Trophy Property Development: Renucci-Tan’s view

One of the messiest divorces in private equity real estate has finally reached a conclusion. Via a delicately-brokered asset swap and management spin-out agreed last month, the institutional investors in hedge fund-turned- private equity real estate firm Winnington Capital’s Trophy Property Development fund – all 140 of them – can now look forward to better times for a vehicle that had promised so much but fell well short of expectations. 

An autopsy of the one-time largest China-focused property development fund does little for the reputation of any of its key protagonists: Winnington Capital, Shui On Land or the investors. Indeed, the $1 billion fund has been described as a case study in how private institutional capital should not engage in China property development. A misalignment of interests from the beginning was compounded by overrunning development schedules and escalating costs and ended up with warring factions and the need to hire a raft of consultants to agree a resolution.

Key among those advisors was Hong Kong-based TAN-EU Capital, another of the Shui On Groups’ private equity partners, which was appointed last year as the relationships between the GP, developer and LPs had reached an all-time low. Originally hired by Shui On Land to force a clean separation from the fund, TAN-EU was understood to have played a pivotal role in determining a solution that saw the fund’s minority stakes in four Shui On Land developments across China traded for one majority stake in one of its developments in Shanghai, and the spin-out of a new management platform to manage the fund going forward. Crucially, the firm also convinced Shui On to stay on as the developer.

PERE speaks exclusively to the firm’s founder Rachel Renucci-Tan about the part it played:

PERE: How did TAN-EU Capital get involved with the Trophy Property Development Fund in the first place?
Rachel Renucci-Tan: Our involvement really came about as Shui On was dealing with the partnership’s funding imbalance. Shui On was funding the developments because the fund had run out of cash. It didn’t help that the relationship between Winnington and Shui On Land was not happy.

At the time Shui On was resolving the funding imbalance by slowly diluting the fund’s shares in the projects as a way of paying off the debt. But that was proving painfully slow. At the same time, Winnington’s relationship with its LPs was also strained. The LPs realised Shui On was owed money but the fund no longer had cash. And there was no way to exit so the panic button was sounded.

Winnington hired Moelis, the investment bank, to advise on a solution because they wanted an independent view. It occurred to me that if Winnington hired an advisor then Shui On should hire an advisor as well. I went to senior management of Shui On Land and told them that TAN-EU would be well placed to advise them because of our experience in private equity real estate.

PERE: You approached them?
RRT: Correct. They asked me to put together a pitch. They asked: ‘why should they hire us and not Goldman Sachs, UBS or another reputable investment bank?’ It took a while but we did convince them.

PERE: What was the mandate on Day One?
RRT: The mandate was to advise on an exit for the LPs. Basically it would be a divorce. We would allow the fund to exit from all its projects and that would be the end of the partnership. That’s how it started out. The fund had no cash at the time, and Shui On was not willing to fork out cash to buy out their interests. Providing an exit was not an obligation of Shui On since they are not the fund’s GP, but they understood that the partnership was no longer tenable.

PERE: In the meantime costs connected to these developments were rising and the development timescales were moving further away.
RRT: Correct. The parties had no alignment of interests so you had Shui On having to bear ever-increasing debts and some unhappy LPs blaming Shui On for the situation they found themselves in. Actually, the dilution was a very generous of Shui On. They could have just called the debt.

PERE: It seems strange that Shui On did not realise the fund was constrained by a limited lifespan and would be unlikely to raise more capital should the underwriting not pan out.
RRT: It was not their business to know about the fund. The developer does not have access to the limited partnership agreement of the fund which was bound by a strict non-disclosure agreement. It’s the GPs responsibility to understand the timing and execution of its investments. The GP should always underwrite a clear exit plan for the fund. Anyone who knows about China development knows that sites in the ‘relocation phase’ have moving schedules and costs. That is why a private equity fund should never invest in a site with relocation issues because it could take 10 years or more to clear.

PERE: During the negotiation process, were you ever doubtful that a solution could be found?
RRT: Absolutely. When we were first appointed, the work was mainly for Shui On Land. We had to come up with ideas about how to separate them from the fund. After a month we had some – all to do with asset swapping, to get the interests in the assets swapped with a combination of assets and cash. Once we settled on options that Shui On approved we entered into a dialogue with Moelis. Unfortunately we struggled with them for months. It was very frustrating, us explaining the concept of what we wanted to do. At the same time, what they wanted to do on behalf of Winnington didn’t make sense to us. Eventually, the LPs realised the separation Shui On wanted would spell the end for the fund because Winnington cannot develop.

The LPs wanted Shui On to stay on and develop whatever the fund was going to hold. But Shui On said they would stay on and develop only if there was a change in the fund’s management. That became a condition for the swap. Funnily enough, that is where the LPs and Shui On found common ground. The LPs knew the way to salvation was to replace their GP.

PERE: Is this when Phillip Mintz came into the fray?
RRT: Yes. He came to Hong Kong late last year from New York, instructed by the LPs to talk to me so we can work things out. I think that was the turning point. We could get the negotiations going in a meaningful way. That led to Winnington stepping down from day-to-day operations and a fund management committee, led by Phillip and chairman Mehmet Dalman taking over. Eventually the committee would take over as the new GP.

PERE: Ok. Now talk us through the swap itself please.
RRT: The swap involves an exchange of the minority shares of Trophy in four master plans for an adjusted 98 percent interest in the cleared site of Taipinqiao (TPQ) 116. TPQ 116 cleared site means that the relocations for the site have been completed and a land title certificate has been secured. Since the value of the fund’s portfolio was lower than the adjusted cleared site value of TPQ 116 by RMB 943.5 million ($155 million) and the fund had no cash to pay for the difference, Shui On has agreed to be compensated in shares, effectively creating a JV between Trophy and Shui On for TPQ 116. In the JV, Shui On will own an 18.9 percent stake. There is also a Put Option of $90 million which Trophy can decide to exercise and an equivalent Call Option which Shui On can decide to exercise. The exercise price of the Put and Call at $81 million each ($162 million in total) can increase Shui On’s stake in the JV to almost 40 percent.

PERE: Do you think it likely that the LPs would exercise the option?
RRT: I think there’s a good possibility that they could exercise it once the joint venture takes place, most likely in Q2 2014. The Put and Call options provide liquidity and a quick exit for some of the LPs who cannot wait another three or four years to get their capital back. Furthermore, I think the LPs would feel reassured if Shui On owned a larger stake. In fact, one of their concerns was that Shui On, as only an 18.9 percent stakeholder, would not develop the site properly, putting their resources into other projects. You see, Shui On does not typically own such small stakes. But the LPs should realise that TPQ116 is a crown jewel in Shui On’s Shanghai Xintiandi master-plan. They cannot afford to mismanage the site. It would negatively impact the entire master plan and, effectively, Shui On’s reputation if there was an eyesore in the middle.

PERE: But you convinced them?
RRT: I could not convince the LPs to just trust us that Shui On would not mismanage the site and not knowingly be in breach of various government regulations. TAN-EU understands the institutional mindset of the LPs, most of whom are themselves fiduciaries. We also empathize that the LPs have lived through a traumatic experience, having lost almost 60 percent of their value and are now taking the risk of swapping out their interests from a diversified portfolio into a single project. Given that Shui On has every reason to make TPQ 116 a success and the risks of the events that the LPs worry about materializing are almost nil, we still agreed to adopt a further mechanism which allows the fund to unwind the JV and return to their original position as if the swap had never occurred, in the event that the site is not properly cleared or the government expropriates the land for reasons other than force majeure. Also the project management agreement was tightly negotiated. So for material delays and material cost overruns, there are remedies. The LPs can effectively terminate the development management agreement with Shui On.

PERE: Nonetheless these concerns have been calmed?
RRT: I would say that the LPs can go to sleep at night knowing that they have effective remedies to deal with Shui On not fulfilling their end of the bargain. Besides, we took some of the biggest LPs on a tour of the site to show that it was 97 percent cleared and that the site sits squarely in the middle of an iconic master plan in Shanghai, making it impossible for Shui On to make a mess of it. Furthermore, the fact that Shui On agreed to the unwind mechanism and to the remedies available to the LPs in the event of material delays and cost overrun demonstrates confidence on the part of Shui On that they will do everything within their means to make TPQ 116 a profitable development which all parties in the JV can be proud of.

PERE: From a valuation only perspective. Was the swap fair?
RRT: I think the LPs got a bargain. They now own almost 80 percent of one of Shui On Land’s most coveted pieces of land without having to fork out a cent for it. This is a prime asset and there will be no more new supply in the area. This is like having the only available site left in Mayfair in London. They also have exited out of developments that would take much longer to develop and out of plots of land still with relocation issues.

PERE: So what return should they expect, when all is said and done?
RRT: If all goes according to plan, barring unforeseen market risks, they should expect to recover at least all their capital invested in china, the $815 million, returned. That would be quite a good outcome given they were losing nearly 60 percent of their fund’s value. Values in the Shanghai market are rising and the fact there is no new supply in the area, the prospects for doing even better is quite good.

PERE: How damaging an episode has this been for the reputation of private equity real estate in China?
RRT: It was damaging for a period of time. When there was this total impasse and 140 LPs were wincing in pain – that was a dark period. It affected LP appetite for development risk in China. But I think time will prove the outcome to be the right path. One telling indicator is that I’ve had calls from reputable fund managers asking about secondary positions for sale. To my knowledge nothing has been sold so far.

PERE: What would you say is the main takeaway from the Trophy Property Development fund saga?
RRT: It’s a cliché but choice of operating partner and how that partnership is structured really is key. Beyond just a simple JV, the way Trophy was structured, the operating partner also needs to be committed to the fund’s interest. It’s the only way it can work. A developer with a fiduciary duty to the fund’s interests is a very powerful proposition.

PERE: Did the misfortunes of Trophy Property Development inform your formation of your own SOTAN fund?
RRT: It did. Originally, the senior executives at Shui On asked me to model SOTAN like the Trophy Development Fund. I said that’s not the way I’d do it and had to convince them to share the GP responsibility. Then the Trophy saga unfolded.

PERE: Does the experience of brokering the solution for the fund attract you to offer advisory services as well as real estate investment management?
RRT: I’ve thought about it but I still feel we’re a new kid on the block as a GP. Our commitment must be to SOTAN and making it a success. We cannot get distracted doing fund restructuring.

PERE: So this was a distraction from your fund?
RRT: On the contrary. Shui On is our partner and this was for them. If we didn’t clean up the mess then Shui On would have been caught up in a saga which would have impacted their reputation. That would also have had negative consequences for SOCAM Development, our partner, which bears the Shui On brand after all. This was our responsibility.

Let’s not forget, the success of the Trophy restructuring has also enhanced our reputation among 140 LPs too.