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Quite a number of people around me and in this forum, I believe, have been burnt by business trusts in one way or another. Some have asked for my personal views on them and I have offered random scraps and sometimes incoherent thoughts depending on who is asking. Seeing that VB is the most serious investment forum I have seen so far, finally found some time to think through and articulate my thoughts on business trusts listed in SGX.
My advance apologies also if this piece is a bit long as I want to give a more detailed treatment on some of the issues I have observed. Any bros with more experience and knowledge, please feel free to correct and/or add on to my piece.
To start off, there is nothing fundamentally wrong when it comes to having a business trust model. In a nutshell, it offers some features which may be beneficial to various stakeholders. It is all about trade-offs and meeting of minds to create a win-win situation for all stakeholders. Some advantages include:
1) Tax transparency
2) Ability for asset manager to reduce capital commitment while maintaining effective control in an effective way
3) Easier to raise capital especially equity without affecting existing shareholding structure of sponsor
4) Unlocking partial value for a selective piece of a conglomerate’s portfolio without doing a full trade sale
5) Ability to better control consistency of distributions due to detachment from vagaries of accounting profitability
6) Easier to set up as fixed term, i.e. an annuity with a pre-described life cycle which is easier to wind up as opposed to a normal company
7) Earns recurring management income for the sponsor
Unfortunately as a matter of practice, the performance of business trusts in SGX so far range from neutral (Pacific Shipping Lease Trust, K-Green) to downright abysmal (CitySpring, FSL, IndiaBulls etc). The crux of the issue is that the business trusts listed so far appears to be not primarily motivated by a combination of the above advantages, but are instead seen as a conduit to “get rich quick” by dumping assets to the public at exhorbitant valuations they would never have gotten in a normal B2B trade sale.
The underlying trick is to promise an initial high, but unsustainable yield through the employment of capex skimming and/or tactical structuring of bullet loans and/or dubious top ups. This enables owners to IPO on nebulous premiums because the capitalization rates seem very reasonable and attractive on first sight. Unfortunately this is a con that one can play only for a few years before the chickens come home to roost.
1) Capex skimming – Replenishing capital expenditures at a significantly lower rate than depreciation and amortization. While this will allow a trust to pay out distributions much higher than its accounting profits, it is much akin to a landlord who tries to maximize rental profits by refusing to repair his property and restock his furnishings. Eventually it not only compromises future growth but also affects sustainability of current income.
In the past there were some trusts who tried to mask the problem by borrowing extra to top up on such expenditures instead of reinvesting a portion of the operating cashflow, thereby maintaining a facade of ever growing distributions. Good example would be SP Ausnet (essentially a business trust in substance), but they have since wisen up after GFC 2008. Nowadays the newly IPO-ed trusts can’t even play this delaying card because they are loaded with so much debt on IPO that there is hardly any debt room thereafter.
2) Structuring of loans – As a general rule of debt employment prudence, one should always try to match the interest payments, tenure and amortizing nature of the debt with the expected income and depreciation of the asset. Most of the assets held in business trusts currently have a limited life span (for e.g. service concessions, ships, infrastructure, short leasehold land etc.), it is therefore a matter of good practice for the both the borrower and the creditor to structure a loan with an amortization schedule that mimics the life cycle of the collateral as close as possible. This will of course mean that a portion of the cashflow must be deployed to pay down debts.
However these sponsors and their financiers have figured out it is far more profitable to boost distributions initially and fetch a good IPO price by using bullet loans and then make some attempt to readjust to the norm by restructuring their loans thereafter or raising new equity to pay down debts that are premised on an increasingly aged asset. There is a good reason why no bank will offer a bullet loan when you buy a car - they figure out 10 years down the road after depreciation and COE amortization, your car will be scrap metal and you are going to run road and default on it. It’s the same principle for trusts albeit in slow motion (their asset life is mostly 20-30 years), except they can run back to the markets and try and raise more money or restructure their loans at the expense of existing unitholders when they run into trouble.
3) Other dubious top ups – A mix bag of really cheap tricks that don’t even pretend to fake the sustainability of the payouts. It comes in various shapes and sizes – sponsor relinquishing their payout entitlements, accepting all fees in new units, setting up special accounts to provide payout support, entering into long term contracts which are higher than current market but curtails upside such that the PV of the entire contract is lower than market, go for loans that have lower interest but higher front loading etc.
These underlying problems are inherent in all the business trusts currently still listed so far, but many a times they are either aggravated or mitigated by other factors like macroeconomics, industry cycle, interest rate fluctuations, asset valuations and a whole host of other variables that nobody has any control on. This explains why some trusts are lacklusture but still surviving while others are as good as kaput.
Although most if not all of the business trusts are currently trading underwater vis a vis their IPO price, I am mildly surprised that some of them can still fetch such high valuations.
My advance apologies also if this piece is a bit long as I want to give a more detailed treatment on some of the issues I have observed. Any bros with more experience and knowledge, please feel free to correct and/or add on to my piece.
To start off, there is nothing fundamentally wrong when it comes to having a business trust model. In a nutshell, it offers some features which may be beneficial to various stakeholders. It is all about trade-offs and meeting of minds to create a win-win situation for all stakeholders. Some advantages include:
1) Tax transparency
2) Ability for asset manager to reduce capital commitment while maintaining effective control in an effective way
3) Easier to raise capital especially equity without affecting existing shareholding structure of sponsor
4) Unlocking partial value for a selective piece of a conglomerate’s portfolio without doing a full trade sale
5) Ability to better control consistency of distributions due to detachment from vagaries of accounting profitability
6) Easier to set up as fixed term, i.e. an annuity with a pre-described life cycle which is easier to wind up as opposed to a normal company
7) Earns recurring management income for the sponsor
Unfortunately as a matter of practice, the performance of business trusts in SGX so far range from neutral (Pacific Shipping Lease Trust, K-Green) to downright abysmal (CitySpring, FSL, IndiaBulls etc). The crux of the issue is that the business trusts listed so far appears to be not primarily motivated by a combination of the above advantages, but are instead seen as a conduit to “get rich quick” by dumping assets to the public at exhorbitant valuations they would never have gotten in a normal B2B trade sale.
The underlying trick is to promise an initial high, but unsustainable yield through the employment of capex skimming and/or tactical structuring of bullet loans and/or dubious top ups. This enables owners to IPO on nebulous premiums because the capitalization rates seem very reasonable and attractive on first sight. Unfortunately this is a con that one can play only for a few years before the chickens come home to roost.
1) Capex skimming – Replenishing capital expenditures at a significantly lower rate than depreciation and amortization. While this will allow a trust to pay out distributions much higher than its accounting profits, it is much akin to a landlord who tries to maximize rental profits by refusing to repair his property and restock his furnishings. Eventually it not only compromises future growth but also affects sustainability of current income.
In the past there were some trusts who tried to mask the problem by borrowing extra to top up on such expenditures instead of reinvesting a portion of the operating cashflow, thereby maintaining a facade of ever growing distributions. Good example would be SP Ausnet (essentially a business trust in substance), but they have since wisen up after GFC 2008. Nowadays the newly IPO-ed trusts can’t even play this delaying card because they are loaded with so much debt on IPO that there is hardly any debt room thereafter.
2) Structuring of loans – As a general rule of debt employment prudence, one should always try to match the interest payments, tenure and amortizing nature of the debt with the expected income and depreciation of the asset. Most of the assets held in business trusts currently have a limited life span (for e.g. service concessions, ships, infrastructure, short leasehold land etc.), it is therefore a matter of good practice for the both the borrower and the creditor to structure a loan with an amortization schedule that mimics the life cycle of the collateral as close as possible. This will of course mean that a portion of the cashflow must be deployed to pay down debts.
However these sponsors and their financiers have figured out it is far more profitable to boost distributions initially and fetch a good IPO price by using bullet loans and then make some attempt to readjust to the norm by restructuring their loans thereafter or raising new equity to pay down debts that are premised on an increasingly aged asset. There is a good reason why no bank will offer a bullet loan when you buy a car - they figure out 10 years down the road after depreciation and COE amortization, your car will be scrap metal and you are going to run road and default on it. It’s the same principle for trusts albeit in slow motion (their asset life is mostly 20-30 years), except they can run back to the markets and try and raise more money or restructure their loans at the expense of existing unitholders when they run into trouble.
3) Other dubious top ups – A mix bag of really cheap tricks that don’t even pretend to fake the sustainability of the payouts. It comes in various shapes and sizes – sponsor relinquishing their payout entitlements, accepting all fees in new units, setting up special accounts to provide payout support, entering into long term contracts which are higher than current market but curtails upside such that the PV of the entire contract is lower than market, go for loans that have lower interest but higher front loading etc.
These underlying problems are inherent in all the business trusts currently still listed so far, but many a times they are either aggravated or mitigated by other factors like macroeconomics, industry cycle, interest rate fluctuations, asset valuations and a whole host of other variables that nobody has any control on. This explains why some trusts are lacklusture but still surviving while others are as good as kaput.
Although most if not all of the business trusts are currently trading underwater vis a vis their IPO price, I am mildly surprised that some of them can still fetch such high valuations.
