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Is Bigger Better? Temasek’s Value Creation Attempts
Corporate Digest | 05 January 2015
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By: Greenshoe Opinion
Articles (2) Profile

“The Philistines were standing on the hill on one side while the Israelis were standing on the hill on the other side, with the valley between them. A champion named Goliath from Gath came out from the Philistine camp. He was four cubits and a span tall, wore a bronze helmet on his head, and wore bronze scale armor that weighed about 5,000 shekels. The shaft of his spear was like a weaver’s beam and the iron point of his spear weighed 600 shekels.” 1 Samuel 17.

The biblical story of Goliath challenging the Israelis resonates in many as a memorable lesson.

A recent slew of announcements from state-owned Temasek seem to draw striking similarities to this parable.

The merger between Cityspring Infrastructure Trust (CIT) and Keppel Infrastructure Trust (KIT) aims to create the largest infrastructure business trust (BT) in the region.

Similarly, Temasek and JTC’s subsidiaries – Ascendas, Jurong International Holdings (JIH), Surbana and Singbridge has intentions to create a Goliath in the field of urban planning.

A necessary disclaimer – the nature of this piece is far from political. The objective is solely on shareholder returns.

Focusing on the BT merger transaction, CIT and KIT are set to create a BT with infrastructure assets amounting to c.S$4 billion.

CIT acquires KIT’s business in exchange for new units in CIT. KIT then carries out a distribution-in-specie of the CIT units to KIT’s unit holders.

Next, the combined trust acquires a 51 percent stake in Keppel Merlimau Cogen funded by an equity fundraising. On paper, it is justified and rationale –DPU accretive, being the flagship vehicle for Singapore’s infrastructure and alignment of investment strategies.

In light of poor performances and an obscurity of future growth from both trusts, the merger is pretty welcomed by unit holders at this point.

Despite positive post-announcement share price performances and seemingly neutral views from analysts and commentators, the lessons of David and Goliath resonate tepidly in the milieu. Mr Greenshoe shall play devil’s advocate and offer 3 points as cheers for the underdog.

1. Competition:

Lists all BT’s in Singapore (excluding stapled securities):

While investors hum along the tune of owning the largest infrastructure trust post-merger, others can easily argue that it is also the smallest by virtue of it being the sole infrastructure trust in Singapore.

Religare Health, Ascendas India, Croesus are property trusts; Rickmers, First Ship Lease are shipping trusts; Hutchison is involved in ports, Accordia in golf courses and APTT in pay TV assets.

Too much of a marketing spin perhaps?

As the sole infrastructure trust in Singapore, the combined trust will lack in suitable comparables for benchmarking.

At present, CIT is the most appropriate and direct comparable for KIT and vice versa. Assets of both infrastructure trusts are predominantly based in Singapore and have similar sponsor profiles.

Analysts and investors alike consistently compare both trusts for understanding and valuation purposes. Albeit the fact that there are several infrastructure players in Singapore such as Sembcorp, Hyflux, United Envirotech, Ausnet, the valuation methodology of a BT and conventional equities are fundamentally different.

Perhaps the only direct comparable for the combined trust is HK Electric Investments, a stapled security, domiciled in Hong Kong. Furthermore, analyst coverage is currently extremely poor in this sector. Will combination and size alone impact the likeliness of stronger analyst coverage?

More importantly however, the combined trust will innately eliminate competition from the infrastructure trust playing field.

The effectiveness and importance of competition has been proven time and again in free market economics.

The combined trust will not only create a Goliath entity of infrastructure assets that investors will find it hard to understand and value, it will also eliminate the incentives to innovate, raise barriers to entry and ultimately render deadweight loss to society.

2. Yields:

As mentioned previously, the key valuation tool for BTs is the forward yield. Current forward yields of the aforementioned BTs:

Both CIT and KIT are poor yield distributors among the Singapore BT universe. The key question to ask is whether yields will improve post-merger?

In accordance to management guidance, both KIT and CIT should see an increase in DPU. On surface, this should bring comfort to investors. But on closer look, the boost in DPU does not come from the improvement of asset yields but instead from simple mathematical alterations.

Presentation slide for CIT unitholders:

Announcement for CIT unitholders:

On the presentation slide, DPU at EFR of S$525 million is at 3.67 cents per unit. Proforma DPU is calculated based on assumptions listed in Footnote 3 and 4.

Footnote 3 states that there is a reduction in trustee manager fee of S$3.6 million. However, this reduction is attributed to a waiver of divestment fee from this transaction.

Base fees are calculated as a function of inflation (unsure if this is better than relying on market capitalization) while performance fees are similarly pegged to an implicit measure of cashflow.

Footnote 4 states that DPU calculations are based on an additional distribution of S$3m from the cash reserves of the trust. No clue where did this S$3m come from and why it must be added into the yield calculation.

The nature of both assumptions are merely a one-off improvement and not an ongoing impact on distributions. Looking retrospectively, Cityspring’s DPU used to be 7.0 cents per unit compared to it’s current 3.28 cents per unit and 3.67 cents per unit post transaction…

Apart from mathematical tempering to boost DPU, the equity fund raising from the KMC acquisition is another valid concern. The case in point here is whether the improvement in cashflow from KMC will offset the potential dilutive effects from the pref + placement equity raising.

Let’s give management the benefit of doubt and assume forward dividend yield surprisingly increases post-merger.

HK Electric Trust trades at a forward yield of 7.5 percent while the Singapore BT average similarly trades at 7.5 percent. Is the new trust able to accrete it’s way to becoming competitive amongst the trust vehicles? Highly doubt so…

3. Synergy:

Looking at the 9 assets the trust will prospectively hold, Mr Greenshoe questions whether the merger is truly synergistic.

Each of these assets function and operates independently. It is hard to ascribe operational synergies when no vertical or horizontal integration are visible.
One possible argument could be that City Gas is able to utilize the waste collected by KIT to generate power.

Nevertheless it appears that this is merely a saving on transaction costs rather than actual operational savings?

News reports attribute synergy from the transaction as being more accessible to investors and being a one stop infrastructure utility provider. Doesn’t this sound rather one-dimensional?

Mr Greenshoe is no expert in the infrastructure space but where are the synergies from this transaction?

Even in the best of cases, realizable synergies are vague and indistinct. And in the worst of cases, there are potential conflicts of interests – Keppel’s recent IPO of the DataCentre REIT is of direct competition with the combined trust’s DataCentre One asset.

The limelight is thus on Keppel, as Sponsor of both assets, to manage this conflict either via ring fencing the assets or setting a clear mandate objective for the new trust.

Moving forward, the success of this merged vehicle lies on one simple factor – the ability to inject yield accretive assets into the trust on a consistent basis.

Neither CIT nor KIT has been capable of doing so. Mergers and acquisitions do not solve the innate flaw.

CIT and KIT’s book value have fallen by 75 percent and 20 percent respectively since initiation. Although CIT purchased Basslink Australia, the asset has significantly dragged down the cashflow of the trust resulting in a need to tap the markets via 2 rights issues.

Equally disappointing, KIT has never injected an asset into the trust post-IPO.

Of course, notwithstanding the noteworthy benefits BTs enjoy in the Singapore yield market, infrastructure trusts faces huge challenges in ensuring stable dividend payouts and capital preservation.

The onus hence lies on Sponsor and Trustee Manager to consistently be on the hunt for good assets for injection. To all unit-holders of this Goliath, the only way forward is to hope big boys Temasek and Keppel shows more tender loving care to this vehicle.

Changing our focus to another Goliath in the making is the urban planning giant formed by the merger of Ascendas, Jurong International Holdings, Surbana and Singbridge.

It is undeniable that with the proliferation of urbanization, the opportunities of creating “model cities” and “urban living solutions” are phenomenal.

Again rooting for the underdog, is a Goliath truly necessary to win more projects on the global arena? Mr Greenshoe begs to differ.

Each of the 4 proposed entities have their own merits and competitive advantages. Combining them into a single entity will potentially render them too large to manoeuvre and not forgetting the inherent inefficiencies of bureaucracies?

It is also important to note that all 4 entities with the exception of Surbana (40 percent held by Capitaland, which is 40 percent held by Temasek) are wholly owned by the state.

Has urban planning become a state affair leaving no vacancies for private players? One might argue that without the merger, a stand-alone company would lack the wherewithal to compete on a global platform.

However, judging from precedent cases such as Suzhou Industrial Park and Tianjin Eco-City, Mr Greenshoe sees no disadvantage in the creation of JVs or strategic alliances in tackling these mega projects.

Instead, by keeping these 4 entities as “independent”, it gives them the ability to be nimble and flexible in choosing for projects and matchmaking the best partners for the job.

All in all, a merger is only synergistic if the whole is better than the sum of the 2 parts. Bigger is better is not always true. Giants are not often what we think they are.

The very qualities that appear to give them strength are typically the same sources of limitations. Creating a Goliath might intimidate and create a perception of strength. However, it is in understanding one’s competitive advantage that a company can achieve a Goliath-sized advantage.

“David quickly ran to the battle line to meet Goliath. David reached his hand into the bag, took out a stone, slung it, and struck the Philistine in his forehead. The stone sunk into his forehead, and he fell on his face to the ground. David defeated the Philistine with a sling and a stone; he struck down the Philistine and killed him, and there was no sword in David’s hand. David ran and stood over the Philistine. He took the Philistine’s sword, pulled it from its sheath, killed him, and then he cut off his head with it. When the Philistines saw that their champion was dead, they fled.” 1 Samuel 17.

Former shoe salesman turned investment banker.

Mr Greenshoe waxes lyrical on equity markets and further confusticates the already bizarre property scene.

Please click here for more information about this author.

Keppel Infrastructure Trust  0.525 -- --   
Business: Co is the largest Singapore infrastructure-focused business trust, with a diversified portfolio of core infrastructure assets, spanning waste management, water and wastewater infrastructure, power generation, telecoms infrastructure.

Insight: Jul-19, 1H19 revenue jumped to $736.5m driven by t... Read More
Ascendas India Trust  1.460 -0.020 -1.35%   
Business: Co engages in the ownership of real estate properties primarily used as business space and real estate related assets in India.

Insight: Apr-19, FY19 total property income declined 3% in ... Read More
RHT Health Trust  0.018 -- --   
Business: Biz trust comprising of healthcare assets in India.

Insight: May-19, Co ceased to have any operating business a... Read More
First Ship Lease Trust  -- -- --   
Business: Singapore-based business trust which owns a fleet of vessels across major shipping sub-sectors.

Insight: Feb-19, FY18 revenue fell 17.7% due to a reduced f... Read More
Hutchison Port Hldgs Trust US  0.168 -0.006 -3.45%   
Business: Co invests in, develops, operates and manages deep-water container ports in the Pearl River Delta.

Insight: Apr-19, 1Q19 revenue inched up 0.3% as combined co... Read More
Accordia Golf Trust  0.540 +0.005 +0.93%   
Business: A business trust specialising in investments in golf courses, driving ranges, and golf course related assets in Japan.

Insight: Feb-19, 9M19 operating income fell 2% to JPY41.1b ... Read More

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