Simon Cheong's buyout offer for SC Global lifts shares depressed by his own strategy

SIMON CHEONG, CEO and chairman of SC Global Developments, is facing resistance to his offer to take his company private at S$1.80 a share. That could soon turn into criticism about how he has been running the company.

SC Global has developed some of the most luxurious residential property in Singapore, including The Marq on Paterson Hill, Hilltops located on Cairnhill Circle and Martin No 38 on Martin Road. The company's strategy has been to price its developments at sky-high levels and take its time unloading them. When demand is weak, it simply holds back the units until buyers are once more willing to pay up. For instance, The Marq on Paterson Hill, where a unit was sold in September at S$4,920 psf, is only 50% sold at the moment, according to analysts. The first unit was sold in 2007.

The downside of this strategy is that SC Global's earnings have been volatile, which has done its share price no good. In the past year, shares in SC Global have traded as low as 94.5 cents. Just before Cheong made his offer, they were trading at S$1.205 each. SC Global reported a book valueof S$1.55 a share as at Sept 30. Analystshave also put its RNAV at between S$1.98 and S$4 a share.

Now, another problem is looming for the company. Under government rules designed to prevent hoarding of property, SC Global might soon have to pay penalties on its unsold units. Some of its projects were built on land acquired with a Qualifying Certificate (QC), which used to be a requirement for foreign-owned developers. Projects under these QCs are required to be completed within five years and fully sold within two years of obtaining their Temporary Occupation Permit. According to Lee Liat Yeang, a senior partner at Rodyk & Davidson, the Residential Property Act considers public-listed property developers such as SC Globalforeign-owned because foreigners can buy their shares and sit on their boards.

What happens if SC Global's development projects fail to meet their QC requirements? The company would forfeit the deposit paid to obtain the QC, which amounts to 10% of the land cost. However, under amendments to the law, which came into force in 2011, they are allowed to apply for an extension, for which they have to pay an extension premium based on a percentage of the land cost pro-rated for the proportion of units still unsold. The premium is 8% in the first year; 16% in the second; and 24% in the third. Lee says no developer has yet forfeited its deposit, and a few have successfully obtained extensions.

Alison Fok, an analyst at Maybank Kim Eng Research, says in a report that SC Global's The Marq will run into its QC deadline on Jan 13, while Hilltops and Martin No 38 will hit their deadlines on April 13 and Nov 13 respectively. If the company does not receive a waiver or extension from the government, it could forfeit as much as S$71.7 million in 2013, according to Maybank Kim Eng.

This looming penalty gives Cheong a strong incentive to take SC Global private, say some analysts. It also gives minority investors a reason to accept the offer. After all, if SC Global were made to pay the penalties for the unsold units, the value of the company would be eroded.

According to filings related to the offer, the offer price of S$1.80 a share is a significant premium of 49.4% to SC Global's last traded price prior to the offer, and a premium of 39.5% to the highest closing price in the last 12 months.

Minority resistance

Yet, it has not impressed SC Global's second-largest shareholder, Wheelock Properties. On Dec 13, Wheelock said it had bought 1.066 million shares in SC Global in the market at just under S$1.81 a share. With the purchase, Wheelock's interest in SC Global edged up to 16.09% from 15.9%. "In our assessment, the current share price represents a discount of some 40% to 50% of RNAV [revised net asset value], and we would be unable to buy property assets directly at anything like these prices," Tan Bee Kim, senior executive director at Wheelock, says in a statement.

Is Wheelock preparing to make a counter offer for SC Global? Analysts say it is unlikely. For one thing, Cheong holds a commanding majority stake of 60.74%. "It is quite likely that Wheelock just wants to elicit a higher price from Simon Cheong," Gregory Yap, an analyst at Maybank Kim Eng, tells The Edge Singapore.

Indeed, Wheelock has been a victim of SC Global's poor share price performance in recent years. It purchased a block of 51 million SC Globalshares in 2007 at an estimated S$2.269 a share, according to Maybank Kim Eng. In 2011, it wrote down the value of this holding to S$1 a share. Wheelock now holds a total of 66.5 million shares in SC Global.

Shares in SC Global are now trading at S$1.915, preventing Cheong from raising his stake in the company at his offer price of S$1.80. But the standoff has also left minority investors in something of a bind. Should they hold out for a better offer from Cheong? Or, should they sell in the market now? More generally, are minority investors such as Wheelock being squeezed out of a company that could be worth much more if it were run differently?

Sitting on its assets

SC Global is not the only company that has to comply with the QC rules. Wheelock, for instance, faced the same situation with its Orchard View development. Yet, it avoided having to pay any penalties because it did not insist on sitting on unsold units. To deliver earnings to its shareholders, the company progressively lowered its selling prices and eventually sold all 30 units at the development. The selling price averaged S$2,845 psf when the entire stock was sold at end-3Q2012, according to its filings.

Recently, other public-listed developers have been cutting prices to move their unsold properties too. According to URA statistics, CapitaLand sold 133 units at its D'Leedon development at a median price of S$1,431 psf in November, somewhat lower than the median transacted price of S$1,519 psf for the year.

SC Global could still realise huge margins on its unsold units even if it chose to cut its prices. The company paid only S$382 million for the land for its Hilltops project, S$266 million for The Marq and S$68.7 million for Martin No 38. Maybank Kim Eng's Fok says SC Global's pre-tax margins are 62.1% for The Marq, 52.1% for Hilltops and 36.1% for Martin No 38. As at Nov 30, it had 195 unsold units at Hilltops, 33 at The Marq and 21 at Martin No 38.

Wouldn't shareholders of SC Global be better off if it quickly converted these unsold units into cash to avoid being hit with QC penalties? Wouldn't a steady stream of earnings and cash flow provide more support to its shares than an unrealised RNAV?

Fok says SC Global is simply not prepared to cut the lofty prices it has set at its developments. Nor will it consider generating temporary cash flow from them by putting them up for lease. "We've asked SC Global in July whether they've considered renting out, but they are not [keen] to rent out units, as renters normally leave the units in pretty bad shape, thus making it difficult to sell afterwards," says Fok.

Instead, SC Global is adamant about holding on to its unsold units. "They believe property development is a long-term business," Fok adds. "They are not concerned about the short-term volatility they may be facing."

Donald Han, a consultant at HSR, says it would indeed be a problem for SC Global to mark down its unsold units because of its positioning at the very top end of the residential property market. The Marq, for instance, differentiates itself by offering buyers a rarefied lifestyle. "You want to make sure that your project has the ability to hold values over time. If you cut prices, it sends the wrong signal, especially to the people who bought earlier," says Han.

However, if developers of high-end properties really want to move their unsold inventory, they would be able to easily find bulk buyers by offering discounts of 10% to 15%, according to Han. "The real estate investment trusts [REITS] are not buying residential properties because the rental income is a paltry 2%, but private funds are interested. There are Malaysian investors in the market and they would buy at a 10% to 15% discount," Han says. "But developers are not willing to give even 5%."

Han adds that the rental market for luxury residences is still very strong. "There is only a small number of such properties on the market. If they released in batches, it is not a problem to rent them out," he says.

What should investors do?

Even if Cheong succeeds in avoiding the QC penalties by taking SC Global private, his future developments will be affected by a new set of rules that require all developers to complete and sell their properties within five years. These rules supersede the QC requirements. So, it seems unclear how he is going to avoid selling his properties at a much faster pace in future.

For now, Cheong's offer might be the best chance minority investors have of realising the value of their shares for some time. Maybank Kim Eng's Yap does not expect any other bidders to emerge for SC Global because of the huge stake that Cheong already owns. But he is betting that Cheong will eventually sweeten his offer to satisfy Wheelock.

How much will Wheelock manage to squeeze out of Cheong? "My estimate is between S$2.10 and S$2.50," Yap says. "It is a conservative number based on a 30% to 40% [discount to] the street's RNAV." Maybank Kim Eng's own RNAV estimate is S$4 a share.

This story first appeared in

The Edge Singapore weekly edition of Dec 24-31, 2012.

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