and minority interests, five times higher than the previous year, with an eightfold year-on-year growth in Singapore ebit as luxury development sales hit a record S$5,500 a square foot.

Just seven years after its formation from DBS Land and Pidemco Land, CapitaLand’s real estate and hospitality empire had spread to 120 cities in more than 20 countries. Investors loved it, and investors in its five real estate investment trusts particularly so: CapitaMall Trust was by then up almost 400% since listing, and CapitaCommercial Trust, Singapore’s first commercial Reit, by more than 200%.

It doesn’t look much like that any more. Between November 1, 2007 and October 28, 2008, the stock fell by 71%. The Reits are looking even worse. Ascott Reit, a trust launched in the serviced residence sector, was trading at more than S$2 a share in July 2007 but plunged to 40 cents in October 2008; even after a modest rally it was down 73% from its highs at the time of writing. All emerging markets and property stocks have been punished in the past year but this is extreme by any standards.

But is there anything really wrong with CapitaLand or is it just being oversold? A look at its earnings numbers makes the market reaction seem puzzling. When CapitaLand announced its third-quarter results on October 31, it was able to boast S$1.18 billion in profit after tax and minority interests for the year to date – a big drop on the previous year when S$2.08 billion had been amassed by this stage but sizeable income nevertheless.

The problem is not really the earnings, nor is it just about the outlook for property in CapitaLand’s key markets of Singapore, China and Australia. It’s about the change in attitude towards the whole model that CapitaLand represents.

For years, CapitaLand has won praise for its model and its efficiency. Throughout this decade it has frequently been named as Singapore’s best-managed company by leading magazines. It made itself a player in every stage of the property supply chain: an investor, a developer, an operator, a manager, active in everything from retail to office, residential and hospitality. Crucially, it bolted on property fund management and real estate financial services as a key part of the business. By September 30 this year it had S$24.8 billion of assets under management. Thinking of CapitaLand as just a property developer, and not a financial services group as well, is to miss the point.

In some respects CapitaLand came to resemble the Macquarie model of acquiring assets, putting them into separate trusts, listing some of them (five Reits in CapitaLand’s case, more than any other Asian developer) and keeping others private (of which CapitaLand has 17). Also like Macquarie, it believed in partnership with local experts in unfamiliar markets. CapitaLand’s partnership with Arcapita in Bahrain is an example.

For years it worked like a dream when liquidity was plentiful, debt affordable and asset prices rising. In Singapore it rode the growing sense of optimism that the City State was becoming a big player on the world stage, whether in financial services, luxury living or marquee events such as Formula One. CapitaLand moved into China and Vietnam early, anticipating that those markets would boom. It can justly claim to be the premier shopping mall developer and operator in China.

Investor alarm

Everything that worked in CapitaLand’s favour on the way up is now hurting it. Singapore and China are two of the markets with the biggest headwinds in their property markets. Liquidity has gone and debt, if accessible at all, is more expensive. On top of that, nobody likes leverage or financial services any more. There also appears to be alarm among investors, who feel they cannot quite get a grasp on a complex business that combines property with finance and is exposed to a host of separate satellites. Which is, once again, something it shares with Macquarie.

CapitaLand can point to the fact that its model has worked perfectly well so far, and that if it gets through all of this, it should be well positioned for the next step-up. In written responses to questions about the viability of its model, CapitaLand says: "Reits and private equity real estate funds are central to CapitaLand’s capital efficient business model and recycling of capital. The Reit model is still very much valid. Reits will remain viable and an important asset class as these are tax efficient vehicles for holding real estate on a long term basis."

CapitaLand says Reits have improved the liquidity of large-scale properties, and that even if they can’t make yield-accretive acquisitions in this market, they can still create value through organic growth.

Chairman Richard Hu put it like this in October: "Our model, developed and honed over the years, has allowed us to be very nimble and quick in unlocking value in stable assets and maintaining high liquidity and financial flexibility to take advantage of the market situation. Today, the group has also built up a portfolio of investment and development properties in its various private equity funds and joint ventures. At the right time, they can be monetized for good returns to our shareholders."

That last sentence leads to another point. CapitaLand has made a series of big sales recently whose timing looks to some observers to be a scramble for cash rather than monetizing for good returns at the right time. Foremost among them was the sale of Capital Tower Beijing in September for S$498 million: a landmark property and exactly the sort of place one would expect to retain pride of price in CapitaLand’s burgeoning China portfolio.

"When they start selling assets like that, you have to wonder how badly they need the money," says a fund manager. Earnings from Capital Tower, another property in Singapore, and the injection of four other Chinese properties into one of its own 50% owned private equity funds for $841 million, bolstered the third-quarter results dramatically. They also helped to de-lever the business, which is what every investor wants to see these days. But for someone to sell an iconic property in this environment, surely the situation must be bleak?

Asked how important the Beijing sale was, CapitaLand responds that, having acquired the tower while it was under construction in 2005 and subsequently filled it with big international corporate tenants, "because of this success we received unsolicited offers for the building from several prospective investors. The sale of Capital Tower in early September was a timely one, done two weeks before the global financial situation worsened. The cashflow generated from the divestment... has further strengthened CapitaLand’s balance sheet."

The company says the deal demonstrates its expertise and "ability to unlock value for shareholders despite the current volatility financial markets", and stresses that "the transaction was in line with CapitaLand’s business model of prudent capital management by divesting mature assets and recycling capital".

Good market access

It does not appear to be in any immediate distress: following its divestments its cash position stood at S$4.2 billion on September 30, with a net debt-to-equity ratio of 0.51. Interest cover is about 4.3 times. These are not numbers that alarm analysts. Macquarie, for example, has an outperform on the stock, with analyst Tuck Yin Soong noting after the third-quarter results: "We believe the group has good access to the capital markets, having raised S$5 billion year to date, and does not face any major refinancing. Further, 76% of debt is on fixed rates."

CapitaLand puts that figure even higher, at 82%, with an average debt maturity of 4.5 years compared with just over two years a few years ago. "CapitaLand has been managing its debt and liquidity long before the present crisis."

In fact, both CapitaLand and analysts are actually talking about acquisitions. "This strong balance sheet will be particularly useful in the current global financial crisis, which has brought down not only Wall Street’s blue-chip financial institutions but also created in its wake a global recessionary environment," said Liew Mun Leong, president and chief executive, at the third-quarter results. "With the situation deteriorating rapidly, we are strategically watching the distressed markets, very carefully seeking out opportunities to make the right acquisitions at the right price."

Tuck at Macquarie also notes that the company is "in a very healthy position to consider tactical acquisitions and investments".

For the future, CapitaLand argues that fundamentals in the core markets of Singapore, China and Australia are robust in the long run, while Liew describes the entry into the Gulf two years ago as timely, with S$1 billion of residential sales in the region since June 2008. The company is growing in India through two joint venture partners, Advanced India Projects and Prestige Estate Projects, and has long-term plans for Vietnam and China in particular.

If CapitaLand, as is rumoured, finds itself getting involved in the vast integrated resort and casino development in Singapore, whose outlook has been clouded by the terrible state of developer and operator Las Vegas Sands, the picture will be muddied. The verdict is still out on whether or not the listed-satellites model is still workable. Here the market’s answer seems to depend on the company. For Allco, the answer was no and it does not look good for Babcock & Brown. As for Macquarie and CapitaLand, it might be a case of the companies taking a heavy bruising rather than suffering a knockout punch.

If CapitaLand’s top team are worried, it’s not showing today. "We were disciplined last year, selling when target returns were met and not buying when target returns were not met," says Liew. "This disciplined aggression is the hallmark of the management team."