Fund Overview The Freehold Absolute Return Fund takes long and short positions in listed securities exposed to assets such as office and industrial real estate, residential development, retail shopping centres, airports, ports, toll roads, rail and utilities. Investment Objectives Generate returns of between 12-15% per annum over rolling three year periods Target portfolio volatility of less than 15% Average Fund Statistics for April 2015 Number of positions: 10-15 Net Long: -10% Total Long Positions: ~35% Total Short Positions: ~45% Gross Exposure: ~80% (longs + shorts) Fund Performance Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2013 0.52% 4.22% 2.79% 2.14% 1.93% -0.19% 2014 0.57% 1.01% 1.21% 1.69% 1.71% 1.34% 1.80% 1.75% 0.36% 1.73% 0.81% 3.22% 2015 1.49% 1.11% 0.23% 1.53% Performance Rolling Quarter 2.89% Rolling 12 month 18.40% Since Inception 38.60% Observed Daily Volatility ~4.7% Attribution Positive Contributors: Spark Infrastructure, APN Property, Goodman Group Negative Contributors: Transurban, Shopping Centres Australia, Investa Office Fund Profile Trustee: Freehold Capital Partners Pty Ltd, AFSL 344 188 Major Shareholders of the Trustee: ASX listed Treasury Group (TRG) and Freehold Executives Fund Managers: Tim Hannon and Andrew Smith Firm Funds Under Management: AUD $298 million Prime Broker and Custodian: UBS AG Administrator: Citco Fund Services Middle Office: Mainstream BPO Auditors and Tax: PricewaterhouseCoopers Legal: DLA Piper Australia Regulator: Australian Securities and Investment Commission (ASIC) 1
Fund Commentary The Fund delivered a +1.53% return over April amid mildly weaker global real estate and infrastructure markets. We are maintaining a mild short position in the Fund, given our view current market pricing is capitalising record low bond yields into perpetuity without factoring in the weaker growth outlook low bond yields imply. Our current strategy is to generate returns for the Fund from individual long and short positions rather than taking a material directional view on the market. If we see bond yields beginning to rise (which is against current market expectations), without a subsequent fall in the real estate and Infrastructure market, we will likely increase our short positions in select securities that appear overvalued and have degrading fundamentals. Fund returns remain solid, with low levels of volatility The Fund continues to deliver solid absolute returns with low levels of volatility, the chart below highlights this: 45.0% Freehold Absolute Return Fund Performance from June 30th 2013 40.0% 35.0% 30.0% 25.0% Over the past 12 months the Fund has delivered an 18.4% return. Since inception from June 2013 (22 months) the return generated has been +38.6%, with only one negative month (-0.2%) 20.0% 15.0% 10.0% 5.0% Monthly Cumulative A skill based income stream 0.0% -5.0% 4.00 3.00 2.00 ASX200 Property Index versus the Freehold Absolute Return Fund This chart illustrates the low volatility of the Freehold Absolute Return Fund by showing dispersion of returns. Whilst the broader market (in blue) has bigger up days than the Fund (in orange), it does not participate in the large down days either. 1.00 0.00 1.00 2.00 ASX200 Property Index Freehold Absolute Return Fund 3.00 4.00 5.00 : Source: Freehold Investment Management The average daily return for the AREIT sector is +5.3 points, compared to the average for the Freehold Absolute Return Fund of +7.8 points. This mild advantage compounds over time into significant outperformance 2
Stock of the month APN Property Group (APD) Introduction APN Property Group (APD) is a real estate focused fund manager with a twenty year trading history. Like many real estate companies, APD experienced a tumultuous time during the 2007/08 global financial crisis. Now in 2015 the company is very well capitalised and has four business units that have developed firm foundations to allow them to grow funds under management materially over the medium to long term. In recent history, institutional investors have been hampered from investing in APD due to its relatively small market capitalisation and associated lack of liquidity. This is the chief reason we think the security trades significantly below fair value. APN Property Group (APD) $0.45 $0.40 $0.35 $0.30 $0.25 $0.20 $0.15 $0.10 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 The very recent APD equity capital raising of $30 million at a share price of $0.37 has moved APD s market capitalisation to $120 million. The raising is also likely to have seen the introduction of new shareholders to the register. These new shareholders should improve the broader understanding and awareness of APD, which may begin to see the stock moving more closer to fair value. Business Composition The schematic below illustrates the four key business units of APD. APN Property Group (APD) Market capitalisation of $120 million Securities Australian Real Estate Healthcare Real Estate Generation Healthcare (GHC) Industrial Real Estate Industria REIT (IDR) Direct Real Estate Various Syndicates Funds under management of $1.2 billion Funds under management of $390 million Funds under management of $406 million Funds under management of $187 million We will walk through each of the business units in turn 3
Business Unit One: Australian Real Estate Securities The initial foundation of APD was an Australian Real Estate Securities funds management business. This strategy has grown consistently over time, and now stands at ~$1.2 billion of funds under management. This business is extremely well positioned on investment platforms in Australia. This wide distribution reach combined with the solid investment returns generated by the funds management team is seeing this business enjoy regular and solid fund inflows. We judge that this business can grow net inflows by at least ~$10 million per month over the medium to long term. The three primary risks to our view of gradually rising funds under management are: 1) Macroeconomic shocks to global asset markets, specifically real estate securities 2) Changes to the current investment team 3) Periods of poor performance of the Funds, potentially exacerbated by the growth in funds under management 1 Real Estate Securities business Growth in Funds Under Management 2000 1800 1600 1400 We concede the growth from this funds management business will not be linear as represented by this chart, but believe the trend will be correct if the operating environment remains relatively stable and the management team remain intact 1200 1000 800 600 : Source: Freehold Investment Management 2012 2013 2014 2015 2016 2017 2018 2019 2020 Unit Two: Healthcare Real Estate General Healthcare REIT (GHC) Four years ago, APD purchased a majority position in the management rights of an existing healthcare REIT run by Dutch banking group ING. It was then renamed Generation Healthcare REIT. This REIT was designed to invest in healthcare assets in Australia. This is a niche area in Australian real estate, with a number of very favourable characteristics: 1. Defensive income stream (healthcare has a low relative economic cyclicality) 2. Favourable demographics (ageing population should see expansion of investable real estate) 3. Long lease expiry profile (low lease expiry risk and net leases) 4. Fragmented ownership (opportunities to make value adding acquisitions) 1 As funds under management grows for a Fund Manager, the ability to perform declines over time. The most simplistic explanation is as a fund manager grows, attempts to change the positions within their portfolio to a better risk/reward situation can cause prices to move away from the prices they would like to trade at. This is known as market impact. 4
Unit Two: Healthcare Real Estate General Healthcare REIT continued At the stage that APD became involved with GHC it owned a portfolio of six properties with a book value of ~$183 million, and after deducting liabilities, net assets of $75.1 million. Since 2011, GHC has undertaken an array of equity capital raisings, expanding its asset base to 16 properties with a total value of $390 million, and after deducting liabilities, net assets of $239.5 million. This process of acquisition has been very rewarding for equity investors, as the following chart highlights Generation Healthcare (GHC) $1.80 $1.60 $1.40 $1.20 $1.00 $0.80 $0.60 2009 2010 2011 2012 2013 2014 2015 Over nine years the core management team of Generation Healthcare, Miles Wentworth and Chris Adams has developed Australia s only listed health care real estate investment trust, Generation Healthcare (GHC). This REIT now provides investors exposure to 16 assets, including hospitals, medical centres, laboratories, and residential aged care facilities. GHC has a market capitalisation of ~$340 million. : Source: Bloomberg Of all the APD business units, we are most excited by the potential growth of GHC. It has taken the team many years to build GHC to a critical mass in the healthcare real estate space. We believe GHC s market capitalisation is sufficient to see demand from a much broader base of investors than in the past, which should allow it to continue to raise equity capital and grow by acquisition in a much more rapid manner than it has historically. How big could GHC grow? Whilst care must always be made comparing situations in the USA versus Australia, we do note that the USA has a number of healthcare based REITs with very sizeable market capitalisations. For example, we highlight Ventas (VTR US), with a market capitalisation of $A28 billion ($46 billion of assets). VTR owns 1,600 assets across hospitals, outpatient facilities, post-acute facilities, biotech facilities and senior housing. The case for VTR according to their company overview 2 : Compelling demographics (ageing population) Ability to make accretive investments ($10 billion of investment over the past two years) Low cost of capital (3.6% of cost of debt) Strong balance sheet (31% debt to market capitalisation) Active Asset Management (4% year on year growth in earnings) 2 March 2015, Citi 2015 Global Property CEO Conference 5
Ventas (VTR US) $32.00 $27.00 $22.00 $17.00 VTR has grown remarkably strongly through acquisition, adding $21 billion of acquisitions since 2011 (more than doubling their asset base). The company has materially outperformed the US real estate index, delivering a 320% total return over the past ten years, compared to 124% by the MSCI US REIT Index Source: Ventas Annual Reports, 2011-2014 $12.00 $7.00 $2.00 2000 2001 2002 2003 2004 : Source: Bloomberg What is the relevance of VTR s growth to GHC? We assess that GHC has all the same attributes as VTR, but is at a much more nascent stage of development. Most importantly, GHC is the only listed Australian healthcare REIT of scale with substantial access to debt and capital markets delivering it an enormous first mover advantage. We believe with solid execution by the well regarded GHC management team, this REIT should be able to grow at a similar trajectory to VTR. We forecast that GHC could ultimately become a A$2 billion Australian healthcare REIT over the next three to five years. Unit Three: Industrial Real Estate Industria REIT APD launched an industrial real estate investment trust late 2013 called Industria REIT (IDR). IDR owns a portfolio of 17 established, institutional grade industrial and business park assets located across Sydney, Melbourne, Brisbane and Adelaide. The portfolio has been valued at $406 million. This REIT has only been in existence for a very short term, and like many exposures in the industrial sector has experienced some earnings headwinds due to difficult market conditions. Nonetheless, we think the APD management team behind IDR will ultimately be successful in growing the vehicle, but it may take some time to achieve material growth in funds under management. We forecast growth in FUM to $1 billion by 2020. Industria REIT (IDR) $2.20 $2.15 $2.10 The performance of IDR since listing has been solid without being spectacular. We assess that over time, the AREIT will move into a position to acquire Australian industrial assets to both grow its asset base and drive earnings. $2.05 $2.00 $1.95 $1.90 $1.85 $1.80 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 : Source: Bloomberg 6
Unit Four: Direct Real Estate The final component of APD s business is the direct real estate business. This business syndicates real estate across the risk/return spectrum to high net worth individuals, family offices and select institutions. The direct real estate business currently comprises just four individual syndicates. Whilst we expect continued, albeit modest growth from this business, we note the most recent APD presentation to investors highlighted ~$150 million of potential acquisitions for syndication, indicating growth might exceed our expectations. Co-investments APD regularly co-invests in its suite of managed funds, to illustrate alignment as well as prevent the funds from being acquired by third parties (and APD losing its funds management income). APD has co-investments in the majority of its funds management schemes, including Generation Healthcare, Industria REIT and direct real estate businesses. This co-investment level is currently valued on the APD balance sheet at nearly $80 million. Forecasts and Valuation We value APD in two separate components: Valuation of the funds management businesses (Real Estate Securities, Generation Healthcare, Industria REIT and Direct Real Estate) Valuation of the co-investments that APD have made in the aforementioned funds to ensure alignment as well as provide some protection from takeovers Valuation of the fund manager and the balance sheet assets Based on our expectations of growth from each business unit of APD (albeit at different rates) we expect APD to reach at least $A5 billion of funds under management over the next three to five years. We value this business at 52 cents per share The valuation of the balance sheet assets is somewhat easier. We take the $80 million of hard assets on the balance sheet (primarily co-investments) and work out a per share value of 36 cents. Total Valuation The culmination of APD s intangible and tangible asset base is a valuation of 88 cents per share. This valuation compares to the current market price of ~40 cents per share, providing a large amount of upside - if the APD management team execute on their growth targets. 7
Valuation Cross Check To gauge the level of market expectations currently factored into the market price, APD management forecast ~2.55 cents per share of earnings for the 2015 fiscal year, equating to a 2015 price earnings (PE) multiple of 16 times. Whilst this PE ratio is in line with Australian peers, it does not take into account the rapid growth that APD is likely to deliver over the medium term. To highlight this, based off current 2015 management expectations, APD earns a return on equity (ROE) of just 7% 3, this compares to a 21.5% ROE across 29 global fund managers 4. This low ROE means that APD trades at a very low price to book value of 1.4 times (40 cent share price versus 27 cents of net tangible assets). The average price to book ratio of global comparables is 3.4 times 5. If our assessment is correct, APD s ROE will rise materially, and APD is likely to trade at the same level of its global peers which would equate to $0.92 per share. This cross check verifies that if APD is able to grow its funds management in the manner we expect possible, our valuation is feasible. Conclusion APD is a real estate based fund manager with multiple growth drivers. Whilst having been established for nearly two decades we judge that the business is not well covered by the market and appears undiscovered. We believe this lack of perception of APD is gradually changing, and we expect APD to perform very well over the next three to five years, providing material upside for medium term investors. Disclosure: Freehold Funds hold a position in APN Property Group. End Important Disclaimer this may affect your legal rights: Because this document has been prepared without consideration of any specific client s financial situation, particular needs and investment objectives, you should consult your investment adviser before any investment decision is made. While this document is based on the information from sources which are considered reliable, Freehold Capital Partners, its associated entities, directors, employees and consultants do not represent, warrant or guarantee, expressly or impliedly, that the information contained in this document is complete or accurate. Nor does Freehold Capital Partners accept any responsibility to inform you of any matter that subsequently comes to its notice, which may affect any of the information contained in this document. This document is a private communication to clients and is not intended for public circulation or for the use of any third party, without the prior approval of Freehold Capital Partners. This is general securities advice only and does not constitute advice to any person. Disclosure of Interest: Freehold Capital Partners and its associates may hold shares in the companies recommended. Freehold Capital Partners Pty Ltd ABN 79 139 750 673 AFS Licence No. 344188 3 This is calculated as forecast net profit after tax divided by net tangible assets of the business 4 Credit Suisse, Australian Diversified Financials, 1 st April 2015 5 Ibid. 8