"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% 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$525m 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$3.6m. 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% while the
Singapore BT average similarly trades at 7.5%. 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% and 20% 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 maneuver and not forgetting the inherent inefficiencies of bureaucracies? It is also
important to note that all 4 entities with the exception of Surbana (40% held
by Capitaland, which is 40% 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.
David with the Head of Goliath; Caravaggio; 1610
