Quarz Capital Management, Ltd. Sends Open Letter to the Board and Management of Sabana REIT and ESR Cayman
GEORGE TOWN,Cayman Islands,Nov. 14,2019 -- Quarz Capital Management,Ltd. (QCM),an investment manager,today issued a letter urging Sabana REIT to expeditiously execute on multiple levers such as the optimization of occupancy rates,enhancement of its 151 Lorong Chuan flagship asset and the utilization of its substantial debt headroom of more than ~S$150million to potentially increase its DPU by more than ~45% to S$0.0422 (Dividend yield of ~9.4%) by 2021E. Sabana also has a substantial untapped plot ratio which can potentially increase its GFA by more than ~1.3million when fully utilized.
QCM believes that the sizeable discount that Sabana trades to its book value can be attributed to ESR's majority controlling stake in the managers and substantial unitholdings in Sabana and ESR REITs. This has created substantial overlapping investment mandates of the both REITs which can potentially result in corporate governance concerns. We find ESR's argument that they can manage the 2 REITs independently unconvincing. Both REITs primarily invest in the Singapore industrial real estate sector which is limited in size and transactions,which can undoubtedly result in both REITs bidding for the same assets as well as evaluating potential transactions regarding each other's portfolio. With recently HK-listed ESR having a fiduciary duty to enhance shareholder value through maximizing the value of its investments,its substantially larger stake (by value) in ESR REIT can potentially create corporate governance concerns on which REIT should have priority. It is also inequitable to minority investors if the REITs are forced to invest out of Singapore such that ESR can mitigate this issue.
QCM proposes that ESR REIT merge with Sabana REIT in a cash and unit transaction where 0.92 units of ESR REIT and S$0.067 of cash will be exchanged for 1 unit of Sabana REIT (total value of ~S$0.545 per unit,~2.7% discount to book value). The merger can solve the critical issue of overlapping investment mandates between the 2 trusts which has important corporate governance implications.
For Sabana REIT unitholders,this potential offer provides an attractive takeover premium of ~21% and addresses the persistent discount at which the unit price trades to its Net Asset Value partly due to continued lack of information on the resolution of the overlapping investment mandates of the 2 REITs.
ESR REIT unitholders can potentially benefit from a ~7% jump in DPU (Dividend yield of ~7.1%) post-merger attributed to the optimization of the many levers for Sabana's portfolio which includes the addition of a retail component at 151 Lorong Chuan post 2Q20 and optimization of management fee payments and occupancy rates. Sabana also has more than ~1.3million of untapped GFA which ESR REIT can capitalize on. Due to the low leverage ratio of Sabana (~30.9%),the combined entity will have ~S$180m of debt headroom to make DPU accretive acquisitions.
The combined entity will be the 4th largest SGX-listed industrial REIT investing in Singapore with assets in excess of ~S$3.9billion. The potential free float Market Cap of ~S$1.4billion is proximate to the estimated ~S$1.7billion required to be included in the FTSE EPRA NAREIT Developed Markets Index which can drive a further rerating of its unit price.
We are positive that the inclusion of the enlarged Trust in the index and potential increase in global institutional investors following and investing in the Trust can potentially drive further yield compression and unit price upside.
Due to the current overlapping investment mandates and low leverage ratio (~30.9%),we urge Sabana to postpone any significant acquisitions which would require capital raising until full rationalization of the overlap is achieved. Focusing on the optimization of its current asset base such as increasing occupancy rates and enhancing 151 Lorong Chuan are 'low hanging fruits' which can already potentially provide sizeable and attractive DPU upside to Sabana's unitholders.
QCM believes that its recommendations will deliver substantial unitholder value and has delivered the following letter to Sabana's REIT management team,board of directors,ESR Cayman and other stakeholders.
QUARZ CAPITAL MANAGEMENT,LTD. ISSUES OPEN LETTER TO
THE MANAGEMENT AND BOARD OF SABANA REIT (SGX: M1GU) AND ESR CAYMAN (HKG:1821)
ALL RECIPIENTS ARE ADVISED TO READ
"IMPORTANT DISCLOSURE INFORMATION"
AT THE END OF THE ATTACHED LETTER
Quarz Capital Management,Ltd.
Clifton House 75 Fort Street
George Town I KY1-1108 I Grand Cayman
Cayman Islands
14 Nov 2019
PROPOSALS TO EXPEDITE THE INCREASE IN UNITHOLDER RETURNS AND THE MERGER OF ESR AND SABANA REITS
POTENTAL CAPITAL GAINS AND DPU CAN GENERATE TOTAL RETURN IN EXCESS OF 30%
Dear Mr. Han,Mr de Portes and Members of the Board of Sabana REIT and ESR Cayman,
Quarz Capital with its affiliates have been long-term unitholders of Sabana REIT (the "Trust","Firm","Sabana",or "SSREIT SP") and are collectively one of the top 5 unitholders of the firm. We commend the board and management for their outstanding execution on the key initiatives outlined in the 2017 Strategic Review.
Non-core assets have been successfully disposed decreasing Sabana's leverage ratio to 30.9%,one of the lowest levels among S-REITs. In particular,Geo-Tele Centre was disposed at 3x its book value,netting the Trust a rich profit of ~S$66million. Exposure to master leases from Vibrant has also been reduced with the successful lease out of 18 Gul Way. The remaining 2 Vibrant leases expire in Nov 2020. Nr. 32&35 Penjuru Lane is a high specification chemical logistics Hub with an untapped GFA of 400,000 sqft while Nr. 51 Penjuru also has an untapped GFA of 150,000 sqft. We are positive in the tenantability of these assets given their competitive rent and high specifications. Our research reveals large income accretive opportunity through redevelopment and increase in rentable space.
We have identified multiple levers that Sabana has at its disposal to increase DPU by more than ~45% (Dividend yield of ~9.4%) by 2020E:
1) Completion of ~43,000 sqft retail space (F&B,supermarket,childcare,school etc.) at 151 Lorong Chuan ("New Tech Park") in 2H2020 can potentially yield incremental annual net property income ("NPI") of S$3.3million p.a.
2) Debt headroom of ~S$150million (factoring leverage ratio of ~41% vs ~31% currently) to purchase yield accretive assets which can potentially yield another S$10million in net property income.
3) Optimization of occupancy rate to national level of ~89% potentially generates an additional NPI of ~S$3.4million.
4) Partial payment of management fees in units can potentially increase distributable income by ~S$3m additionally.
Altogether,DPU can increase to S$0.0422 which can make Sabana one of the highest yielding SGX-listed REITs with Singapore assets. In the mid-term,151 Lorong Chuan's underutilized plot ratio can be further optimized to yield an additional ~240,000 sqft of prime business park space while other key assets such as Nr. 32&35 Penjuru,Nr. 51 Penjuru,3A Joo Koon Circle and 26 Loyang Drive can potentially increase their GFA by more than 50% yielding an additional ~1.3million sqft of total industrial space. We therefore call on the board and management to expedite on the execution of these levers to substantially boost unitholder returns in the near and mid-term.
We believe that it is for the same reasons that ESR Cayman ("ESR" or "1821 HK") purchased a substantial stake in Sabana at S$0.48/unit as well as the controlling stake in the REIT's manager at an estimated rich premium of P/E 2017 and 2018 of ~33.6x and ~26.1x respectively[1]. We welcome ESR as a major unitholder and owner of the REIT manager. With ESR's extensive expertise and success in Asia Pacific industrial real estate,we are confident in their capability to further drive value for Sabana REIT.
ESR's controlling stakes in the managers and major unitholdings in ESR and Sabana REITs have unfortunately created substantial overlapping investment mandates of the 2 REITs. Both REITs are mainly invested in Singapore industrial real estate properties. The cross ownership of its managers can potentially result in corporate governance concerns especially relating to divestments and acquisitions of properties. This key issue has been identified by the Monetary Authority of Singapore (MAS) when it did not approve the manager of the then Cambridge REIT (now ESR REIT) to be the manager of the then Macarthur Cook REIT (now AIMS APAC REIT) due to severe concerns of overlapping investment mandates. It also partly drove the merger between Ascott and Ascendas Hospitality Trust.
This issue is particularly critical for Sabana which has substantial debt headroom to make DPU accretive acquisitions. We are not convinced by ESR's argument that they are able to clearly manage Sabana and ESR REITs independently. As a recently listed company in Hong Kong,ESR has a fiduciary duty to enhance the value of their shareholders which translates to ensuring that the value of its stakes in both ESR and Sabana RE are maximized. The 2 REITs primarily invest in the Singapore industrial sector which is limited in size and transactions. Undoubtedly,both might tender for the same assets. As ESR's stake in ESR REIT has a substantially larger value vs the stake in Sabana,this can potentially create corporate governance concerns on which REIT should have priority. It would be clearly inequitable to Sabana's minority unitholders if the REIT is forced to invest out of Singapore such that ESR can mitigate this issue. The duplicity in cost to manage the 2 REITs independently is also suboptimal for ESR shareholders.
We believe that the uncertainty over its future and the continued lack of information on the resolution of the overlapping investment mandate are some of the key reasons resulting in Sabana to trade at a sharp discount of ~20% to its book value of S$0.56 per unit.
Quarz believes that a Win-Win value accretive solution for all stakeholders including ESR is the merger by way of a Trust Scheme between ESR and Sabana REITs. We propose a cash + unit offer totaling ~S$0.545 per Sabana unit (proximate to book value) comprising of 0.92 ESR units and S$0.067 of cash for 1 Sabana unit.
For Sabana unitholders,this represents an attractive merger premium of ~20%.This price is higher than that paid by ESR for Vibrant's stake in Sabana (S$0.48/unit). However,the critical difference is that Vibrant could bundle the sale of the controlling stake in the REIT manager at a rich valuation of P/E 2018 of 26.1x together with Sabana units in the all-cash transaction.
With the completion of the 151 Lorong Chuan retail extension,optimization in the payment of management fees,as well as vacancy rates,we believe that DPU to ESR unitholders in the enlarged REIT can jump by ~7% to S$0.037[2] (Dvd Yield of ~7.1%).Sabana's low leverage ratio of 30.9% results in overall leverage level to decline to ~40.4% which can potentially increase DPU by another ~4% to ~S$0.0385 (Dvd Yield of ~7.4%) to unitholders of the enlarged REIT when fully utilized.
The increase in debt headroom of the enlarged REIT to more than ~S$180million can enable ESR to capitalize on its extensive network and industry expertise to make value accretive acquisitions regionally. We are confident in their capability to build the enlarged trust into a successful Pan Asian industrial real estate REIT.
The combined entity will be the 4th largest Industrial REIT owning Singapore assets and rank among the 14th largest REITs[3] in Singapore with assets in excess of ~S$3.9billion. The potential free float Market Cap of ~S$1.4billion is proximate to the ~S$1.73billion required to be included in the FTSE EPRA NAREIT DM index tracked by global REIT funds with >S$250billion of assets under management. We are bullish that the inclusion of the enlarged Trust in the index and the increase in global institutional investors following and investing in the Trust can potentially drive further yield compression and unit price upside.
It would be critically detrimental to the interest of Sabana's unitholders if the Trust was limited to investing in certain jurisdictions or asset classes such that ESR could resolve the overlapping investment issue brought about by its purchase of Sabana's manager. This is especially in view of the immense value accretive opportunity in the combination of the 2 REITs.
Due to the overlapping investment mandates and the low leverage level,we urge Sabana to postpone any significant acquisitions which would require capital raising until the clear rationalization of the investment mandate overlap. Focusing on the optimization of the occupancy rates of the existing asset base and the enhancement and refurbishment of 151 Lorong Chuan are 'low hanging fruits' which can potentially provide sizeable and attractive DPU upside to Sabana's unitholders.
Quarz firmly believes that its recommendations can provide a clear pathway to deliver a significant potential total return of more than ~30% for all Sabana's unitholders in the mid-term. As long term unitholders,we look forward to working with Sabana REIT's board and management to move forward expeditiously on delivering value to all unitholders.
Sincerely yours,
Mr. Jan F. Moermann
Chief Investment Officer,Quarz Capital Management,Ltd.
Mr. Havard Chi,CFA
Head of Research,Quarz Capital Asia (Singapore)
For further information,please contact:
operations@quarzcapital.com
About Quarz Capital Management
Quarz Capital Management,Ltd. is a value oriented and research driven investment advisory firm that seeks to earn above average,long-term returns by identifying value investments across the globe.
www.quarzcapital.com
Important Disclosure Information
SPECIAL NOTE REGARDING THIS LETTER
THIS LETTER CONTAINS OUR CURRENT VIEWS ON THE VALUE OF SABANA REIT'S SECURITIES AND ACTION THAT SABANA REIT'S BOARD MAY TAKE TO ENHANCE THE VALUE OF ITS SECURITIES. OUR VIEWS ARE BASED ON OUR ANALYSIS OF PUBLICLY AVAILABLE INFORMATION AND ASSUMPTIONS WE BELIEVE TO BE REASONABLE. THERE CAN BE NO ASSURANCE THAT THE INFORMATION WE CONSIDERED IS ACCURATE OR COMPLETE,NOR CAN THERE BE ANY ASSURANCE THAT OUR ASSUMPTIONS ARE CORRECT. SABANA REIT ACTUAL PERFORMANCE AND RESULTS MAY DIFFER MATERIALLY FROM OUR ASSUMPTIONS AND ANALYSIS. WE HAVE NOT SOUGHT,NOR HAVE WE RECEIVED,PERMISSION FROM ANY THIRD-PARTY TO INCLUDE THEIR INFORMATION IN THIS LETTER. ANY SUCH INFORMATION SHOULD NOT BE VIEWED AS INDICATING THE SUPPORT OF SUCH THIRD PARTY FOR THE VIEWS EXPRESSED HEREIN. WE DO NOT RECOMMEND OR ADVISE,NOR DO WE INTEND TO RECOMMEND OR ADVISE,ANY PERSON TO PURCHASE OR SELL SECURITIES AND NO ONE SHOULD RELY ON THIS LETTER OR ANY ASPECT OF THIS LETTER TO PURCHASE OR SELL SECURITIES OR CONSIDER PURCHASING OR SELLING SECURITIES. ALTHOUGH WE STATE IN THIS LETTER WHAT WE BELIEVE SHOULD BE THE VALUE OF SABANA REIT'S SECURITIES,THIS LETTER DOES NOT PURPORT TO BE,NOR SHOULD IT BE READ,AS AN EXPRESSION OF ANY OPINION OR PREDICTION AS TO THE PRICE AT WHICH SABANA REIT'S SECURITIES MAY TRADE AT ANY TIME. AS NOTED,THIS LETTER EXPRESSES OUR CURRENT VIEWS ON SABANA REIT. IT ALSO DISCLOSES OUR CURRENT HOLDINGS OF SABANA REIT SECURITIES. OUR VIEWS AND OUR HOLDINGS COULD CHANGE AT ANY TIME. WE MAY SELL ANY OR ALL OF OUR HOLDINGS OR INCREASE OUR HOLDINGS BY PURCHASING ADDITIONAL SECURITIES. WE MAY TAKE ANY OF THESE OR OTHER ACTIONS REGARDING SABANA REIT WITHOUT UPDATING THIS LETTER OR PROVIDING ANY NOTICE WHATSOEVER OF ANY SUCH CHANGES. INVESTORS SHOULD MAKE THEIR OWN DECISIONS REGARDING SABANA REIT AND ITS PROSPECTS WITHOUT RELYING ON,OR EVEN CONSIDERING,ANY OF THE INFORMATION CONTAINED IN THIS LETTER.
As of the publication date of this report,Quarz Capital Management Ltd. and its affiliates (collectively "Quarz"),others that contributed research to this report and others that we have shared our research with (collectively,the "Authors") have long positions in and own options on the stock of the company covered herein (SABANA REIT) and stand to realize gains in the event that the price of the stock increases. Following publication of the report,the Authors may transact in the securities of the company covered herein. All content in this report represent the opinions of Quarz. The Authors have obtained all information herein from sources they believe to be accurate and reliable. However,such information is presented "as is",without warranty of any kind – whether express or implied. The Authors make no representation,express or implied,as to the accuracy,timeliness,or completeness of any such information or with regard to the results obtained from its use. All expressions of opinion are subject to change without notice,and the Authors do not undertake to update or supplement this report or any information contained herein.
This document is for informational purposes only and it is not intended as an official confirmation of any transaction. All market prices,data and other information are not warranted as to completeness or accuracy and are subject to change without notice. The information included in this document is based upon selected public market data and reflects prevailing conditions and the Authors' views as of this date,all of which are accordingly subject to change. The Authors' opinions and estimates constitute a best efforts judgment and should be regarded as indicative,preliminary and for illustrative purposes only.
Any investment involves substantial risks,including,but not limited to,pricing volatility,inadequate liquidity,and the potential complete loss of principal. This report's estimated fundamental value only represents a best efforts estimate of the potential fundamental valuation of a specific security,and is not expressed as,or implied as,assessments of the quality of a security,a summary of past performance,or an actionable investment strategy for an investor.
This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment,security,or commodity discussed herein or of any of the affiliates of the Authors. Also,this document does not in any way constitute an offer or solicitation of an offer to buy or sell any security in any jurisdiction in which such an offer would be unlawful under the securities laws of such jurisdiction. To the best of the Authors' abilities and beliefs,all information contained herein is accurate and reliable. The Authors reserve the rights for their affiliates,officers,and employees to hold cash or derivative positions in any company discussed in this document at any time. As of the original publication date of this document,investors should assume that the Authors are long shares of SABANA REIT and have positions in financial derivatives that reference this security and stand to potentially realize gains in the event that the market valuation of the company's common equity is higher than prior to the original publication date. These affiliates,and individuals shall have no obligation to inform any investor about their historical,current,and future trading activities. In addition,the Authors may benefit from any change in the valuation of any other companies,securities,or commodities discussed in this document. Analysts who prepared this report are compensated based upon (among other factors) the overall profitability of the Authors' operations and their affiliates. The compensation structure for the Authors' analysts is generally a derivative of their effectiveness in generating and communicating new investment ideas and the performance of recommended strategies for the Authors. This could represent a potential conflict of interest in the statements and opinions in the Authors' documents.
The information contained in this document may include,or incorporate by reference,forward- looking statements,which would include any statements that are not statements of historical fact. Any or all of the Authors' forward-looking assumptions,expectations,projections,intentions or beliefs about future events may turn out to be wrong. These forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks,uncertainties and other factors,most of which are beyond the Authors' control. Investors should conduct independent due diligence,with assistance from professional financial,legal and tax experts,on all securities,companies,and commodities discussed in this document and develop a stand-alone judgment of the relevant markets prior to making any investment decision.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this letter are forward-looking statements including,statements that are predications of or indicate future events,trends,plans or objectives. Undue reliance should not be placed on such statements because,by their nature,they are subject to known and unknown risks and uncertainties. Forward-looking statements are not guarantees of future performance or activities and are subject to many risks and uncertainties. Due to such risks and uncertainties,actual events or results or actual performance may differ materially from those reflected or contemplated in such forward-looking statements. Forward-looking statements can be identified by the use of the future tense or other forward-looking words such as "view," "believe," "convinced," "expect," "anticipate," "intend," "plan," "estimate," "should," "may," "will," "objective," "project," "forecast," "management believes," "continue," "strategy," "promising," "potential," "position" or the negative of those terms or other variations of them or by comparable terminology.
Important factors that could cause actual results to differ materially from the expectations set forth in this letter include,among other things,the factors identified in the risk sections in SABANA REIT's Annual Report for the year ended DECEMBER 31st,2018 and prospectus. Such forward-looking statements should therefore be constructed in light of such factors,and Quarz Capital Management is under no obligation,and expressly disclaims any intention or obligation,to update or revise any forward-looking statements,whether as a result of new information,future events or otherwise,except as required by law.
[1]51% stake at ~S$21million (valuation of ~S$41million for entire manager). Sabana's REIT manager had net profit of S$1.19million and S$1.53million respectively in 2017 and 2018
[2]Excluding capital return in ESR REIT's 1H19 distributable income
[3]By Asset Base
