ARA Asset Management Ltd: Upcoming SGD Perpetual?

What's happening?

ARA Asset Management Ltd met with fixed income investors yesterday, with a view to launching a new perpetual issue. While we would like to caution that there is no certainty a new bond issue from the company will eventually ensue, we offer some comments on ARA Asset Management as well as on the potential pricing and structure for a perpetual bond issue.

An asset manager focused on real estate

ARA Asset Management is a leading Asian real estate fund manager, focusing on the management of REITs and private real estate funds. ARA is currently one of the largest REIT managers in the Asia ex-Japan region, with AUM of approximately S$36 billion (as of end-Mar 17); the manager currently manages 6 listed REITS in Singapore, Hong Kong and Malaysia (see Table 1), as well as 6 privately-held REITs in South Korea. The manager also manages 10 private equity funds in Asia, and provides property management and convention & exhibition services.

Table 1: Listed REITs managed by ARA Asset Management

Recent developments

Just under 10 years after its listing (in November 2007), ARA Asset Management has since been privatised (and delisted in April 2017), following an acquisition of the company via a “scheme of arrangement” by a consortium of investors. Based on the offer price of S$1.78 per share, this valued the company at around S$1.78 billion at the point of privatisation. The company is now owned by a consortium of investors, which includes Alexandrite Gem Holdings Limited (an affiliate of Warburg Pincus, owning 30.72%), The Straits Trading Company (20.95%), AVICT Dragon Holdings Limited (an affiliate of AVIC Trust, which owns 20.48%), JL Investment Group Limited (an entity wholly-owned by CEO John Lim, with a 19.85% stake), and Wealthman Group Limited (an indirect wholly-owned subsidiary of Cheung Kong Property Holdings) with an 8% stake.

Income stability, very conservative gearing

A sizable proportion of ARA Asset Management's overall revenue comprises recurring revenue streams, according the manager a fair level of income stability, similar to that of a REIT. The largest proportion of revenue is generated from REIT management fees – these constituted 50.6% of overall FY16 revenue (which totalled S$176.8m) for ARA Asset Management in FY2016 (see Chart 1). Portfolio management fees are also another sizable recurring revenue contributor (15% of overall FY16 revenue), while the manager also receives recurring income from the distributions paid out on its ownership of strategic stakes in various listed REITs, and, to a lesser extent, its seed capital investments in private real estate funds.

Chart 1: Revenue breakdown

As of end-Dec 16, ARA Asset Management sported total borrowings of S$122.027m, which comprised an S$80m secured term loan facility (utilised for seed capital contributions into various private real estate funds), a S$41.7m revolving credit facility, as well as finance lease liabilities of S$327,000; the manager had no unsecured borrowings. We note that ARA Asset Management's secured borrowings are secured by ~80% of its Suntec REIT units and 100% of its Cache Logistics Trust units (representing 118.2m units of Suntec REIT and 23.8m units of Cache) – these are securities which constitute highly separable assets and do not affect the rest of ARA's business.

Offsetting these borrowings was a cash and equivalents balance of S$109.067m (as of end-Dec 16), which means ARA Asset Management's net debt position was a mere S$12.96m at the end of last year, representing almost a negligible level of net debt in comparison with the S$761m of assets, or S$589.47m of equity recorded on the firm's balance sheet. As of end-Dec 16, ARA Asset Management's debt-to-asset and debt-to-equity ratios were an undemanding 16% and 20.7% respectively, while net debt-to-assets and net debt-to-equity were 1.7% and 2.2% respectively. In short, ARA Asset Management sports a very strong balance sheet, with a minimal level of gearing and an almost non-existent net debt position.

A potential SGD perpetual issue

We're hearing that ARA Asset Management is considering an SGD-denominated perpetual issue, with a possible NC5 (non-call 5) structure. This may follow a structure seen in selected perpetual issuances in 2017 so far, including the likes of Starhub's STHSP 3.950% Perpetual Corp (SGD)s  or Mapletree's MAPLSP 4.500% Perpetual Qsov (SGD)s which are callable 5 years after issuance but have a coupon reset feature only 10 years after issue, although we note that other perpetual structures are possible, such as Hotel Properties' HPLSP 4.650% Perpetual Corp (SGD)s and Wing Tai's WINGTA 4.080% Perpetual Corp (SGD)s, both of which have a coupon reset at the 5 year mark.

How to think about potential pricing?

What kind of pricing should ARA Asset Management command on a subordinated perpetual issue?

Given that there are no asset management peers in the SGD market, the obvious peers to look at are the REITs, which are some of the more prominent issuers of perpetual debt in the market, although there are some key differences between ARA and the rest of the REIT sector.

For a start, ARA Asset Management's balance sheet is significantly less levered than most of the REITs; the lack of other unsecured borrowings means the subordinated nature of the new bonds is not particularly worrying from a bondholder's perspective. Also, the firm's sizable cash balance (which almost covers the firm's existing debt position) is unique to ARA as a real estate asset manager; REITs are not in a similar position to retain a sizable level of cash given their distribution policies to unitholders.

Like a REIT, ARA generates resilient streams of cashflows by virtue of its asset management fees and income distributions from ownership of REIT units so there are some similarities here. ARA's specific sector risk is somewhat mitigated by being a stakeholder/manager in numerous REITs and private real estate funds, as opposed to a REIT which is usually concentrated in a particular sector. Also, while ARA Asset Management's fortunes are generally tied to property values, its ownership of REIT units means that these can be monetised fairly quickly should the need arise; a REIT may face more difficulties in monetising physical real estate to raise capital quickly.

While it is currently not the case, where ARA may be deemed as riskier than a typical REIT (as a creditor) is its flexibility to lever up the balance sheet (possibly for improved profitability or to fund acquisitions utilising debt), or to take on capital intensive projects which could ultimately hurt the company's ability to service debt. In contrast, Singapore-listed REITs have gearing and redevelopment limits to adhere to, and will not be able to lever up the balance sheet beyond the 45% leverage limits prescribed by the MAS.

Mid-to high 4% pricing would be attractive

In the context of the many similarities of ARA Asset Management vis-à-vis the Singapore REIT sector, we think the Singapore REIT bond segment offers a useful reference point for potential pricing for a new perpetual issue. At the time of writing, the mid-sized Singapore REIT perpetuals are quoted at between 160bps-220bps over swaps, although these have coupon resets after the first 5/5.5 years. Outside of the REIT space, real estate developers like HPL and Wing Tai's HPLSP 4.650% Perpetual Corp (SGD)s and WINGTA 4.080% Perpetual Corp (SGD)s are quoted at around 240bps and 227bps over swaps respectively; these also have resets at the 5Y mark. Other possible comparables include Mapletree's MAPLSP 4.500% Perpetual Qsov (SGD)s at +200bps and Starhub's STHSP 3.950% Perpetual Corp (SGD)s +190bps.

Taking the peer comparable universe into consideration, we think a spread of around 250bps over swaps would be appropriate for ARA Asset Management Ltd's maiden issue, with the firm's strong existing balance sheet and persistent revenue generation ability weighed against the potential risk of overzealous debt-funded acquisitions which could subordinate the claims of holders of perpetual (subordinated) debt. This implies a pricing in the low- to mid-4% region (on expectations of a 5 year call structure), although taking a more conservative view (that the bonds may only be called at the 10 year mark, where an anticipated coupon penalty may be applicable), we think a mid- to high 4% pricing would be possible for a potential SGD perpetual, which would still make the issue attractive on a relative value basis vis-à-vis the rest of the SGD perpetual market.