Friday 5 September 2014

Centurion Corporation: Completion of Acquisitions of UK Student Accommodation

On the 2nd of September, Centurion has finally completed the acquisition of four student accommodation asset for the total price of £77 million (S$157 million). This is significant as this represents an increase of 37% of the company's long term assets. It may then strange that I did not mention this is my prior post. This is with good reason.

When you are short a company which is planning to make extremely poor capital allocation decisions and at the same time signals weakness is its existing business, you keep quiet and let it do it. 

The acquisition of the four UK student accommodation is significant in many ways:

1) Leverage.

With a S$68 million cash balance, Centurion must finance the acquisition with debt. The announcement of the acquisition stated that the company would tap into its S$300 million 5.25% Multicurrency MTN program and borrow S$100 million. 

Using a listed UK student's accommodation company, Unite Group, as a proxy to determine EBITDA/Assets margin, Centurion should generate an additional S$10.5 million in EBITDA. I believe this estimate is aggressive as this assumes that Centurion has not overpaid on its acquisition and that they are as efficient run as Unite-Group. 

From this, Net Debt/EBITDA would rise from 7.2x to 9.2x, Interest Bearing Debt/EBITDA would rise from 2.7x to 4.5x, and EBIT/Interest Expenses would drop from 4.4x to 3.0x. This adds tremendous pressure to the company.

For a company that is trading at an adjusted net income of 47x, every incremental risk unit adds an increasing amount of pressure on valuation.

2) Inability to renew Westlite Tuas

Centurion's Westlite Tuas lease is soon to expire in 2017. Using a recent BCA tender as a proxy, expected cost of renewal of a 9 year lease would be S$150 million*.
*This assumes a cost of $161.5/bed/month. 

With Centurion's current financial situation as stated out in 1), Centurion likely would not be able to finance their Tuas dormitories, UNLESS, the company puts the financial health of the current company in jeopardy (Another S$100 million would bring Interest Bearing Debt/EBITDA to 8.4x from 4.5x) or the company issue equity (which would be dilutive to existing shareholders).

Given the situation, Centurion would most likely lose a significant portion of its earnings when the lease runs out. This is what I believe to be the most likely scenario. Given that the majority portion of Centurion's earnings is derived from their Singapore portfolio, and the Westlite Tuas dormitory is estimated to be over 35% of the Singapore portfolio returns, I expect the damage to be material. Putting further pressure on valuation multiples.

However, on a positive note, I was informed that my adjusted net income and EBIT is inaccurate in my previous post as I did not normalize net income for upcoming projects such as the Westlite Woodlands project. However, the effect of such would not offset much of the damage caused by the Westlite Tuas expiry.

3) Decision to acquire

It seems strange to me that the company's management would divert their attention from their apparently highly profitable and growing Singapore workers' dormitories business to the UK student accommodation market, which is mature and competitive. This is likely due to a couple of reasons: A) The company is an operator of workers' dormitories, not a construction company. They are restricted by the number of workers' dormitories available for acquisition in Singapore and it seems that they have ran out of options. B) The prospects of the workers' dormitories market is likely not as attractive as once sought out to be. The market has virtually no barriers of entry, and has high replacement cost. A combination of the two would result in margin compression and low EBIT margin.

As a result, growth rate embed in valuation seems ever more detached from reality.

4)  A sign of euphoria

Unite-group, which uses the same, if not more conservative, accounting method as Centurion trades a ~1.0x book value. This makes sense as Unite-group basically did the valuation work for investors.

However, when the acquisition was proposed by company's management, stock price rose from 47.5c or 1.37x book value then to a high of 76.0c or a ~1.8x book value. This seems illogical as 1) Centurion has the same, if not more aggressive, accounting policy as Unite and 2) If a significant portion of your assets is going to have a comparable which is trading at 1.0x book value, it doesn't make sense to me for multiple expansion. I believe this is a sign of euphoria.

All in all, I believe this company is a good short with a bull case of 42c per share. However, as the company is actually destroying value in growth as said in my previous post, and has a balance sheet with growing leverage, I believe the bear case is much more compelling.

4 comments:

  1. how did you arrive at the figure of 42c?

    ReplyDelete
    Replies
    1. Read my previous post for more details. But the summary is as such: If you have a company that destroys value in growth, the best case scenario is if the company do not attempt to grow. In addition, if the mtm accounting is reliable, the book value shld be the proxy for a no growth, asset based company.

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