SPH operates as a media company doing publishing and distributing of newspapers, magazines, books in print and digital version. But this industry is facing a structural decline due to technological shifts and changing consumer behaviours. Gone are the days when they used to be a monopoly. Information is now consumed anywhere and everywhere on the internet.
In the past, they used to earn big from advertising revenue on papers, but nobody does that now. Businesses are turning to digital marketing, Facebook marketing and the likes. Consumers’ attention has shifted offline to online. Even when SPH attempts to go aggressive on digital, it doesn’t seem to do much to lift their declining earnings.
Here is a quick look at their financials over the past 10 years.
Most of the other companies have made a strong recovery after the 2008 financial crisis. Not for SPH. Their revenue, operating income and net earnings have been dropping year after year. The business model is obsolete. If SPH does not pivot, it would be possible we see another Kodak or Nokia.
Here is a breakdown of SPH’s revenue over the past 10 years.
(The “Others” segment refer to aged-care, events and exhibitions, education businesses and categories that are not related to media and property.)
It is clear that the media segment is falling drastically. That’s why SPH has been engaged in an acquisition spree of all sorts. They have malls, properties, condominiums, education, aged-care and recently student accommodation. This is done to offset the decline in revenue from media.
Origins of SPH’s Aged-Care Business
SPH’s venture into the healthcare sector starts with Orange Valley. They have a subsidiary, Orange Valley, which is a nursing home provider that they acquired in 2017 for $164m. With a net asset value of $71m, SPH is paying 2.3x book value and the deal was done in full cash.
Orange Valley runs five nursing homes in Singapore with more than 900 beds. They are charging a premium price of around $2500 – $2700 for each bed and the company is in a profitable stage at the time of acquisition. The reason for this deal is because SPH expects the healthcare ageing sector to grow over the next decade due to a growing ageing population.
In 2019, they partnered with a real estate asset management firm, Bridge C Capital, to set up a fund that invests in aged care and healthcare assets in Japan. SPH invested seed equity of up to $50m in this deal and Bridge C Capital offered its expertise on deal sourcing of properties in Japan.
SPH’s Aged Care Venture into Japan and Canada
More recently in Feb 2020, SPH made another two acquisitions to expand its aged-care business.
The first acquisition is five aged care assets in Japan for $65.8m, paid in full cash. Three of them are located in Hokkaido, one in Tokyo and another one in Osaka. These healthcare properties have 365 beds in total and they offer community-based activities, laundry, meals and care services. This acquisition was part of the partnership they entered into with Bridge C Capital.
The second acquisition is a portfolio of assets in Canada for $244.5m. The portfolio consists of six five properties in Ontario and one in Saskatchewan. There is a total of 717 suites and the properties provide independent and assisting living accommodation for the seniors. Managed by Hawthorn Senior Living, these properties have occupancy rates of > 90% over the past three years. The $244.5m is funded by a mix of debts and internal funds.
Management rationale for acquiring healthcare assets is to build up a defensive and recurring income that is resilient in times of economic downturns. At the moment, the earnings from aged care contribute to a very small % of the group’s business.
The “Others” business segment makes up only 9% of FY 19 total revenue and aged care is just one portion of “Others”. They want to expand the group’s recurring income base and they might be doing more aged-care acquisitions in the months or years ahead.
Is Acquisition a Good Idea?
Interestingly, the dean of valuations, Aswath Damodaran, has a blunt message for companies considering an acquisition: “Don’t do it.”
He stated the best way is to grow organically, from its core product or service. Apple is one good example. They are laser-focused on iPhone and iPad for 10 years. The second most effective way is through expansion into new markets. The third is to grow and expand the current market share. The very bottom of the barrel is acquisition.
He stated that acquiring companies tend to overpay by a lot. In a study conducted by KPMG, more than half of the acquisitions have no synergy and a third of them even have reversed synergy. Companies with 20 years of hard work are destroyed with one bad acquisition. OSIM’s acquisition deal in Brookstone for $450m is one perfect case study. The acquired target eventually filed for bankruptcy.
But what options does SPH have? Growing organically doesn’t work as they are in a declining industry. Expand or maintain current market share? There isn’t even a big market to begin with. SPH is now resorting to acquisition to grow the company. For the better or worse, time will tell.
How are the deals going so far for SPH?
As for the recent acquisitions in Feb 2020, there are no financial data available and impairments are usually done on an annual basis. It would be premature to tell whether they are overpaying or underpaying.
Meanwhile Orange Valley was acquired in 2017. As of FY 2019, SPH recognised an impairment charge of $22.1m on its aged care business. The carrying value of goodwill in Aged Care has declined from $78.8m in 2018 to $57.4m in 2019. This is due to the increase in build-own-lease (BOL) nursing home bed capacity coming on stream.
BOL is a model where the Ministry of Health (MOH) would build the nursing homes and selects an operator through an open tender. An increase in BOL means the supply of nursing homes in the market has increased. The auditors from KPMG came up with some assumptions and calculate that the future cash flow from Orange Valley is not as high as what was projected.
The supply of new nursing homes would probably reduce occupancy rates and earnings for Orange Valley. As a result, the goodwill of the business should be reduced and an impairment cost has to be recognised on the income statement. Do you think SPH paying 2.3x NAV or $164m for Orange Valley is a good deal?
Competition of Nursing Homes in Singapore
The impairment sums up the potential threats of Orange Valley and SPH’s aged-care business. Even though the aged-care industry is in high demand and the population of aged 65 and above would double to 900,000 by 2030. It is a space that is largely dominated by charities, government, Voluntary Welfare Organisations (VWO) and non-profit organisations.
The private sector takes up only a small portion of the market share in Singapore. Though Orange Valley is one of the largest nursing home providers in the private space.
The other few private nursing home providers is Econ Healthcare Group, Pacific Healthcare Holdings and United Medicare Centre. Econ Healthcare has 11 Medicare centres and nursing homes in Singapore and Malaysia. Pacific has two in Singapore. United Medicare has 3 centres and 689 beds in total. Orange Valley has 5 nursing homes and over 900 beds.
The Ministry of Health (MOH) has also extended subsidies to elderly people who are admitted into accredited private nursing homes that meet the criteria. There are some branches from Orange Valley that are eligible for the subsidies. This would level-off competition as the subsidy scheme does not favour VWO over private ones. Some non-profit nursing homes are not eligible because they are funded through their fund-raising efforts. It is a mix of both rather than VWO vs private.
Sustainability of Acquisitions
How about the question of acquisitions? Are they sustainable? That is probably the key question to ask as an investor. Most of its aged care acquisitions are paid in full cash. Except for the portfolio of healthcare properties in Canada, which was paid with a mix of internal funds and debt. How much cash do they have?
They have a billion dollars of cash as of 2020! That is a huge pile of war chest to be deployed. Looking back at the past healthcare acquisitions, it seems that the amount paid pales in contrast with the amount of cash they have in their balance sheet.
Their debt to total capital is also quite conservative at 30%. EBIT to interest expense and EBITDA to interest expense are 4.8x and 5.5x respectively. Traditional analysts use an interest coverage of <3 as a benchmark, Warren Buffet prefers 5 to be conservative. Both the current ratio and quick ratio are at 1.3x. While it all looks good, there is one important development to take note.
In 2019, SPH has announced that it will establish a $1b multicurrency medium-term note programme. On June 19, SPH issued $150m of perpetual securities with a coupon rate of 4.5%. On Nov 19, SPH launched another non-callable perpetual bond for $300m with a rate of 4% and a maturity term of 5.5 years. On Jan 20, they issued another 10-year bond for $500m at 3.2% and due on 2030.
SPH is starting to go heavy on debts to fund upcoming acquisitions of income-generating assets. The size of debt in its balance sheet has grown about 4x since 2009. Financing expenses will inevitably spike up and there are perpetual securities to factor in now when calculating interest coverage ratio.
Despite the Fed cutting rates to 0%, SPH is not able to enjoy the benefit from lower financing costs. This is because SPH REIT’s debt maturity profile comprised of 63.5% fixed rates and 36.5% floating rates. Furthermore, fixed rates made up more than half of its total debt from FY20 to FY22.
SPH has very weak earnings from media and they rely highly on properties such as SPH REIT. SPH liquidity risks would start mounting up very quickly if a property crisis comes and their ventures into other areas fail. Fortunately, they specifically chose defensive sector such as student accommodation and aged care to hedge again such volatility.
Latest Financial Performance
Let’s look at the 1st quarter of 2020. Only the property segment was up 19% but not enough to prevent the Q1 FY20 revenue from declining 4% as compared to Q1 FY19. Aged care which falls under Others has fallen 1.2% in revenue.
Profit before tax (PBT) has also fallen 10% from $75.6m in Q1 2019 to $68.3m in Q1 2020. You can clearly see their media business is showing no signs of recovery. Aged care and Others are up $2.3m. But the proportion of earnings is too insignificant to be a game-changer for SPH. The property segment seems to be the only profit driver here.
How about the previous 2 years?
Operating revenue from aged care is pretty much stagnant too. Revenue for FY19 was $66.5m and FY18 was $66.1m, a difference of $0.4m.
Based on the FY19 and 1st quarter FY20 results, we have not seen any strong growth catalyst coming from Orange Valley or aged care. With the recent acquisitions of aged care properties in Japan and Canada, the group will see an additional stream of cash flow coming into the “Others” segment for the next few quarters.
The recent acquisitions cost them about $310.3m in total. Assuming a cap rate of 5%, that would be an additional $15.5m in property income from the newly acquired assets.
Once again, you see the recurring financial trend of flattish performance from “others”, deteriorating performance from “media” and a strong performance from “property”.
Can SPH REIT save SPH?
Speaking of SPH REIT, despite their net property income increased by 23.3% for Q2 2020, DPU fell sharply by 79% as the earnings are likely passed back to tenants in the form of rental reliefs.
Furthermore, SPH REIT has a weak spot in Paragon. Tenants are going to be hit harder as compared to essential services tenants in the suburban malls. Fortunately, only 2% of leases are expiring in FY20. But we are seeing about one-third (29%) of gross rental income at risk of lease renewals in FY21. Singapore Tourism Board (STB) has projected a 25 to 30% drop in visitor arrivals in 2020 due to Covid-19. So I expect weaker tenants to go bust and occupancy rates would fall further.
For UK student accommodation, it looks like this segment is not as defensive as everybody thought. Universities in the UK have now moved to online teaching for the remainder of the academic year 19/20. All the payments made by students are now refunded back to them. Just recently on 11 Mar 2020, SPH spent $18.9m on asset enhancement for UK accommodation portfolio.
Lastly, the worst nightmare for SPH is a real estate market meltdown. This is the pin that will pop SPH’s lifebuoy. The property market is a lagging indicator as a recession usually starts from the bond market followed by stocks and lastly properties.
The downgrade of property valuations would lead to a drastic drop in net asset value & negative rental reversions. Cash flow might start dwindling and let’s not forget that SPH has issued huge amounts of debts, bonds and perpetual for acquisitions. Alternatively, the bullish scenario that could potentially play out might be SPH acquiring massively undervalued properties during this period of recession. They dispel all doubts, emerge as a larger Singapore Property Holdings company and all short positions are liquidated.
Dividend Performance of SPH
Using FY 19 dividends paid and the last trade price of $1.88, SPH has a dividend yield of about 6.4%. Is that a good bargain? Let’s check out the history
There is hardly any margin of safety between their cash flow and total dividends paid. The cash flow from operations or free cash flow if you wish to be conservative, threads very closely along total dividends paid. What this means is that they are using all its earnings to pay shareholders.
The Future of SPH
It is clear that their core media business is becoming less relevant and financial performance is deteriorating. To offset losses from media, they made a pivot into the property segment to generate a stable and recurring source of cash flow.
If you look at the history of many companies, a capital outflow to other non-core business is a sign of a crumbling business. They are pumping air into a lifebuoy now and this lifebuoy is property. But are all these properties doing well? That is a crucial question to ask since this lifebuoy determines whether SPH survives or drowns. Here are some updates on the latest news due to the Covid-19 measures,
- SPH REIT’s 2Q DPU plunges 79% to 0.3 cent
- Student accommodation expects a loss of $7m – $14m from refunds made to students
- Termination of Acquisition of S$245m aged care assets in Canada
- SPH Directors and Senior Management to take pay cuts
Firstly, I think there is a high chance that dividends would be cut in the next few quarters. I would be very surprised if this doesn’t happen. The payout rate right now is simply unsustainable, even before the Covid-19 event. Most senior management across all companies are starting to take pay cuts to offset revenue losses. The next line of defence will be the shareholders’ dividends. This is to save tenants and save themselves.
Next, their proposed acquisition of aged care assets in Canada has been scraped off due to Covid-19. It could be good or bad news depending on how the valuation of properties plays out during the recession.
This is a tricky one for SPH. It would be a big test for SPH management to see if they can tide through the Covid-19 crisis as well as establishing a rejuvenating business in the long run.