In my last post, I talked about why I sold off Croesus Retail Trust and decide to observe this stock from afar.
Croesus retail trust is a business trust listed on the SGX currently with a dividend yield of nearly 10% on a high debt to asset leverage.
It invests in Japan malls which have rather long master lease with rental escalations.
The typical Net Property Income yield is around 6% to 7%.
Since my article, management have taken 2 actions. They have taken 2 actions.
The first one is to acquire two more malls, and with the first mall purchase, the three malls come with an average NPI Yield of 7.1%.
The second is propose to do one more rights issue to internalize the management team.
The first action to purchase the mall answers my question that the capital raising done previously was not accretive to existing shareholders.
With this deal the existing share holders would see their forecasted dividend yield go up.
It is the second action that is hotly debated.
By internalizing the management team, this means that Croesus Retail shareholders will buy over the management team, instead of the management team being owned by the sponsor.
Here are some points to think about:
1. The benefits of internalizing the management team
Internalizing the management team theoretically is good.
When the team is owned by the sponsor, the management have an economic bias to work for the sponsor, that means gobbling up any mediocre deals of the sponsor, justifying to the shareholders these deals are good.
By internalizing, there are cost savings as explained by Croesus in that acquisition and divestment fees, performance fees that are usually paid to the management can be saved.
Secondly, the management team are under the watchful eye of the shareholders and may be removed more easier.
2. Internalizing the management team might bring its own share of problems
However there are some possible problems I see as well.
If the manager do not do a good job, is it possible to find a manager that can risk manage, operate and at the same time able to tap more deals that are attractive?
You do need someone rather connected and experience in this. This person could possibly be a second in command in another developer who didn’t get a chance to rise to the top.
If the majority of the ownership still falls in the main shareholders and they control on the voting rights, it might not be that different from an external structure.
3. Unless there is a downturn, you cannot pick and choose
REITs that have a sponsor are part of their asset recycling strategy.
If a developer sponsor have a building they want to sell, they will see if there are sovereign funds, private equity funds that are willing to pay a good price.
If not, they sell to their owned REIT to realize at what they deemed full asset value.
If you lose your sponsor, you rid of this property dumping problem to an extend.
However, you introduce the “how do I find assets to grow” part.
It is really up to the manager to find the good deals, that people do not want, or under the radar.
A downturn will increase the mispricing of assets, and be good for internalized manager.
4. Why would the Croesus Sponsor sell off a Traditional High Return on Capital Business?
Asset managers are high return on capital business. In the case of reit managers, such as ARA Asset Management in their early days, the capital outlay is low to manage more assets.
For such a business it is not easy to find it listed. If you have something good you keep it to yourself, why share it with others unless you need visibility to gather more assets or tap the debt market better.
Possible conclusion for this I can think of is that it is quite difficult to be an asset manager with such a theme focus on Japan retail. They want to be out of this game.
They couldn’t get the investors to find Croesus Retail Trust to be attractive. There is no yield compression the way Japanese REITs are trading at (which can be near 3%)
At this point, they are finding it extremely tough to raise capital. Their cost of equity capital is at 10%, their debt leverage is very high, and they cannot attract Japanese investors to buy preference securities in a low yielding environment.
Another possible reason is with the new rules, specifically compliance laws, make cost for the manager to be high enough that it is not lucrative any more.
5. Was the internalization at SG$50 million expensive?
When I first look at the internalization I thought it was rather expensive.
Here is the Profit and Loss statement of the Trustee Manager in the proposal:
The left column shows the profit and loss in the work year and the right column shows the proforma after the shareholders see the benefits.
The main bulk of the savings is the JPY 213 million in cost of sales which is made up of acquisition fees to be paid to trustee manager of the sponsor, monthly sponsor management fees, consultation fees for school lessons to the current manager.
Now that the manager have graduated from their fund management university, there is no need for the consultation fees.
JPY 32 mil and 274 mil translates to SG428k and SG$ 3.7 mil.
If we judge the price to income that Croesus shareholders are paying for the fund management now its 116 times. That doesn’t make sense.
If we view it from the private equity acquisition angle, where if instead of internalization, I purchase the asset manager, I am concern about how much future EBITDA or cash flow i could generate from this.
In this way, we should be looking at SG$3.7 mil in net income.
At SG$50 mil, the shareholders would be purchasing the manager at 13.5 times income. Not cheap, but not too expensive either.
I manage to coincidentally pick up the following from a 2015 Morgan Stanley Report:
When Frasers Centrepoint bought over Allco REIT’s manager in 2008, it was at 3.8% of AUM and 10x management fees.
YTL bought half the REIT and property managers of Macquarie Prime REIT for a combined 7.2%
of AUM and 18x management fees, and a 26% stake in Macquarie Prime REIT at a 52% premium to its last close
and 0.5x P/B.
If we put the internalization side by side with them, Croesus have existing 96 bil Yen of properties, and the 2 sets of new acquisitions would add 6.1 bil and 3.3 bil respectively. Total investment properties to be manage is around JPY 105 bil. This translates to SG$1.4 bil.
3.8% of SG$1.4 bil is SG$53 bil.
When Frasers Centrepoint bought over the manager it was in the GFC. This makes Croesus internalization deal not look too expensive.
6. Apparently, the management think the shareholders need more convincing
So after the proposal, the management do think the shareholders need additional assurances.
7. If Internalization is Beneficial to the Shareholders…..
Given how well an internalization would benefit the shareholders, it is puzzling why the sequence of events happen this way:
- 7 Apr: Announced the proposal to purchase Fuji Grand Natalie
- 13 May: Announced the proposal to purchase Mallage Saga and Feeal
- 12 Jun: Announced the proposal to internalize
These 3 deals happen in a short span, in the time frame of business deal making.
Shareholders could have benefited if they pair this internalization with one of the purchases.
Or that they could have internalize first then purchase the 3 properties. That will save the shareholders much acquisition and school fees paid to the sponsors.
This sequence makes me wonder whether in a short span of 30 days, the sponsors and managers suddenly realize the shareholders can gain tremendous benefit in internalizing the management team and decide to propose to shareholders.
Why the rush?
At this point, my criteria for sustainable REIT or Business Trust investing are:
- Economic Growth, Jobs, Productivity
My gut tells me its better to stay as an observer.
Right now there are no shortage of high yielders:
Some will crash and burn some will present value. Do check them out here.