"Why I Think Metro Holdings' Management Will Not Accede To Activist's Demands"

Republished from ThumbTackInvestor with permission

1stly, who’s Quarz Capital Management (QCM)? They’re a private investment fund, with about $100mil of AUM, with offices in Switzerland, Monaco, Cayman Islands and Singapore.

The fund’s investment philosophy:

“Quarz relies on a value oriented and research driven approach to investing with the ambition of creating portfolios that are attractively priced with several embedded catalysts”

The media bills them as an activist fund, although from what I found, their activism mainly revolves around writing public letters to the management of companies with their proposals/suggestions.

So what exactly is QCM proposing?

Their investing thesis, complete with a nice powerpoint presentation, can be found in this link. The letter they sent to Metro Holding’s BOD is there as well:

https://www.quarzcapital.com/en/research/metro-holdings

Let me dissect the details and proposals in their letter. The words in orange are quoted directly from their letter:

“In spite of being a mid-cap stock, Metro has the 2nd largest net cash holding among listed companies in the SGX, amounting to SGD 393 million, more than half its current market capitalization of SGD 758 million. This is in addition to the attractive dividend yield of 7.7% the company paid in FY2016. Together with the loans to its JVs of SGD 133 million and listed equity investments of SGD 111 million, Metro’s net cash, loan receivables and liquid investments total SGD 637 million, amounting to more than 80% of its current market capitalization.”

QCM helpfully explained in a little note that they derived a net cash holding of SGD 393 million by subtracting the “dividend payment of SGD 58m and liabilities of SGD 28m from the cash holding of SGD 479m reported in Metro’s FY1Q17 Financial Statement”.

Anyway, I get a bit confused here because the “liabilities of SGD 28m” that they subtracted out, only includes the non-current liabilities. It’s NOT the total liabilities. Here’s the relevant segment of it’s FY17Q1 financial statements:

Maybe I’m missing something here. But QCM basically calculated the “net cash” as:

Cash and cash equivalents (479mil) – dividends paid (58mil) – total non current liabilities (28mil) to derive a figure of SGD 393mil.

How about the current liabilities of 127mil?

Why is that conveniently left out? Afterall, what they’re trying to illustrate here is how much EXTRA cash Metro Holdings has after accounting for the liabilities. If management has no plans for this amount of extra cash, then it should be distributed to shareholders.

If we do include the current liabilities, the net cash becomes SGD 266mil. Well, that’s still a hell lot of cash sitting around, but not as much as the SGD 393mil that QCM worked out.

The slide is taken from QCM’s presentation.

Let me continue. From QCM’s letter:

“Together with the loans to its JVs of SGD 133 million and listed equity investments of SGD 111 million, Metro’s net cash, loan receivables and liquid investments total SGD 637 million, amounting to more than 80% of its current market capitalization.”

Here QCM is trying to add in the receivables and supposedly liquid investments to illustrate how much “cash and cash equivalents” Metro holds.

The problem is, the loans to JV of SGD 133 million is not exactly liquid, nor is it a “cash equivalent”. 

What exactly are these JVs that Metro has loan receivables from?

• Metro City, Shanghai
• Metro Tower, Shanghai
• Wing Crown (The Crest)
• Scarborough (Sheffield Digital project)

Of these 4 JVs, only the Metro City and Metro Tower are mature assets. They are continuously generating cashflow for Metro in the form of stable rental rates.

The Crest project is not going to be able to return any of these receivables anytime soon. Just go look up the sales figures in the URA property caveats page. The $$$ receivables are currently converted into the form of bricks and mortar sitting pretty somewhere at Prince Charles Crescent. (Interestingly, I can see it right this instance by looking out of the window while I type this).

Sales figures are not good. You’d only get your receivables back in $$$ if some buyers buy the units, converting the bricks and mortar in the balance sheet of Wing Crown, back into $$$.

As for the Sheffield Digital project, well, that’s worse. It’s currently in the development phase, and instead of giving you back $$$, instead it NEEDS yet somemore investments. How do I know that? Well, in FY17Q1:

“Amounts due from joint ventures (Non-current assets) increased from $129.0 million as at 31 March 2016 to $132.8 million as at 30 June 2016 mainly due to an amount of $4.1 million advanced to a United Kingdom joint venture during 1QFY2017.”

As of FY17Q1m Metro had to advance annother $4.1mil. So how would the outstanding receivable be “received” anytime soon?

Good luck getting your receivables back in the near future.

The point that I’m trying to make is that QCM treats these receivables to JVs as cash equivalents. In reality, they’re investments. You’re not going to be able to call back these investments and receive cash anytime soon, until they are mature, successful investments. If, at all.

Metro Holdings management themselves basically confirmed my thoughts. This is taken from Page 104 of Metro’s FY16 AR:

Let me highlight the (a):

“The non-current amounts due from joint ventures are interest-free ….”

“These amounts due from joint ventures are considered quasi-equity in nature”

In plain english, it means “the $$$ that’s loaned to these joint ventures, are treated as though we’re buying equity in the joint venture”

Why else would this receivables be “non-current”, “interest free” & “quasi-equity”?

Again, let me move on. From QCM’s letter:

“Together with the loans to its JVs of SGD 133 million and listed equity investments of SGD 111 million, Metro’s net cash, loan receivables and liquid investments total SGD 637 million, amounting to more than 80% of its current market capitalization.”

The other part that they’ve included in their calculation of “liquid cash” is the “listed equity investments of SGD 111 million”

Well, these equity investments ARE listed, so you can say that they are liquid in nature. The problem though, is that if you understand Metro’s direction, you’d know that these equity holdings are going to be held for a long long time, because they are strategic in nature.

They refer to equity stakes in HKEx listed property developers: Shui On Land and Top Spring International. In fact, Metro Holdings increased it’s equity stake in Top Spring such that TSI is now considered an associate of Metro. I don’t think Metro would do a turnaround and liquidate any part of the stake anytime soon.

These stakes have been held for several years, and in fact, for Shui On Land, Metro has held the equity stake since Shui On Land’s IPO in 2006.

Both share prices are also at multi year lows.

The investments are liquid, but they’re not cash. They’re strategic. Metro has stated in practically all previous ARs that they treat this investment as strategic and intend to leverage on their HK partners to work on projects.

From QCM’s letter:

“Progressive profit recognition and capital return from the delivery of its Nanchang Fashion Mark (China) mixed-use development project, Sheffield Digital Campus (UK), Manchester Middlewood Locks (UK) and The Crest @ Prince Charles Crescent (Singapore) will further boost Metro’s net profit and cash flow in the next few years.”

Perhaps. Perhaps not.

In my earlier post on my divestment of Metro Holdings, I’ve already illustrated why  the Nanchang project will have subdued profits. I have not followed since then, but at that point, the selling prices psm have been on a downtrend, although they are still moving units.

In Q1 up to Mar 2016, 12,670sqm of area was sold for $222.3mil HKD. ASP of Nanchang fashion mark is HK$17,545/sqm

For 1H 2016, 27,759 sqm of area was sold for 445.5mil HKD. ASP of HKD16,049/sqm

The ASP has been dropping. I do think it’s still profitable, just that margins are likely to be substantially lower. That’s in line with management’s guidance too.

The UK projects and The Crest are not going to contribute in the near or even the mid term. The Crest potentially may turn out to be a bomb. We don’t know yet, but the latest sales figures are not good.

“It is thus inconceivable that Metro’s share price continues to languish at SGD 0.915, trading at a deep discount of 43% to its intrinsic book value of SGD 1.61 per share despite the company’s strong recurring earnings profile and valuable assets.”

Can’t say I disagree with this. The discount to BV is ridiculous. That’s why I was a shareholder. But this is not something new. To begin with, almost all property developers on SGX are trading at discounts to BV. Especially so in a climate where the real estate prices are dropping.

Metro’s is particularly stark, but it’s been particularly stark as far back as I can research.

“Firstly, the firm holds an excessive net cash balance which has been largely under-utilized and low yielding. Investors are worried about the inefficient allocation and potential mismanagement of this sizeable cash balance.”

Again, I can’t disagree with this. Just look at the ROE figures. Metro’s operations are actually fairly efficient in generating a good return (Except retail). The problem is the cash they’re holding on to. That’s dragging down the ROE figures.

Knowing the management’s style though, I think Metro will continue to build and hold on to a cash hoard. This is because many of Metro’s projects actually do require large capital investments.

Just look at their investments in the InfraRed Funds. Both it’s predecessor and the current InfraRed China Real Estate Fund II. What does Metro contribute? Mainly funds to co invest. Without liquid $$$, Metro’s ability to get involved in projects overseas becomes severely limited.

“This is exacerbated by Metro’s insufficient communication with investors with regards to its strategy in its key real estate division beyond the opportunistic acquisition and divestment of property assets and development projects. Lack of management access (reflected by no sell-side coverage and low institutional shareholding level) and hard to decipher financial results add to the complexity of understanding the intrinsic value and strong cash flow profile of Metro. This partly results in lower trading liquidity, reduces the investability, and increases the substantial discount to intrinsic value of Metro’s shares.”

All of which I fully agree with. The late Jopie Ong’s distaste for interacting with minority SHs is legendary. In the AGMs that I’ve attended, he always appeared like he’d rather be ANYWHERE else than at the AGM.

“Low shareholding level and the lack of share-based compensation as part of management’s remuneration might have also resulted in the de-prioritization of Metro’s share price as a key management KPI.”

OK, I’ll have to STRONGLY disagree with this.

Share based compensation?! No no no no no. I have seen way way WAY too many abuses by management when it comes to share based compensation.

Share based compensation is a concept that perhaps may work for US listed companies. Essentially, you are paying management in shares or in stock options, that supposedly vest when certain share prices are met. This incentivizes management to think long term (As they own shares as well), and aligns management interests with common share holders.

That’s in theory.

In practice, many stock options are issued to management with:

1. Exercise price that’s close to, or sometimes even BELOW the current share price. What incentive are we talking about here?
2. Immediate vesting period, with no lag time. So much for long term interests
3. No lock in period. Upon vesting, management can sell the shares immediately
4. To compensate for using shares/stock options instead of cash for remuneration, the options tend to be overly generous

And because share based compensation is more indirect, it brings about less scrutiny amongst retail investors.

“We believe that now is the time that Metro takes the decisive step to close this substantial valuation gap by distributing SGD 150 – 200 millions of excess cash to shareholders (amounting to SGD 0.21/share or a 23% dividend yield). The remaining net cash balance and liquid investments of more than SGD 329 million will be more than sufficient for Metro to execute on its long term strategy of value creation and to pay its recurring dividend. We urge Metro to implement a clear dividend return policy and a shareholder accretive buyback programme to repurchase shares whenever the share price discount to NAV breaches >40%.”

23% dividend yield! That would certainly make some headlines. But I’d like to point out that if QCM’s real motive is to have “Metro’s share price trade at a higher valuation permanently”, then distributing a massive $0.21 dividend doesn’t do that at all.

What it does is to increase the share price by $0.21 or so when it’s CD, with a resulting massive fall, probably >$0.21 after it goes ex-div. Come on, tell me I’m not the only one who can tell this is exactly what’d happen.

Repurchasing shares definitely makes sense for Metro Holdings. It’s literally buying dollar bills with pennies.

“We recommend Metro to strengthen its investor relations work by enabling frequent institutional access to management (commonplace among high quality SGX-listed firms) and to provide better quality and quantity of reported financial metrics such as recurring rental income, lease expiry profile (for the next few years), as well as forecasted rental rate trends, development margins and profit.”

“The foresight and execution ability of the late Mr. Jopie Ong and his team have provided a strong foundation for Metro Holdings. We are confident that the current team has the capability and pedigree to lead the company to greater heights. The return of excess capital, clear corporate strategy, and proactive investor relations can result in Metro’s share price to trade at a higher valuation permanently and provide a significant upside of more than 40% by 2017 to all Metro shareholders.”

A bit of praise for JO to add pressure to Lawrence Chiang?

Ironically, they talk about Metro strengthening its IR blah blah blah. And continue to talk about the strong foundation due to JO. It’s ironic because JO is not known for his IR, and that’s putting it very mildly.

MY THOUGHTS

I hope my comments earlier do not come across as being critical of QCM.

In fact, I am glad to see more activist hedge funds come in. Please come to play in SGX. As a deep value investor, I really see the need for more such activist funds. That’d lend a voice to the minorities. I have previously mentioned Dektos in an earlier post about my personal experiences dealing with management. (Minority Shareholders Vs Management Of SG Companies)

I hope more activists shareholders start turning up in SGX. Not necessarily funds. They could be deep pocketed individuals. The problem with SG public companies is that our retail investor community is generally rather docile. I mean, I have listened to numerous quarterly conference calls by Valeant and Chesapeake Energy management. Imagine SG companies having to do something like that!

That’d be a real treat for shareholders. Instead, as it stands currently, many management are in my opinion, not worth their remuneration packages. They sit pretty, letting the ship run on auto pilot while collecting fat pay cheques to do mediocre stuff.

I have attended numerous AGMs, queried numerous IRs. Read my earlier blog post about minority shareholders vs management.

So I’d welcome more activist funds. Please come, but please live up to your name. It’s no good just putting forth proposals. If you’re truly confident of your proposals, call for EGMs if need be. Prepare to change the management if required. In short, be prepared to back up your bark with real bite. At the end of the day, true, well thought out logic would always win.

The share price has shot up massively from $0.915 to close at $0.99 today. That’s great for existing shareholders. The rise can only be logically explained by buyers who have jumped on the bandwagon today.

Why would they do so? Presumably those who bought today and contributed to the sharp rise, think that with QCM’s proposals, Metro would adopt this 23% dividend payout. And that’s the main reason for my in depth explanations above.

IMHO, I doubt Metro would. So if you bought in today, if you’re a player contributing to the sharp rise today, my question is, have you thought about what’d happen if none of these proposals, (and I suspect the main one is basically the cash payout. The other stuff about better IR, share based compensation etc are cosmetic) are eventually passed?

Furthermore, I think that QCM already knows about the points I’ve mentioned above. If they really don’t know, well tsk tsk, a fund should be doing better due diligence than a part time retail investor. If they DO know, and that’s what I suspect is the scenario, then the only plausible reason for releasing anopen letter is to…. hmmm let me put it this way, “generate public interest in Metro Holdings and increase the share price”.

For existing shareholders, my opinion, as I have mentioned several times before in earlier posts, is that Metro Holdings is still a rather well managed company. I think the new CEO took over at a tough period (see my earlier posts about investment cycles) and the company is in a “reinvesting” phase. But I believe the company is in good hands.

It’s always tough when the main guy running the show for many many years, is suddenly gone. You’d inevitably have a period of upheaval. But a well run company with good business dynamics would eventually bounce back. Kinda like Manchester United.

Again, I’d emphasize that my post is mainly for those who have suddenly jumped on the bandwagon just today with this piece of news.

I’m just not so sure if it’s wise to base your investments on a single, possibly improbable event.

In a game of musical chairs, don’t be the guy caught without a chair when the music stops.