Through the Lens of CitySpring, SGX Business Trusts Examined
Singapore Exchange (SGX) issued a consultation paper in October seeking public opinion on proposed improvements to the corporate governance structure within real estate investment trusts (REITs). For many industry participants, it was the first time they learned how trust managers and sponsors function within a REIT, and some were amazed at the potential sources for conflicts of interest.
Considering that REITs, as a listed asset class, have existed on the SGX for more than a decade, the level of comprehension among investors is somewhat disparate. Many simply consider REITs a portfolio of real estate that generates regular cash flow. Some even have apparently concluded that anything to do with a “trust” is simply a collection of underlying assets that will generate a regular cash flow.
While the above conclusions are true to an extent, the cash flow from a “trust” may not be regular at all times. This, therefore, brings us to the need to shed light on another younger, but structurally different listed asset class on the SGX — the business trust.
To compare the two, we are using CitySpring Infrastructure Trust as our case study. The areas we are examining include:
- Differences between business trusts and REITs
- Asset acquisition
- Remuneration model
- Suitable types of assets and/or businesses for a business trust framework
First of all, REITs in Singapore are regulated as property funds under the Code on Collective Investment Schemes, whereas business trusts are governed by the Business Trusts Act.
Secondly, the ownership and operational management of a REIT fall onto two separate parties, the trustee and asset manager. In the case of a business trust, these two duties fall onto one party — the trustee-manager, which is often the sponsor responsible for selecting the assets for the business trust during inception. As such, the trustee-manager has the dual responsibility of safeguarding the interests of unit holders and managing the business trusts. In the CitySpring case, both sponsor and trustee-manager is Temasek Holdings. Temasek is also holding 37.4% of the total outstanding units.
Thirdly, as long as 90% or more of the net operating income is distributed back to unit holders, REITs enjoy tax exemption at the corporate level. Business trusts, on the other hand, are treated as normal companies and are subject to a corporate levy.
Last but not least, the gearing limit of REITs is capped at 35% (60% if the debts are rated), while no limit exists for business trusts.
As with REITs, the trustee-manager of a business trust raises funds from public investors by issuing units in an initial public offering. The proceeds from the initial public offering, together with subsequent borrowings, are used to acquire the trust assets.
After listing, business trusts can issue rights on a pro-rated basis to all existing shareholders on a first right of refusal basis. Rights issues are always offered at a discount to current share prices to attract subscription. Exercise of rights issues typically takes a relatively long period of time and may not be a suitable mechanism for business trusts, especially during times of fire-sale acquisition opportunities.
An outright share placement to an institutional investor might be a more appropriate approach when business trusts have to raise funds quickly. Unlike pro-rated rights issues, share placement dilutes the unit value for all existing shareholders.
During asset acquisition, it is a common practice for deal makers to seek valuation reports from at least two independent valuators. With the exception of related-party transactions, this practice is not mandatory during asset acquisition for business trusts. To minimize the perception of conflicts of interest, most business trusts will still seek the advice of at least one independent valuator. When CitySpring entered into a joint venture with Shimizu Corporation to build a SGD$130 million data center to be leased to MediaCorp subsidiary’s 1-Net Singapore Private Limited, they did seek the advice of an independent financial adviser.
The trustee-manager typically receives an incentive payout on top of a base fee on a per-annum basis. For CitySpring, the base fee is 1% of market capitalization while its incentive payment is tied to some mathematical formula in which CitySpring’s share performance is benchmarked against the Morgan Stanley Infrastructure Index.
One thing to note for a business trust and REIT, management’s remuneration should not be linked to the net asset value (NAV). It could encourage acquisition that may not add value in the long run. On the other hand, management fees should also not skew too much towards stock market performance as that would encourage unnecessary short-termism behavior. In all, the performance fees should align with the nature of the business rather than adopting a one-size–fits-all structure.
Unlike REITs, business trusts can distribute cash flow back to unit holders even when they have an accounting loss. This is a feature that would be particularly relevant for capital-intensive assets with a short accounting life. During the initial years of “heavy duty” depreciation, operational cash flow remains positive and distributable. Infrastructure falls precisely into this category. CitySpring Infrastructure Trust assets include City Gas, SingSpring (a seawater desalination plant), Basslink (a power transmission network) and CityNet (a telecommunications network).
Nevertheless, critics of business trusts have lamented the difficulty that investors encounter when attempting to understand the business model of the underlying assets, infrastructure being one of them. Instead, it might be more suitable for infrastructure to be funded on a private trust basis where the unit holders are infrastructure-specialized fund managers.
We do not have a position on the suitability of infrastructure trusts for investors at large. It is new, invigorating, and the structure can be both complex and/or simple. Instead, we would advise investors to stick with old wisdom — invest only in what you understand; gain an understanding of the business model and corporate governance structure; and finally consider how comfortable you are with the frequency and amount of dividends.
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