Manulife US REIT’s (MUST) BTOU decision to sell an Atlanta asset to its sponsor is “a deal that matters” and will move the needle in lowering the REIT’s persistently high gearing, say DBS Group Research analysts Derek Tan and Rachel Tan.
On May 24, MUST’s management announced that they have entered into a letter of intent with its sponsor, The Manufacturers Life Insurance company, or Manulife, for the potential sale of Phipps Tower.
Phipps is valued at US$210 million ($283.88 million) as of December 2022, down 2.8% y-o-y. The property roughly accounts for some 10% of MUST’s net asset value, which was US$1.02 billion at the last valuation.
DBS’s analysts say Phipps is “one of the gems in the portfolio, which has historically shown resilient cash flows”.
They add in a May 24 note: “While the potential sale of a property with strong attributes could mean that the impact from occupancy challenges faced by MUST’s other existing properties is amplified, we see this as a potential bitter pill to swallow in order to bring forth more stability for the portfolio.”
Assuming it is sold at US$200 million, or a 5% discount to the last valuation, with the proceeds used to repay debt, the sale will bring MUST’s gearing down towards the 42%-43% level, says DBS. This will cure the perception of a stretched balance sheet, with MUST’s gearing at 49% during its results briefing for 1QFY2023 ended March.
See also: Manulife US REIT announces proposed divestment of Phipps to sponsor
Based on the reported US$12.2 million net property income for FY2022, DBS’s assumed transaction price of US$200 million will imply an exit yield of 6.0%.
The proposed divestment is subject to the execution of a definitive agreement with the sponsor where the purchase consideration is to be no more than the average of two average independent valuations commissioned by the manager and the trustee, a price that will be internally approved by the purchaser and discussed at an extraordinary general meeting (EGM).
Minimal dilution, lower risk of large fundraising
See also: Potential rescue by acquirer Mirae could dilute Manulife US REIT's DPU; DBS halves TP to 24 US cents
With the proposed sale, the risk of sizable equity fund raising (EFR) by MUST’s management is reduced substantially, says DBS. “Post the deleveraging of its balance sheet to 42%-43%, the risk of a sizable dilutive fundraising, estimated at US$175 million, is reduced and we see a possible lift in the share price overhang of the stock.”
That said, DBS believes that capital of US$50 million to US$75 million needs to be raised to bring gearing towards the 38%-39% level, a strategy that the analysts believe is still in consideration.
The analysts had raised the US$175 million figure in an earlier research note. On May 18, DBS nearly halved its target price on MUST to 24 US cents, warning that the rescue from potential acquirer Mirae could be dilutive to distribution per unit (DPU) by some 42% - 47%.
The earlier note predates the May 24 announcement by MUST. DBS had based its calculations on media reports that Mirae intends to acquire a stake in MUST and its manager for some US$150 million.
Based on this, DBS had estimated that a likely scenario would include a US$109 million capital injection by Mirae into MUST, or 32% stake of the enlarged entity. Meanwhile, the remaining US$41 million would be used to acquire the REIT manager, based on a ballpark estimate of 6x price-to-earnings (PE).
Exclusive no more
At the same time, the manager announced on May 24 that the exclusivity period regarding the potential transaction with Mirae Asset Global Investments has lapsed. While the manager is open to ongoing discussions with Mirae, it is also considering other proposals with other partners in relation to a strategic transaction involving MUST.
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The lapse of its exclusivity with Mirae provides MUST with the flexibility to pursue other strategic investments or mergers and acquisitions with other interested platforms, say DBS’s analysts. “Over time, investors will want to see more commitment with the sponsor (Manulife or new investors) to support the REIT in its growth journey.”
At the release of MUST’s results for 1QFY2023 ended March, the manager said the team is working “expeditiously” with Miae and aims to update unitholders with the finalised proposal by 2Q2023.
Now, DBS anticipates a near-term relief rally on the stock. While the stock was up 20% on May 23 to 17 US cents per unit, it is still trading at 0.3x price-to-book value (P/B) and offering a forward yield of 24%-25% (pre-disposal).
DBS’s target price is 25 US cents per unit. They believe that an upward revision will be subject to the outcomes of its strategic review and EFR that is yet to be announced.
RHB Bank Singapore analyst Vijay Natarajan has kept his "buy" call and unchanged target price of 40 US cents per unit as he sees the REIT being "on the road to redemption".
"We think the Phipps Tower disposal to MUST's sponsor is another positive step, demonstrating much-awaited sponsor commitment and brightening its longer-term prospects amid a very challenging near-term US office outlook," he writes.
"With the lapsing of the Mirae Asset Global Investments’ (Mirae) exclusivity period, the likely next steps for the REIT are further asset disposals and bringing in longer-term value-add strategic partners," he adds.
Factoring in the recent rate hikes, the downsizing of tenants at Phipps as well as its outlook, Natarajan is estimating that the tower's sale will fetch between US$190 million to US$200 million.
With the sale of Tanasbourne in April at US$33.5 million, the total estimated proceeds are likely to be used to pare MUST's debt and lower its gearing to a more comfortable 43%. That said, the move may not be fully sufficient as likely further asset write-downs at the end of 2023 will bring gearing above the critical 45% threshold.
As such, the analyst believes that the REIT needs to conduct further asset disposals or strategic equity injection from long-term partners.
"A rights issue is still a possibility but, with the Phipps sale, MUST has breathing space, allowing it to wait for conditions to stabilise," says Natarajan.
As at 10.44am, units in Manulife US REIT are trading 0.1 US cents higher, or 0.62% up, at 16.2 US cents. Its units reached an all-time low of 13.3 US cents on May 16.
