Source: The Business Times
As an investor, you could have all the numbers and all the facts, be completely right in your investment thesis, and yet, still lose money. The property recovery story was perfect, the stars were all aligned, and yet, in less than 24 hours, whatever bullish investor sentiment was eviscerated. It was just last week where The Business Times published the article above, re-reading it now reminds me of the quote: “Man plans. God laughs”.
There is enough well-written coverage on the latest round of cooling measures so I will not be covering it in this article. What I will do, is to discuss the investment merits and valuations of APAC Realty and Propnex.
APAC was listed in Sep 2017 at $0.66 per share with a market cap of $205.3m.
Propnex was listed in Jun 2018 at $0.65 per share with a market cap of $240.5m.
- There is currently a huge valuation gap/mispricing between Propnex and APAC.
- At $0.585, Propnex is trading at 13.3x FY17 P/E with a market cap of $216.5m.
- At $0.605, APAC is trading at 7.5x FY17 P/E with a market cap of $195.2m
- Propnex is trading at a 77% premium to APAC despite inferior fundamentals.
- APAC is trading at a 44% discount to Propnex despite superior fundamentals.
- The pair should trade at a closer valuation given no unique competitive advantages of either company.
- Either Propnex is overvalued or APAC is undervalued.
- Biased towards Pronex being overvalued.
- Catalysts will be 2Q & 3Q results, and end of Propnex’s moratorium in Jan 2019.
Unbelievable Valuation Gap Bound to Narrow
The valuation gap between APAC and Propnex was narrowing the first few trading days post-Propnex’s IPO. Even during the day after the cooling measures, the valuation gap did not move much. The next week, however, the gap spiked to 78% and ended above 76% at last close (13 July 2018). Plausible reasons for the persistent mispricing could be due to share purchases by the stabilizing manager and insiders (discussed further below) of Propnex.
With reasons I will substantiate in the rest of the article, I posit that the valuation gap will narrow over time and that APAC should trade at a premium compared to Propnex.
Propnex’s Stabilising Manager Out Of Bullets
In just two days, UOB Kay Hian, the stabilizing manager maxed out the total number of shares it can repurchase from the open market amidst the aggressive selling. On 9th July (2nd day), Propnex’s shares closed 14.6% higher. If you look at the total market trading volume of that day, 42% was attributed solely to UOB Kay Hian. If it were not for the stabilizing manager, shares of Propnex would certainly be trading at much lower levels.
Propnex’s Insiders Propping Up Share Price
The day after the stabilizing manager ran out of bullets, the insiders joined the fray by buying up shares in the open market. In 4 trading days, they have since repurchased a total of 2.05m shares between $0.575-$0.590. I am not certain how long the insiders can/will continue doing so but I am certain they cannot do it forever.
Propnex’s Moratorium To End In Dec 2018
The price chart above belongs to APAC. One interesting point to note is that the end of APAC’s moratorium on 27 Mar more or less coincided with the beginning of its downtrend. Perhaps Propnex might experience similar price action when its moratorium ends on 1 Jan 2019. Then again, correlation does not mean causation.
Absolute Revenues & Net Profits – APAC beats Propnex
Based on the latest audited financial statements of APAC and Propnex, you can see that while Propnex is marketed as the “largest real estate agency in Singapore”, APAC delivered higher revenue and net profit.
Revenue stream diversity – APAC beats Propex
Source: Propnex Prospectus
Source: Propnex Prospectus Page 58
Source: APAC Annual Report 2017 Page 6
In the front coloured pages of Propnex’s prospectus, it showed that it has four core business segments namely: 1) Real Estate Brokerage, 2) Training, 3) Property Management, and 4) Real Estate Consultancy. However, if you turn to page 58 (non-coloured) of the same prospectus, you find that Real Estate Brokerage accounted for a whopping 99.1% of FY17 revenue. Training and Property Management accounted for only 0.3% and 0.6% respectively. No revenue was attributed to Real Estate Consultancy. Since when does a zero to sub-1% of contribution to revenue become recognized as a core business segment? The fact that Propnex showed glamour in the front pages of the prospectus but hid the specific figures 58 pages into the ponderous tome makes me feel uneasy.
APAC, on the other hand, provided a clear breakdown of its gross profits in its 2017 Annual Report on page 6. In FY17, 84.9% came from Brokerage while 15.1% came from Non-Brokerage.
While both Propnex and APAC are heavily reliant on brokerage as a revenue driver, it appears that the latter has a more diversified revenue stream compared to the former.
Geographical Presence – APAC beats Propnex
Source: Propnex Prospectus
Source: APAC Annual Report 2017
As at 6th June 2018, there are 7,248 Propnex agents in Singapore. As at 25th April 2018, there are 6,100 APAC agents in Singapore. While Propnex is the largest in Singapore by agent count, APAC beats Propnex when it comes to geographical presence.
While Propnex is still in discussion to expand to Vietnam, APAC had already done so last year and now has 308 agents there. Also, compare the numbers for Malaysia and Indonesia, APAC has more agents there as well. APAC also has agents in places Propnex has not even been/considered yet (Korea, Japan, Taiwan, Cambodia).
Propnex may be the largest real estate agency in Singapore with over 7,000 agents, APAC is the largest international real estate agency in the Asia-Pacific region with 17,500 agents.
Ratio Analysis – APAC beats Propnex
Source: Company Prospectus and Annual Report
The charts speak for themselves, in terms of gross profit margin, operating profit margin, net profit margin, APAC beats Pronex. This is despite the fact that APAC incurred a one-off IPO expense of $1.2m; if not, operating margin and net profit margin would be higher.
In terms of financial position, both companies are on par, net cash position is approximately 30% of their respective market caps. I have not factored in the yet-to-be-completed Toa Payoh property purchase for APAC.
No smoke without fire – Propnex & DWG in recent news for the wrong reasons
Source: The Straits Times
Source: The Straits Times
Source: The Straits Times
Source: The Business Times
Corporate governance is a crucial determinant of the long-term sustainability of any enterprise, the recent Midas saga is a great testament to that point. A simple google search on recent news related to Propnex and APAC would raise red flags on the corporate governance and business practices regarding the former. Hence, it seems like Propnex is more exposed to compliance and reputational risks which may translate to fines or loss in brokerage revenue, both of which would hurt valuations.
DBS downgrades APAC to fully valued, TP $0.66 (from $1.22, -46%)
Source: DBS Group Research
After the cooling measures were announced, DBS promptly downgraded APAC to fully valued from a buy, revising TP to $0.66 from $1.22 (-46%). One salient point in the report is how highly sensitive APAC’s revenue is towards private transaction values/volumes. From DBS’ financial model, a -5% decline in FY18F private transaction value would result in earnings to fall by 23%, almost a by a factor of 5x. The report ended by valuing APAC at 10x forward P/E based on FY18F EPS of $0.0657; this implies a historical FY17A P/E of 8.2x based on FY17A EPS of $0.0803. Using the same valuation multiple on Propnex, the implied target price is $0.36 based on FY17A EPS of $0.0440, representing a 40% downside.
In my opinion, the report is too optimistic. More specifically, the -5% forecasted drop in private transaction value is too optimistic and that we should be expecting low-to-mid-teen percentage (e.g. 10-15%) declines instead. Also, it is quite hard to justify paying 10x forward P/E when you are facing significant negative earnings growth in the near term and the everpresent regulatory risk. Here are two reasons why:
Firstly, the property developers have been backloading their project launches into 2H18 so as to maximize selling prices amidst the euphoria. Given the new cooling measures, property developers may not be able to sell the bulk of the units as easily and quickly as they would have hoped.
Secondly, according to a Colliers report published on 10 July 2018 [Click here], it expects/states the following:
- New home sales to decline significantly in the initial few months as the market takes stock of the potential implications.
- The last two rounds of cooling measures announced in Jan 2013 and Jun 2013 caused new home sales to drop 65% in Feb 2013 and 73% in Jul 2013 respectively.
- For the whole of 2018, it expects new private home sales (excl. ECs) to be 15-20% lower compared to 2017.
- It also expects developers to delay launches as they adjust strategies after the implementation of the new measures; inventory may take a longer time to sell.
- Collective sales to cool and land rates to drop as developers take into consideration the higher ABSD and 5% upfront tax.
- Tighter LTV limits to slow demand; expected to delay home-buying even for some genuine owner-occupiers.
Source: Monetary Authority of Singapore
Given the fact that DBS was the Issue Manager and Underwriter for APAC’s IPO, it may be predisposed to be more upbeat of APAC’s prospects.
RHB maintains APAC at a Buy, TP $0.77 (from $1.35, -43%)
RHB took a bit more time to downgrade APAC’s TP by 43% to $0.77. While the broker has a more bearish view on the property transaction values (-10% in 2018, -5% in 2019), its financial model suggests less sensitive impact on APAC’s bottom line.
RHB’s TP of $0.77 is DCF-derived using a WACC of 8%. While APAC is a cash flow generative business, it is a cyclical one. Cyclical businesses’ cash flows are hard to forecast due to economic cycles. As such, the reliability of using the DCF method on a cyclical business such as APAC is limited. Furthermore, besides cyclicality, APAC exposed to above-average regulatory risks, which should warrant a higher WACC (i.e. above 10%). This should bring TP down a third to approx. $0.52. In addition, the DCF model seems to have left out the $72.8m acquisition of the commercial property in Toa Payoh. If and when completed, APAC will be in net debt position and have negative free cash flow in FY18, both of which will further reduce the DCF derived TP.
- Property transaction volume declines more than expected (Short-term risk)
- Additional cooling measures imposed by the Singapore Government (Short-term risk)
- Brokerage commissions to fall from disruptive technology (Long-term risk)
- Similar to the stock brokerage industry where trades are now executed mainly online (min. $10) and not through brokers (min. $40)
To conclude this article, no premium should be accorded to any market leader(s) whose profitability is so highly dependent on the regulatory climate. APAC/Propnex does not have any pricing power and its profitability/valuation rests upon the whims of policymakers. Case in point, APAC’s valuation by DBS was cut by half in less than 24 hours despite clear and strong fundamentals. In this kind of operating environment, there is little management can do to value-add.
APAC is superior to Propnex in terms of absolute revenues & profits, revenue diversity, geographical presence, profitability margins, and valuations. APAC should trade at higher valuations than Propnex, but we have the opposite right now. I believe that over time, as both companies report their quarterly financial results, the market will adapt and the pair will at least trade at the same valuation multiples.
Alternatively, if possible, since Propnex’s shares are valued at a 13.3x P/E, it should just buyout APAC (valued at 7.5x P/E) from the latter’s controlling shareholder, Northstar, which is a private equity firm. The deal will be instantly earnings accretive and solidify Propnex’s position as number 1 in Singapore.
Disclaimer: I am not vested in either company. But if I had to choose one, I would certainly go for APAC.