The week: Is CDL oversold following family disagreements over Sincere and M&C?
Kwek Leng Peck, cousin to City Developments’ (CDL) executive chairman Kwek Leng Beng and uncle to its group CEO Sherman Kwek, has resigned as a non-executive director of the property group from Oct 19. The company’s announcement raised speculations that Leng Peck resigned in protest. He is said to have disagreed with CDL’s investment in Sincere Property Group, including the continuing of financial support totalling $1.9 billion to the China-based developer. In addition, Leng Peck has “reservations” with CDL’s approach in the management of its hospitality unit, Millennium & Copthorne Hotels (M&C).
First appointed to the board in August 1987, Leng Peck holds directorships in M&C, Hong Leong Investment Holdings (HLIH is the major shareholder of CDL) and several related companies under Hong Leong Group such as Hong Leong Asia, Hong Leong Finance, Tasek Corporation and China Yuchai International. According to CDL’s FY2019 annual report, Leng Peck owns a direct stake of 0.005%, while HLIH is currently CDL’s largest shareholder with a stake of 48.552%.
On Oct 21, CDL disclosed that it has invested a total of $1.9 billion in Sincere, comprising of an equity stake of 51.01% worth RMB4.4 billion ($894.9 million), US$230 million ($311.8 million) in bonds issued by Sincere, a working capital loan of RMB650 million, liquidity support of RMB1.5 billion relating to Sincere’s bonds maturing on Oct 26 and a corporate guarantee of RMB1.5 billion relating to Sincere’s external loan.
In April 2020, CDL acquired a 51% stake in Sincere for the equivalent of $880 million which was then seen as a 50% discount to Sincere’s NAV at the time. In August, CDL announced that nega
tive goodwill and fair value of the call option to further acquire 9% in Sincere totalling $50.9 million was recognised in 1H2020. The group also accounted for a post-acquisition share of loss of Sincere due to financing and marketing costs incurred by Sincere, and depreciation of Sincere’s investment properties due to alignment of accounting policy.
“CDL subsequently wrote down Sincere’s investment property values in August, resulting in a 42% decline in [the latter’s] NAV. We believe valuation and execution concerns in Sincere are under the spotlight once again,” Bank of America says in a recent report. “We do not think [Kwek Leng Peck’s] concerns are entirely new and were already well-flagged, particularly regarding M&C (30% of CDL’s revalued NAV), whereby most hoteliers are facing tough operational issues given Covid-19. We think more assistance to Sincere (7% of RNAV) highlights its liquidity issues,” the report adds.
Also on Oct 21, CDL announced its board of directors is in the process of identifying and appointing an External Financial Advisor to assist with further evaluation and review of the group’s investment in Sincere includ
ing sales of investment properties.
During a results briefing in August, CDL group CEO Sherman had said: “[Of] Sincere’s investment properties a fairly large chunk are in retail and hospitality, and still suffering from the aftermath of Covid. We have more than 10 assets on the list to be divested. It will be something that will likely take time.”
“Having injected $1.9 billion into Sincere, we doubt it would walk away. Hence the financial advisors’ evaluation, pace of asset sales and residential sales momentum will be pivotal in Sincere’s refinancing ability. As of end FY2019, we estimate Sincere’s net debt at $7.3 billion,” Citi says in a note to clients.
“The question now is whether the board should continue to provide financial support to Sincere under the assumption the market would eventually recover, or push through divestments now and take a haircut on its investment. Either way, in our view, this may lead to a valuation drag,” says the Bank of America report.
For 1HFY2020, CDL reported Patmi of $3.1 million versus Patmi of $362 million in 1HFY2019. The decline in Patmi includes impairments for M&C and allowances for Sincere.
“This event leads us to revisit our assumptions. We lower our price objective by 13% to $8.70 on a 4% reduction to RNAV (on higher debt in Sincere) and a higher valuation discount of 40% (vs 35% previously), in line with historical downturns. A bear case of a complete write-down of its $1.9 billion investment implies an $2.10 per share hit on its valuation,” Bank of America calculates.
CDL last traded at $7, versus its NAV of $11.66 and RNAV of $16.61. CDL’s NAV is based on the book valuation of its properties where the company uses historical cost accounting. Its RNAV is based on the market valuation of its properties. “We reiterate buy on valuation as we think the sell-down is overdone. A successful restructuring of Sincere could be a catalyst,” Bank of America adds.