ARA Asset Management

[mrEngineer]

This is a great business.
If they and their funds never bought anything else for the rest of their existence, we have a 2.6% dividend yield + annual growth in rent of about 3-5% or inflation. Over a long enough period, assuming Singapore & HK are ok property markets, growth in rent should at least equal inflation, so this is definitely better than bonds - esp the recent ones out at retail investors.

They generally grow by adding new assets. So either their funds by more buildings e.g. Suntec Reit buys a chunk of MBFC, or they start a new fund like Cache. So since most property in Sg, HK, Msia, China isn't already in a REIT, they're quite far from their growth limits. ROE is high because ARA is not spending very much capex to add a new building - the funds spend the capex, and then ARA even charges fees for doing the work to add new buildings.

So returns = inflation + 2.6% (current dividend yield) + (assets they keep adding - as 2010 has been a year when they grew very nicely).

There are 2 issues: 1. when property prices fall, but then they're not on the hook for rights issues refinancings the REIT holders are - since fees are based on assets not net-assets. 2. when they have to invest some of their own money into their funds, so it's very unlikely that their funds can give them 35% returns.

PB is not really relevant for valuing such a company.
http://pages.stern.nyu.edu/~adamodar/New...inants.htm has a mathematical derivation, but the point is that when ROE is much higher than the cost of equity, the expected book value is much higher than 1. You can examine Buffet's largest positions e.g. Coke, P&G etc - the book value is far above 1.

IMO, PB should be relevant in valuing for almost all companies. And of course you do not take BV that is based solely on the NAV obtained from B/S but rather the RNAV and perhaps some additional value for the intangibles that are not measurable by accounting practices.

But P/B just tells you how much you are paying for the company in terms of the size. So P/B of 7 means you expect to pay 7 times for a company of its current asset and intangibles worth. To assess whether is it worthwhile to pay for the size of the asset u are purchasing, one has to use ROE to determine how many years before the current asset can compound to reach the amount you pay for.

Compounded growth for asset can be easily calculated based on earnings history but compound growth for intangibles may not be so obvious or one can simply treat that value as a premium add onto whatever asset value has grown into.

Agree on your point on high ROE would naturally lead to higher P/B due to lower cost of equity. If you look at ARA price history, the lowest price it went to was 24 cents almost equivalent to P/B of 1 only and not lower. But the question is how long can the high ROE sustain?

In the case of ARA, compounding growth at 35% (also ROE) at asset level would mean they have to continously grow its earnings more than 35% each year for 4-5 years. My most optimistic estimate would be at most 2 more years and they have to stagnate. The reasons are because there are no other developments from Cheung Kong that they can tap onto locally (other than MBFC 2) and they have to develop other source of business trusts themselves where some point they will hit law of diminishing returns from the size and no. of CEOs to manage.

Therefore, at my selling price, I have determined that I would not expect to see further intrinsic upside and could not exactly measure over-exuberance to a certain extent which lead to my decision to sell. Securing profits also mean some certainty to myself and possiblities to tap onto other opportunities evaluated before my sell decision.

Correct me if I am wrong, I am learning from this experience as well.

[Nick]

They can maintain 35% ROE with the same earnings (no growth) by paying out their earnings as dividends. This will lead to zero growth in equity so ROE can be maintained.

[redcorolla95]

First the theoretical part:
Generally, and it’s been mathematically shown that in a steady P/B = (r-g)/(k-g). So if r (ROE) ~k (cost of equity), then P/B is close to 1. So usually in developed countries like Singapore, r is about 13%, k is about 10%, g about 4-5%, gives a P/B of around 1.5-1.6, so historically the STI has traded around there. So that’s the mathematics.

The very rough intuition is that for most business, to add earnings, one needs to add capital e.g. for most manufacturing – factories, airlines – planes, banks – deposits, property developers & REITS – properties, retailers – shops, inventory etc. This means that growth is constrained by capital. When business is good, other firms will enter by adding capital, and they enter until the return on capital is at some equilibrium, which means that there is some ROE that will be a bit more than the cost of equity. So then we have price is a little more than book.

As the ROE goes up to 35%, then this mathematical relationship is harder to use because (i) cost of equity is higher & harder to estimate, (ii) this is usually not a steady state, so growth & ROE are unstable.

The intuition is also when ROE is at this level, the constraint to growth is usually not capital. For ARA, the constraint is finding more buildings to buy, for SGX –more companies to list & people to trade, Moody’s (which has had negative capital since 2007) – more bonds to rate.

To the extent that: growth can be achieved without capital, then the valuation isn’t constrained by capital; in other words, the amount of capital is not relevant for valuation, or P/B is not relevant. All these companies trade at P/B which are much higher than 1, so then can we know what’s the right PE e.g. 3 / 7 / 10 / 20?

The next thing is intangibles or economic goodwill. Buffett covers that very nicely in his 1983 letter. http://www.berkshirehathaway.com/letters/1983.html I don’t think I can explain it any better than this.

So if you look at a company like Coca-Cola, you subtract the goodwill & intangibles, tangible equity 12m ago is about $11.3b, Return on Tangible Equity is about 66%, Market Cap of $146b is a whole lot more than tangible equity. For Kraft, the tangible equity is negative. The conclusion: that tangible equity or tangible book value, is not helpful in estimating the value of a company when return on (tangible) equity is much higher than average.


Next back to ARA:
How long can 35% ROE sustain? The US has some listed asset management companies e.g. Legg Mason, Affliated managers, etc, they’ve been able to keep their ROE high for sometime. ARA has the added advantage that REITs are captive assets, unlike a unit trust where people can redeem, Suntec REIT contractually manages Suntec City, and it can be quite hard to change REIT manager.

[koh_52]

Wow ! this counter keep on inching up..it really keep up the analyst expectation of T.P.$1.80.
Today closed at 1.84....how far this counter can go, anyway must have some insight news surfacing up soon.

[Contrarian]

Wow ! this counter keep on inching up..it really keep up the analyst expectation of T.P.$1.80.
Today closed at 1.84....how far this counter can go, anyway must have some insight news surfacing up soon.

Valuation is high side.

But I am expecting at least 2 new REITs that ARA is managing this year - middle east REIT.

The next wave of growth should come from the private funds...

I am hanging on...

[corydorus]

I will bet it will reach $2 without much effort. As mentioned earlier assume nothing happen of add listing, dividend alone is not bad. So seems to me is upside. I can be wrong.

Vested before earlier posting.

[mrEngineer]

Is it only me but I smell something fishy about ARA recent rise attributed to the mega Hutchison IPO? If somehow or somewhere, ARA is given the opportunity to manage this trust or just part of it, I think they can almost have another Suntec REIT equivalent in their portfolio!

Now if this is true, I can really see ARA going up to $3..

---

After reading through e hutchinson ipo in more detail set me thinking why did Li ka shing did not entrust this mega ipo to John lim? Have they fallen out or Li ka shing wants to diversify some of his eggs or maybe shareholding in ARA is too expensive now to increase his stake to remain in control of his Hutchinson baby? Ara venture into cache logistics should provide some form assurance on logistics management capabilities..

But nonetheless, HPH is still a subsidiary and pte limited with no identified key personnel handling. So ARA might still have a chance or even a merger may take place between these 2 managers.

Haha. Better go and sleep and stop dreaming..

[Contrarian]

> After reading through e hutchinson ipo in more detail set me thinking why did Li ka shing did not
> entrust this mega ipo to John lim? Have they fallen out or Li ka shing wants to diversify some of
> his eggs or maybe shareholding in ARA is too expensive now to increase his stake to remain in
> control of his Hutchinson baby?

This decision making process is the 64 million $ question. If we can solve it, we will know the value of ARA.

But of course Li KS will put his interests as #1.

[mrEngineer]

Theoretical Question for learning purpose

I was just going through CFA materials on Special Purpose Entities (Trust is considered as one) consolidation on accounting statements on the sponsor of the entity (ARA) and learnt that IAS 27 requires consolidation of SPEs onto sponsor entity if the sponsor entity has decision-making powers to obtain benefits, absorb risk and rewards of SPEs and residual interest in SPE.

Seems to fit the description of ARA well with its variety of trusts. So I wonder would it be useful if to consolidate all ARA managed trusts into ARA balance sheet so as we can accurately view the risk involved in the business? If such consolidation becomes mandatory, we should see high ROEs or excellent financial results being eliminated and a more conservative valuation on ARA.

Any comments?

[EnSabahNur]

Theoretical Question for learning purpose

I was just going through CFA materials on Special Purpose Entities (Trust is considered as one) consolidation on accounting statements on the sponsor of the entity (ARA) and learnt that IAS 27 requires consolidation of SPEs onto sponsor entity if the sponsor entity has decision-making powers to obtain benefits, absorb risk and rewards of SPEs and residual interest in SPE.

Seems to fit the description of ARA well with its variety of trusts. So I wonder would it be useful if to consolidate all ARA managed trusts into ARA balance sheet so as we can accurately view the risk involved in the business? If such consolidation becomes mandatory, we should see high ROEs or excellent financial results being eliminated and a more conservative valuation on ARA.

Any comments?

How would ARA obtain benefits, absorb risk and rewards of SPEs and residual interest?