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Frasers Commercial Trust (FCOT) is offering its unitholders the opportunity to subscribe to a Convertible Perpetual Preferred Unit (CPPU) for every 20 FCOT units they hold. Should you take up the offer?
What are Convertible Perpetual Preferred Units?
The Convertible Perpetual Preferred Unit (CPPU) is a kind of a hybrid security with elements of equity (the convertibility feature) and debt (the preferred feature).
In the case of Frasers Commercial Trust (FCOT)?s CPPU, it can be converted into units of the FCOT Reit.
FCOT's CPPUs are ?senior? in that they rank higher than ordinary FCOT Reit units when dividends are distributed at the end of each financial period. CPPUs however do not carry voting rights. They are thus similar in this aspect to preference shares or regular bonds.
How does the FCOT CPPU work?
Each CPPU, priced at $1, can be converted to units of FCOT, from 26 Aug 2012 onwards. The conversion price has been fixed at $0.2369. Therefore, each CPPU can be converted into 4.22 FCOT units.
Why would anyone want to pay $1 for a CPPU and then $0.2369 to pay for a FCOT unit which costs only $0.15 now?
CPPU holders would in theory be able to convert to FCOT units at $0.2369 (the strike price) even if an underlying FCOT unit rises to $0.30 (market price) in the future. In this scenario, CPPU unit holder?s profit is thus the difference between the strike price and the future market price.
At conversion, CPPU holders need not pay more to convert their CPPU to FCOT units.
If the future market price remains below $0.2369, CPPU holders are not obliged to convert their CPPUs, but can continue to enjoy the 5.5% annual yield.
Why did FCOT issue CPPUs in the first place?
FCOT was highly leveraged, when the financial recession of 2008/08 hit. In lieu of cash, CPPUs were issued by FCOT to Orrick Investments, a subsidiary of Frasers Centrepoint Limited (FCL), as payment for the acquisition of Alexandra Technopark by FCOT in July 2009. Now FCL is divesting part of its CPPUs to other unitholders of FCOT.
FCOT is managed by Frasers Centrepoint Asset Management (Commercial) Ltd (the ?Manager?), which like Orrick Investments, is also a subsidiary of FCL.
Why is FCL selling the CPPUs?
As with most divestment decisions, FCL probably have other investment opportunities that are more attractive than the 5.5% yield from the CPPU. Offering the CPPUs to other FCOT unitholders is part of the exit strategy by FCL.
Do unitholders have the option to redeem the CPPUs?
No. As a ?perpetual? instrument, the CPPU do not have an expiry date and only the Manager have the option to redeem CPPU at the option price of $1 at a time of its choice.
What choices do CPPU holders have?
Until the Manager decides to redeem the units, CPPU holders may either:
- Hold the CPPUs and collect the 5.5% dividends,
- Sell the CPPUs on the open market or
- Convert the CPPUs into FOCT Reit units after 26 Aug 2012
Is the CPPU suitable for my investment profile?
The CPPU has elements of debt and equity. Its complexity is lower than that of warrants and higher than that of shares. It is probably not suitable for the typical Reit investors who may not be sophisticated enough to understand the mechanisms of convertibility and options.
What are some of the possible risks?
Being backed by the Frasers Centrepoint that is part of the Frasers and Neave (F& N) conglomerate, the CPPU probably carries low risks, some of which are as follows:
- CPPU?s yield of 5.5% is not guaranteed and may be less if FCOT?s distributable income falls below the threshold required to pay all CPPU holders.
- General inflation and interest rates may rise to such a large extent that open market prices for the CPPU may be severely depressed since the CPPU expected yield is a fixed 5.5% of the offer price.
- In the worst case, FCOT may collapse and funds from its liquidation may be insufficient to compensate for the principle put in by CPPU holders.
Is the FCOT CPPU worth investing in?
Yes, if you are an existing FCOT Reit unitholder who foresees a sharp decline in distribution income to FCOT units. Otherwise, it may be more worthwhile to invest in the ordinary FCOT Reit units.
This is because at the current FCOT market price of $0.15 per unit, the annualized yield is the 6.33% based on the latest quarterly available results. This compares favorably to the CPPU?s yield of 5.5% at the issue price of $1.
Moreover, although the CPPU offers a possibility of a call option on FCOT Reit units, the prospect of a profit is low as the rules behind the CPPU is tilted in favour of the Manager. Should FCOT?s unit price rises above the conversion price of $0.2369, the Manager would have the incentive to redeem the CPPU and thus deprive the CPPU holders from taking advantage of the call option.
Disclaimer
This FAQ is only intended to provide a simplified explanation of the FCOT CPPU to retail investors. Please refer to the SingWealth general Terms of Use.
