On 12 June 2016, Croesus Retail Trust (SGX: S6NU) (CRT) shocked the market when the trust announced it intended to acquire its manager for S$50 million. This will be the first of its kind in Singapore where a property trust is an internally-managed investment vehicle. As the proposed deal required unitholders’ approval, an extraordinary general meeting was carried out on Thursday, 30 June 2016.
When questions were opened to unitholders, one was quick to challenge the board of directors: “Frankly, I do not support this deal because you’re doing all this only for a 1% dividend yield accretion. How does this deal help increase retail yield and reduce financing cost for the trust? Those are the two big elephants in the room rather than this internalisation deal.”
According to Chairman David Lim, the internalization will result in significant cost savings for the trust. Croesus Retail Trust has grown its asset under management from S$600 million at IPO to S$1.3 billion to date. As CRT continues to grow in size, its fees paid to its manager will continue to go up and it makes sense for the trust to internalise its manager.
Another unitholder pointed out that it makes better sense for the trust to do a share buyback with the money than to internalize the manager. According to his calculations, the yield accretion will be higher as the valuation for the internalisation deal is expensive and another 10% of the acquisition cost will be wasted on paying financial advisers.
The chairman responded that in years to come unitholders will see bigger contributions from this internalisation deal. While he didn’t specifically point out how the contributions will come about, I believe some unitholders got the chairman’s hint that there will be more acquisitions ahead for CRT to justify the internalisation.
Here are ten key points I learned from the Croesus Retail Trust’s EGM:
- CRT is not a REIT; it is a business trust. Whenever we conduct the Dividend Machines workshop, oftentimes I get participants asking why we don’t cover CRT since it is a ‘REIT’? I remind them that CRT is not a REIT, but a business trust. They are two different animals!
- The purchase price for the manager is valued at 14 times earnings. Assuming consistent earnings, it would take 14 years for unitholders to recoup their investment. However, the chairman said this is assuming CRT has no intention to grow or trade its underlying properties. Should CRT grow its AUM to S$1.9 billion, he quantified that the savings can be quite substantial – up to S$9 million.
- The manager will be paid based on salary instead of fees. With the internalization, the manager now works for the trust and earns a salary instead of receiving its income through fees like a fund manager. The trustee-manager of CRT is 64% owned by Jim Chang and Jeremy Yong and the pair will continue to work for the trust after selling their stake to CRT.
- Should the CEO be replaced after cashing out on their business? One top twenty unitholder was annoyed that the owners of the trustee-manager will continue to receive a salary after selling their stake to CRT. He said: “You need to visit the fact that these two founders, after they cash out, should not remain on the board or with the manager. You can hire a new CEO. What’s the problem with that? You’re doing something quite illegal and it can be challenged. You claim that this deal is beneficial for us and I am one of your top twenty shareholders so I am pretty annoyed by this. So I came here today.” A round of applause went off in the room and he continued: “You really have to examine your whole conscience and whether you think this is a fair deal for unitholders. A valuation of 14 times earnings for a manager is not a fair deal at all. The current yield for CRT is 9% which translates to a P/E of 11. How can it be a good deal?” The chairman didn’t respond to the gentleman but respected his view and pointed out that the decision is up to all unitholders at the end of the day.
- The way to value a REIT/trust manager is not so straightforward. One unitholder agreed that the internalization is the right move for CRT but he thinks that it is very difficult to justify the valuation using peer comparisons with either earnings multiple, discounted cash flow or percentage of AUM – which the Straits Trading Company used to value ARA Asset Management. He argued that it isn’t an apples-to-apples comparison because CRT is not buying an independently profit-generating company: “CRT is a trust that employs the manager to manage its properties. Essentially, CRT is the one who gives business to the manager. So the manager earns money from the trust. But now you’re asking the trust to buy out the manager for S$50 million with money they already earn from the trust. In that aspect of it, the comparison doesn’t sound right.” The chairman replied that using earnings multiple as the valuation for the manager was done by a reputable independent valuer and the peer comparison is for unitholders’ reference only.
- CRT could go on an acquisition frenzy but that may not necessarily lead to DPU growth. From the meeting, the chairman was indirectly dropping hints multiple times that the internalisation deal would be considered justifiable when future acquisitions are done without paying acquisition/management fees to the manager, therefore aligning the interests of the internal manager and unitholders. However, one concerned unitholder brought up a good example of one office REIT in Singapore that grew its AUM from S$600 million to S$6.5 billion over ten years but failed to grow its distribution per unit at all over the same period. According to him, they (the office REIT manager) did not take into account unitholders’ interests at all. (Do you know which REIT this unit holder is referring to?)
- CRT’s Japan properties are not insured against natural disasters. A unitholder verified that with the management and warned the manager to be prudent when using the trust’s cash in times of uncertainty. With its latest acquisitions in Japan, the financials (especially gearing) for CRT are deteriorating.
- Japan has lost two decades and is suffering from an ageing population. As CRT’s properties mainly serve the Japanese, asset enhancement initiatives are not going to help as long as the locals are not spending. Generally, older people tend to spend less than younger people since they already mostly have what they need. Unlike Singapore which has opened itself up for foreign immigration, Japan is still largely closed to it.
- CRT may be listed on the SGX but currency risk for distribution remains. CRT collects its rent in Japanese yen and needs to convert the proceeds to Singapore dollars for distribution to unitholders in Singapore. As a result, this poses a continuous currency risk for unitholders. On a positive note, CRT mentioned in its 2015 annual report that the trust has hedged close to 100% of its distributions till end FY2017.
- With internalisation, the board hopes CRT can trade at valuation similar to their contemporaries in Japan. CRT owns Japanese retail malls and trades at a distribution yield of more than 9% while similar peers in Japan trade at a higher valuation with yields ranging from 3-4%.