Newsletters

Swire Pacific ‘B’ was AGT’s largest detractor over the month, reducing returns by 50bps. The primary culprit was a falling NAV (-16%), with underlying holdings Swire Properties (69% of NAV) and Cathay Pacific (12%) returning -21% and -14% respectively. Swire Pacific has significant exposure to Hong Kong, which has been badly affected over the past year by civil unrest and lockdowns. Fuel was added to the flames recently by the Chinese government’s imposition of the National Security law, achieved through a controversial circumvention of the Hong Kong legislature. This sparked further debate on the possible cessation of Hong Kong’s special relationship with the US and fears of how this would impact the HK economy and currency. Key asset Swire Properties has an estimated 64% of its NAV in Hong Kong properties, which have been badly affected by falling tourist numbers from mainland China, disrupted retail activity, and lower office activity. A further 32% is exposed to mainland Chinese properties, which have also been affected by lockdown regulations. We estimate that Swire Properties trades at a 62% discount to its sum-of-the-parts NAV.

Troubled flag carrier Cathay Pacific – which has suffered from the triple whammy of falling tourist numbers, being the subject of the Chinese air regulator’s ire for not sufficiently disciplining staff that took part in demonstrations, and lockdowns –announced a recapitalisation plan following the month-end, aiming to raise HKD39 billion (GBP4 billion) through theissuance of preference shares, a 7-for-11 rights issue, and a loan facility from the Hong Kong government. The Hong Kong government will own 6% of Cathay following the recapitalisation; this is the first time that the government has directly interceded to aid a business since the 1980s, highlighting the exceptionally acute nature of the crisis.

At the time of writing, Swire Pacific ‘B’ shares trade at a wide 55% discount. However, valuing Swire Properties at NAV, puts the ‘B’ shares on an extraordinary look-through discount of 77%. The stub value of the ‘B’ shares (market value less Swire Properties plus debt) is negative HKD9 billion.

Swire Pacific was the second-largest detractor over the month, reducing returns by 66bps. A combination of NAV declines (-7%) and the discount widening from 42% to 46% resulted in share price returns of -14%. The civil unrest in Hong Kong has continued to weigh on the company. Key holding Cathay Pacific (11% of NAV, -8% share price decline) spent an uncomfortable amount of time in the headlines. CEO Rupert Hogg and COO Paul Loo stepped down from their roles, a move which appeared to appease the Chinese Aviation Authority which had previously questioned Cathay’s commitment to safety and security. These moves came after Swire Chairman, Merlin Swire, visited Beijing with the obvious read-across being that he was told to resolve the situation swiftly. While appeasing the Chinese authorities reduces pressure in the short term, it remains to be seen what effect this policy of acquiescence will have in the long-term – not just on Cathay, but on businesses across the board in Hong Kong if senior management need to be “approved” by the Chinese. Following these departures, Swire Pacific further attempted to draw a line under the sand as Chairman John Slosar stepped down at the beginning of September after comments made at the interim results were construed as being supportive of the demonstrators.

Swire Properties (74% of NAV, -9% share price decline) has been at the epicentre of the recent demonstrations, with its large Pacific Place mixed-use scheme located beside Admiralty, where the protests originally took place. Indeed, demonstrations led the centre to lose some trading time to closures. The demonstrations have had and will have a big impact on this scheme. Tourist numbers are down significantly (-50% according to some reports), reducing retail spending in their high-end retail exposure at Pacific Place. Decreased tourist numbers will also have an impact on the hotel occupancy here with Swire managing and leasing numerous hotels at Pacific Place. The extent of these problems will be revealed in results for the third quarter.

The ‘B’ shares still ascribe an efficient-market-hypothesis-busting negative valuation to the ex-Swire Properties businesses. While this situation has now persisted for well over a year, it seems unlikely the family will let this persist indefinitely, with half their economic holding in Swire Pacific held through the ‘B’ shares.

Swire Pacific was the largest contributor over the month, adding 57bps
to returns. The share price returned +9%, with a NAV return of +6%,
buoyed further by a tightening of the discount from 46% to 44%. Swire
Pacific’s two major listed holdings – Swire Properties (77% of NAV) and
Cathay Pacific (12% of NAV) – posted share price returns of +7% and
+4%, respectively.

Swire Properties had a particularly strong 2018 which was reflected in
its results for the year. Realisation of several large assets and fullyfunded
developments for the next phase of growth led the company to
increase its dividend by 9%. Trading on a 35% discount to its own NAV,
Swire Properties offers compelling value. Elsewhere in the portfolio,
Cathay Pacific posted a HKD2 billion profit for FY2018 (the first since
FY2015), harvesting the first fruits from its turnaround program intended
to help lower its cost base while still retaining its premium brand.
Increased competition from low-cost Chinese carriers remains a threat,
but the recent proposed acquisition of Hong Kong Express should help
address this.

We view Swire Pacific B shares as being fundamentally undervalued:
the ‘B’ shares trade on a 44% discount to NAV (or a ‘look-through’
discount of 60% when we factor in Swire Properties’ 35% discount); on
a 22% discount to the A shares; and have a negative stub value. In
other words, the market is ascribing a negative value to the nonproperty
assets in Swire Pacific – which we view as extraordinary, given
the quality of its underlying assets. We remain excited about the
prospects for future growth.

Swire Pacific contributed positively over the month on the back of a +4%
increase in its share price, with losses at the NAV level comfortably
outweighed by discount narrowing. We have long believed that the large
discount and implied negative stub value of the ex-Swire Properties assets
were unlikely to persist indefinitely, and that the company would feel
compelled to address/take advantage of the situation. With an overhaul of
the Board in 2017 and the appointment of Merlin Swire as Chairman, we
thought a more robust and active capital allocation strategy would be
forthcoming to drive performance and close the discount. Evidence of the
new approach came in June with the announcement that Swire Properties
(74% of NAV) had sold two properties, City Plaza 3 and 4 in Hong Kong, for
a combined HK$15bn. The sale price is well above the company valuation of
HK$9.3bn, and reflects an estimated gross rental yield of 3.1%. Swire
Pacific also announced the proposed privatisation of HAECO, the HK-listed
aircraft maintenance and service company. While HAECO is a relatively
small holding at just 5% of NAV, and details on future plans for the company
are yet to be revealed, this transaction and those at Swire Properties are
encouraging signs of the long-awaited more dynamic approach to capital
allocation.

We regularly discuss our active engagement with the boards and
management of investee companies in these monthly updates, but more so
in relation to closed-end funds than holding companies. This is
understandable given that our holding company investments are controlled
by family shareholders with our investment theses predicated more on an
alignment of interest than on our ability to effect change. Essentially, we see
the families and management of the holding companies as the activists
themselves, playing key roles in driving changes at their own investee
companies. That said, we often make recommendations to holding
company managers/families in our regular meetings with them, and usually
find them to be a receptive audience given our deep experience in investing
in structures likely to attract discounts. Two such meetings occurred this
month, with the management of Pargesa (Swiss-listed holding company
trading on a 34% discount to NAV) and Swire Pacific (HK-listed holding
company whose B shares, which we own, are priced at a 41% discount to
NAV). Both trade at discounts far in excess of their average levels, and we
can see several levers that management could pull to spark a re-rating.

Swire Pacific is a Hong-Kong listed holding company that has a majority of its
assets invested in Swire Properties, a listed HK developer that controls a
portfolio of high quality Hong Kong commercial assets. Swire Pacific also owns a
stake in Cathay Pacific as well as a wholly-owned beverages business. Like many
Asian companies it has had a weak year and particularly so over the summer
when its share price fell by 20% in August alone. Its discount to NAV has also
widened over the period and today stands at 47% on the basis of Swire
Properties (listed and 68% owned by Swire Pacific) being valued at NAV. We
own the B shares, which trade about 8% cheaper than the As and could benefit
from the recent decision by the HK stock exchange not to reverse a ruling
disallowing dual share classes. This could see a merger of the two share classes.