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"E-book" by AK

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An incomplete analysis of OUE Limited.

Sunday, September 18, 2016

I really enjoyed this email from a reader:

Hi AK,


I'm a long-time fan of your blog (around 5 years, I think!). I especially liked the back-of-the-envelope calculations you used to do when valuing stocks.

I read your post on OUE as an asset play a few years back but only got around to evaluating it myself last week over the long weekend. 

In OUE's latest financial report for 2Q 2015, it's NAV/share is reported to be $4.31. At the current price of $1.60, that's a pretty crazy 63% discount! But it immediately raises the question of whether reported net asset values can be trusted. 

So I decided to try and value the properties... Fortunately, OUE only has a few properties that haven't been divested to their REITs:

1. OUE Downtown - fair value S$1,477m
2. US Bank Tower - fair value US$530m
3. Marina Mandarin (30% stake) - fair value S$560m
4. OUE Twin Peaks - book value S$768.2m

OUE Downtown comprises 2 office towers, OUE Downtown 1 and 2, the first of which is being transformed to a mixed-use development. OUE Downtown 1 is having its low-mid zones converted to serviced suites and its podium converted to a shopping mall, while the upper levels, plus the entire OUE Downtown 2, will remain as office space. 

To value this building, I turned to URA's records of sale transactions for commercial properties over the past quarter (Jun-Sep 2016), looking for office buildings of roughly the same age and located in the same area (districts 1 and 2). I found transactions for office space in 3 buildings that looked relevant:

1.  International Plaza - S$1,626 psf
2. Shenton House - S$1,602 psf
3. People's Park Centre - S$1,296 psf

There were multiple transactions for International Plaza and People's Park Centre over this period, with the psf value increasing for higher floors, but since I wanted to value OUE Downtown conservatively I opted for the lowest psf values. Since OUE Downtown has a net lettable area of 867,000 sq ft, assuming it can be sold for the same S$1,296 psf as office space in People's Park Centre gives us a valuation of S$1.1 billion.

Going further back in time, in Nov 2015 the CPF Building, which is very close to OUE Downtown and which lease expires in the same year, was sold for S$1,697 psf of net lettable area. This gives me some confidence that my valuation is indeed conservative.

Obviously there are still some caveats with this valuation, I can think of at least 3:

1. OUE Downtown 1 is going to have retail and hotel components; these might be valued less than office space is, especially if the mall and the serviced suites are not successful.

2. OUE Downtown has about 50 years remaining on its lease, so depreciation each year henceforth is 2%.

3. There is significant supply of new premium office space coming online in 2017 and 2018 (e.g. Marina One, DUO Tower), which may depress valuations for older buildings like OUE Downtown.

For the US Bank Tower, I used pretty much the same approach. The US Bank Tower is a freehold Class A office building in downtown Los Angeles, so I looked for recent transactions for prime office buildings in the same area. Here I was able to find transactions for 3 entire buildings:

1. One Bunker Hill - US$300 psf, sold in 2015
2. 800 Wilshire Blvd - US$358 psf, sold in 2015
3. The Desmond - US$573 psf, sold in 2016

Again, I took the lowest psf value and multiplied it by the US Bank Tower's 1.44 million sq ft of net lettable area. This gave me a value of about US$430 million. Now if OUE did divest this building for this amount that wouldn't be a great deal for them, since they bought the building for about US$370m and spent US$50m renovating it - a total cost of US$420 million. But I believe they should be able to fetch a higher psf for the US Bank Tower, because:

1. It is an iconic building; when built in 1989, it was the tallest building in the whole of California (and is still the second tallest).

2. It is significantly newer than all 3 of the buildings listed above; The Desmond was built in 1916, One Bunker Hill in 1930 and 800 Wilshire Blvd in 1972. The US Bank Tower on the other hand was built in 1989.

Nevertheless there are also at least 2 caveats with 
this valuation:

1. Occupancy is still only 75%. This is an improvement from the 60% occupancy when OUE first purchased the building in 2013, but 25% vacancy is still quite a bit higher than that for Class A office buildings in LA overall, which is 15.6%. All 3 of the LA office buildings above had occupancy above 90% when they were sold. Then again, the 75% figure is for end-June 2016, which is when asset enhancement works had just completed, so it's possible that occupancy has already improved since then.

2. California is a seismically active region and although the US Bank Tower is supposedly designed to resist an earthquake measuring up to 8.3 on the Richter scale, obviously if the building is destroyed it will have no value.

With OUE Downtown and the US Bank Tower out of the way, that leaves us with the Marina Mandarin hotel and OUE Twin Peaks. I think these properties are less relevant to my investment thesis though. OUE does not have a controlling stake in Marina Mandarin (its effective interest is only 30%) and so it can't make the decision on whether or not to divest the hotel.




The Twin Peaks condo is more interesting. Popular opinion is that the prospect of paying extension charges if OUE is unable to finish selling all 426 units has been weighing on the share price. When I called an agent to inquire, I was told the following:

- Tower 2 of Twin Peaks is completely sold
- 50% of units in Tower 1 have been sold, 20% are under negotiation (including for the bulk sale of some floors) so only 30% are still available
- The developer has bought a few floors for himself (???) When I asked OUE's IR about this, I was assured that they had bought only a few units, but still.

There is an article in yesterday's Straits Times (13/9/2016) which states that half of a batch of 86 units at Tower 1 have been sold since the units were launched in July, so it does seem that sales have picked up. 

If OUE can maintain this sales momentum, I think there is a good chance that they will be able to avoid the extension charges that will kick in Feb 2017 if units are left unsold. That the company has reversed some of its previous impairment losses on Twin Peaks in its latest financial results is also a good sign. 

It's true that even if OUE manages to sell all Twin Peaks units the project may still be loss-making overall, but this also doesn't seem too important to my valuation since I am assuming that all the costs for the land and development costs have already been incurred and accounted for (please let me know if I'm wrong!).

If Twin Peaks and Marina Mandarin are not important to my valuation (as long as extension charges for Twin Peaks are avoided), that means I'm counting on the valuations of OUE Downtown and the US Bank Tower. I established earlier that I think conservative valuations of these properties are S$1.1b and US$430m  respectively. Assuming, again, a conservative exchange rate of 1.3 USD - 1 SGD, that adds up to S$1.1b + S$559m = S$1.66b.

What is OUE's current market cap? Each share trades at about $1.60 and there are close to 903m shares, so the market cap is about S$1.44b. 

In other words, the combined, (what I believe are) conservative valuations for OUE Downtown and the US Bank Tower, already exceeds what Mr. Market thinks the entire company is worth! That looks really compelling, especially since I haven't even taken into account the values of its stakes in OUE Commercial REIT and OUE Hospitality Trust, which are significant:

- 35% of OUE Hospitality Trust, which has a market cap of S$1.2b
- 65% of OUE Commercial REIT, which has a market cap of S$900m



-----------------------------

This fits in very nicely with what I said during the last "Evening with AK and friends".

I will add that if we look at OUE Limited as an asset play, we have to be very realistic about the time it might take to see value unlocked. It could be years before we see anything. 

So, we need to size our position conservatively as well unless we have money to burn and we need to be very patient.

Related posts:
1. OUE Limited: A nibble.
2. An incomplete analysis of Wing Tai.
3. OUE Limited: An asset play.

8 comments:

Kevin said...

Hi AK and reader,

Lots of share buy-backs done by OUE for August and September. Is something brewing on the sidelines? ;)

Bruce said...

while an interesting counter, it looks more like a major shareholder's investment vehicle, for public shareholders, where/when is the trigger? else only a miserable 1.26% dividend payback.

AK71 said...

Hi Kevin,

Your guess is as good as mine.

There are many reasons for insider selling but only one reason for insider buying or so Peter Lynch said.

AK71 said...

Hi Bruce,

Anyone in his right mind who is investing for income wouldn't consider OUE Limited. ;p

Bruce said...

Indeed, AK you are right on the spot.

Since my 1st following your blog starting from 2013/09, it is a entirely 3years' journery, i learnt quite a lot from you, thanks; and I grow a lot, too. so i'd much prefer your blogs focusing on specific counter's analysis, whether it is from your readers or from yourself, whether it is good or bad company, it makes me learn something new. Such type of articles however carries less percentage weight on your blogs nowadays.

AK71 said...

Hi Bruce,

To be quite honest, I am more retiring these days as an investor and don't spend as much time looking at stocks. I might add to existing holdings on price weakness and I might start new positions if I come across something interesting but I won't actively look for things to invest in. I am more of a waiting investor now.

AK is so lazy. Bad AK! Bad AK!

AK71 said...

In 2Q 2016, OUE’s revenue jumped by 40.4% YOY to S$134.3m, thanks to the consolidation of revenue from One Raffles Place. Profit attributable to shareholders was S$25.7m in contrast to a loss of S$16.3m a year ago.

OUE’s NAV per share is S$4.31. It is currently trading at more than 60% discount to NAV.

AK71 said...

After active marketing effort and the implementation of a deferred payment scheme, the group has enjoyed significant success at selling units at OUE Twin Peaks, which by now has over 268 units sold (out of 462 total units) as at end Sep 2016. Looking ahead, management reports that it remains focused on asset enhancement works at OUE Downtown and active lease management at US Bank Tower.

A management agreement was signed in Oct 16 with Oakwood Asia Pacific Ltd to operate serviced residences, Oakwood Premier OUE Singapore, at OUE Downtown which is expected to open by mid-2017. Occupancy rates at OUE Downtown and US Bank Tower remained steady at 87.0% and 74.3% as at end Sep 16, versus 85.3% and 74.6% as at end Jun 2016, respectively. Maintain BUY with an unchanged fair value estimate of S$2.17.

Source: OCBC Research

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