Out of the blue, RHB Bank Singapore says it sees strong merits in internalising Suntec REIT’s manager “due to its unique positioning of differing asset class focus and strengths compared to its Sponsor, high free float and low sponsor stake, and its large size with high quality assets”.
As a point to note, Suntec REIT is relatively large compared to that other REIT which activist hedge fund Quarz Capital Asia is attempting to internalise without having an EGM to change the trust deed. Internalised REITs need to have an adequate size to enable its internalised manager to reap economies of scale, according to RHB. Notably, even Link REIT, Asia’s largest, is looking to get a slice of management contracts to add to its fee related income.
Back to Suntec REIT which has AUM of around $12.2 billion as at end-Dec 2023. RHB believes that internalising the manager could narrow the discount between its unit price (around $1.11) and the NAV of $2.10 as at end-Dec.
A bit of history. When Suntec REIT was first listed, it was an exit vehicle for a bunch of Hong Kong tycoons which had invested to develop Suntec City. The tycoons had about equal share in Suntec REIT when it listed, but one of them was also the patriarch of Cheung Kong Holdings (now CK Asset).
Separately, Cheung Kong also owned a stake in ARA Asset Management which was Singapore’s first real estate investment manager. ARA became Suntec REIT’s manager. As a result, these tycoons and ARA together held around 29% of Suntec REIT when it listed in 2004.
The tycoons included the likes of the late Frank Tsao who founded International Maritime Carriers and MISC; Li Ka-Shing, patriarch of Cheung Kong; Cheng Yu-Tung of New World Development; Lee Shau Kee of Henderson Land; and Shaw Trustee.
Over the years, the tycoons either divested their stakes, or their offspring did. As a result, the CEO of ARA, John Lim, and friendly parties together aimed to hold around 18% of Suntec REIT. ESR Group completed the takeover of ARA in January 2022 which is when it inherited a 10.3% stake in Suntec REIT. The second largest unitholder is Gordon Tang and family with around 9%. Although Suntec REIT has had placements over the years, it has never had an equity fund raising.
RHB says Suntec REIT “historically had a limited reliance on its Sponsor for acquisition and fundraising. In addition, the REIT is different from other sponsor-led S-REITs as: i) The current sponsor, ESR Group, focuses on new economy assets compared to Suntec’s office and retail portfolio, ii) High free float and limited shareholder concentration with the Sponsor holding a mere 10% stake, and iii) no visible sponsor growth pipeline”.
RHB says: “in order for a successful internalisation, majority unitholder approval (>75%) and amendments to the trust deed are needed. We therefore believe it is important to align all stakeholders including the Sponsor and minorities. This, in our view, can be done by buying the REIT manager at a fair market value and also fully retaining the existing management team”.
See also: RHB still upbeat on ST Engineering but trims target price by 2.3%
The point for RHB is that internalisation can take place if the REIT is sizeable, and it is done in a friendly manner including by following the law and regulations instead of trying to change the law and regulations.
“Based on our initial analysis of past REIT manager transactions, the fair value range has been 7-9x of the historical management fees. Considering Suntec REIT’s matured growth profile and size as well as limited embedded growth from the internalisation process, we believe a fair value estimate should be at a slight discount, or in the 5-7x range of FY2023 management fees (base and performance fees).
RHB believes this could be satisfied fully through equity or a combination of equity and cash.
In FY2023, Suntec REIT’s manager monetised $94.4 million through sale of strata units at Suntec Office Towers at a 31% premium to book value.
Chong Kee Hiong, CEO of Suntec REIT’s manager has a stated strategy to bring the REIT’s aggregate leverage of 42.4% as at Dec 31, 2023, down to 40%. He plans to divest assets to raise cash rather than an equity fund raising.
In view of the rate cycle, Chong would like to divest one of the Australian office buildings if possible. However, liquidity and financing are limited down under for large transactions and actual selling prices of buildings may well be lower than valuations for these large transactions. “Transactions are at about 20% to 25% off their last valuations. There is a gap between valuation and transaction prices,” Chong had said during is FY2023 results briefing.
In FY2023, Australia contributed 18% to the REIT’s income, and accounted for 14% of AUM. Operationally, NPI from its Australian properties was 9.5% lower y-o-y in 2HFY2023, and 14.3% lower in Singapore dollars.
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The Australian portfolio, valued at $1.72 billion as at Dec 31, 2023, is down 5.3% y-o-y in Singapore dollars. The portfolio comprises five buildings, 177 Pacific Highway in Sydney, Southgate Complex Melbourne, 477 Collins Street Melbourne, 35 Currie Street Adelaide and 21 Harris Street Sydney.
Chong has classified the Australian portfolio as core and core-plus. Core represents the properties Suntec REIT plans to hold on to while the manager would be willing to part with core-plus properties. Among them, 477 Collins Street is viewed as core; 21 Harris Street is fully occupied and core as is 177 Pacific Highway. At present, only the 50% stake in Southgate Complex in Melbourne is core-plus.
RHB reckons that the internalisation could provide mid-single digit DPU accretion. Based on ACRA filings, in FY2022, Suntec REIT’s manager posted a net profit of $33 million. A $30 million in distributable income translates into an FY2023 pro forma accretion of 3%-6%. Suntec REIT reported distributable income of $203.8 million in FY2023 (-19.1% y-o-y), DPU of 7.135 cents (-19.7% y-o-y) and DPU of 1.866 cents in 4QFY2023.
The DPU accretion of 3% - 6% is based on the assumption that all of the internalisation costs would be paid in new Suntec REIT units at $1.10 per unit. “Gearing should also be lowered from equity issuance while there will be a slight NAV dilution,” RHB says.
The argument for internalisation is that there will be future savings on acquisition fees (1% of value) and divestment fees (0.5%).
Its author, Vijay Natarajan, vice president, real estate and REITs, RHB, says there is likely to be limited impact to overall debt cost for the REIT due to its large, high-quality portfolio and potential lowering of its cost of equity. This is in contrast to Sabana Industrial REIT where internalisation could possibly cause margins on its loans to rise, analysts have warned.
Quarz Capital Asia has requisitioned a third EGM to attempt to internalise Sabana Industrial REIT without an EGM and extraordinary resolution. Analysts are increasingly articulating that it would have been easier and far less expensive to have the extraordinary resolution to change the trust deed on Aug 7, 2023, as that would have saved legal and all the other fees that have been charged to the REIT.
RHB has given Suntec REIT a "buy" call and target price of $1.35.
