SINGAPORE (Dec 2): In April this year, following overwhelming votes in an extraordinary general meeting (EGM) in favour of resolutions by CapitaLand’s independent shareholders to acquire Ascendas-Singbridge (ASB), Quarz Capital Management (QCM) wrote an open letter to Ascendas Hospitality Trust (A-HTrust) proposing that Ascott Residence Trust (Ascott REIT) acquire A-HTrust in a cash and unit transaction. At the time, CapitaLand had issued a statement saying that the merger with ASB was subject to conditions precedent being fulfilled. However, CapitaLand added that it was aware of the overlapping mandates of the two trusts. Ascott REIT and A-HTrust eventually announced a merger in July, which will be completed by year-end.
On Nov 11, QCM wrote an open letter to ESR Cayman, the sponsor of Sabana Shari’ah Compliant Industrial Real Estate Investment Trust, proposing that ESR-REIT merge with Sabana REIT. QCM proposed that the merger be done through a cash and unit transaction in which 0.92 unit of ESR-REIT and $0.067 in cash be exchanged for one unit of Sabana REIT for a total value of 54.5 cents a unit.
While these are the actions of an activist investor, QCM is different from other activist investors. The usual modus operandi of activist investors, such as Elliott Capital globally, Argyle Street Management (ASM) in Asia-Pacific and Sandon Capital Investments in Australia, is to take a significant stake in a poorly run company and lobby for changes to unlock value, or take a substantial stake in a company to “clean up” issues such as debt.
For instance, ASM roped in the Sinar Mas Group to invest in the troubled United Fiber System and inject its coal-mining business. UFS was renamed Golden Energy and Resources and is now profitable.
Separately, ASM took a 19.25% stake in Australian Securities Exchange-listed Donaco International, by acquiring senior bonds issued by Orchard Capital Partners. OCP had acquired its stake from Donaco founders Joey and Benjamin Lim after they defaulted on the repayment of a loan from OCP in November 2018. (The Lims are from the same family as the one who controls Genting Bhd.) In March, The Edge Markets reported that Joey Lim Keong Yew and Benjamin Lim Keong Hoe, the grandsons of the late casino king Lim Goh Tong, had lost control of Donaco. Donaco runs casinos in Cambodia, including one on the Thai-Cambodian border.
The tussle for control of Donaco appears to be ongoing and an EGM on Nov 29, the day The Edge Singapore goes to print, could resolve the issue. Two new investors in Donaco, Gerald Tan Eng Hoe and Patrick Tan Teck Lee, have been pushing for Donaco’s entire board of directors to be dissolved. A source close to ASM suggests that the two new investors are proxies for Joey Lim and his brother.
ASM is also known in Singapore for getting Saizen REIT’s manager to realise the REIT’s net asset value. The REIT’s portfolio of Japanese residential units was divested to a unit of Lone Star Funds for $517.3 million and the transaction was completed in March 2016. The divestment price was 3.4% above Saizen REIT’s NAV. This translated into $1.17 a unit, or a 36.9% premium above the closing price prior to the announcement of the offer. After divesting the assets and repaying debt, Saizen REIT became a “cash trust”. It then returned $1.056 to unitholders on March 28, 2016, 2.83 cents on March 29, 2016 and 7.5 cents on Sept 29, 2016.
Another activist investor familiar to Singapore investors is Sandon Capital, which manages and co-invests in the Sandon Capital Activist Fund. It has twice attempted to get AIMS Property Securities Fund — most recently in December 2018 — to divest its assets and delist. It has so far been unsuccessful. Sandon Capital’s rationale is that investors can realise AIMS Property Securities Fund’s NAV, which is higher than its market value. AIMS Property Securities Fund is managed by AIMS Financial Group, which is also the sponsor and major unitholder of AIMS APAC Industrial REIT. ESR Cayman owns 10.02% of AA REIT.
Getting paid to wait
“The main difference between activist investors and ourselves is that they go for companies in distress and/or companies whose management has done a bad acquisition. We go, in almost all cases, for companies that are severely undervalued,” explains Jan Moermann, chief investment officer of Quarz Capital Asia, the Singapore entity of QCM. Quarz Capital Asia has a registered fund management company licence issued by the Monetary Authority of Singapore.
How severely undervalued must these companies be? Most of them need to be trading at below 0.7 times tangible book value, Moermann, a Swiss national, says.
“We check the financials; the companies must have a well-run business that pays a good dividend, and they must be able to maintain their dividends. There should be no surprise on the downside, and we get paid for waiting,” Moermann adds. “So, if we get in at a share price of 0.3 times book and it drops to 0.25 times, by working with the company, we get paid dividends. That’s important to us, to cap the downside for our margin of safety.”
Take the case of A-HTrust. QCM in its April open letter to A-HTrust suggested that 0.75 unit of Ascott REIT and 18 cents in cash be exchanged for one unit of A-HTrust. In July, Ascott REIT proposed paying $1.0868 per A-HTrust stapled unit, comprising 5.43 cents in cash and 0.7942 Ascott REIT-BT stapled unit issued at a price of $1.30.
Whatever the case, QCM made a hefty gain. Its Quarz Global Opportunities Fund is up more than 65% this year and it had just one investment, A-HTrust (see Chart 1). “Quarz Global Opportunities Fund is where we do a concentrated approach, where single family offices are interested and have concentration in. This is a onestock- by-one-stock fund,” Moermann says. A-HTrust announced a dividend of 6.03 cents in FY2019 (for the 12 months to March 31). Its unit price in March and April was around 88 cents, which provided a distribution per unit (DPU) yield of 6.85%. This is what Moermann means by being paid to wait. The fund continues to collect dividends.
QCM also manages the Quarz Active Value Fund, which is up 20% year to date. This fund is more diversified, with 10 to 15 stocks.
Not just below book value
For a REIT, QCM looks for undervaluation. “Our strategy is based on finding a few good companies that are sound but undervalued, that have tangible assets, with a cap on the downside and a generous dividend policy,” says Moermann.
When QCM looked at Sabana REIT more than a year ago, it was trading at the 40-to- 42-cent range versus its NAV of 52 cents. Sabana REIT last traded at 46.5 cents versus its Sept 30 NAV of 56 cents.
How robust is that NAV? One of the gripes that minority unitholders — who requisitioned an EGM to remove the manager in April 2017 — had was that master leases caused asset valuations to be artificially high. At the time, valuers would just state the outlook for rents based on these master leases. Properties with a long weighted average lease to expiry (WALE) as a result of long master leases, had higher valuations than adjacent properties at market rents and with shorter leases. Now, though, REITs have to indicate what valuations would be if the properties were rented out at market rents compared with master leases with artificially high rents.
Interestingly, as at Sept 30, of Sabana REIT’s 18 properties, 10, or 66.4% of the portfolio by net lettable area, were multi- tenanted, with eight properties, or the remaining 33.6% of NLA, on master leases. While some investors argue that master- leased properties could have rents that are above the market rate, the rents of multi- tenanted properties are usually priced at market rate. In addition, Sabana REIT’s WALE is relatively short for an industrial REIT, at just 2.8 years by gross rental income. The industrial REIT’s balance sheet is underleveraged, with gearing at just 30.8% and interest cover at 4.8 times.
In the meantime, Sabana REIT’s manager has announced an asset enhancement initiative for New Tech Park, the REIT’s largest property by valuation and net property income contribution. New Tech Park’s gross floor area is 75,317 sq m (810,710 sq ft), and plans are underway to add 3,980 sq m of new commercial GFA, comprising a supermarket, F&B options and a gym. This first phase of AEI will be completed in 2QCY2020. In the second phase, AEI for F&B units on the second floor will be completed in 4QCY2020. Commercial GFA carries a higher valuation than that for industrial and business park GFA.
In a September report, DBS Group Research pointed out that Sabana REIT’s portfolio has 1.56 million sq ft of unutilised GFA. The biggest uplifts would be for three properties: 1 Tuas Avenue 4, where GFA could be lifted by 130%; 33&35 Penjuru Drive, with a 142% hike in GFA; and 26 Loyang, where GFA could increase by 226%.
The risk, though, is that 33&35 Penjuru Drive are master leased to former sponsor Vibrant Group, and Vibrant’s lease terms are due to expire in 2019/20, at a time when there is likely to be supply of 822,000 sq m of factory space coming onstream. DBS Research reckons this could place downward pressure on the occupancy rate and rents.
A major gripe that QCM has with Sabana REIT is that sponsor ESR Cayman also owns the manager of ESR-REIT and a stake in ESR-REIT.
QCM says the overlapping investment mandates of the both REITs can result in corporate governance concerns. “We find ESR [Cayman]’s argument that they can manage the two REITs independently unconvincing,” QCM had said in a Nov 13 statement.
DBS Research too thinks that “the industrial REIT space looks ripe for consolidation. We believe that Sabana REIT is a natural target, given that its new sponsor holds stakes in a fellow industrial S-REIT that has been on the lookout for acquisitions”.
Singapore offers value
Even then, Moermann likes investment opportunities in Singapore. “Some companies here are undervalued. There is no tax on dividend, and family owners prefer to run their businesses, make a profit and pay out a dividend,” he elaborates. This is unlike in Europe and the US, where external managers get incentivised to run the businesses. “The companies are run much leaner, and they don’t have excess cash. If the companies have excess cash, they are likely to do an M&A or grow by buying new factories in, say, Eastern Europe, or be encouraged to do a share buyback because in Europe, investors pay withholding tax on their dividends,” Moermann continues. “In Europe, companies do more buybacks and use their share price to defend their companies, because they need a high share price for acquisitions,” he explains. That is why in Germany, Switzerland and the US, most companies trade at multiples of book value, with lower yields and higher valuations.
As Moermann sees it, CEOs also get rewarded if their companies are sold for 20 to 30 times earnings, hence they are incentivised to keep share prices high.
In Singapore, QCM has a list of undervalued stocks. “Our job is to filter out value from a value trap,” Moermann says.
How does he tell the difference between value and a value trap? “We use consultants, valuers and other shareholders and, in the end, we put out our view in a letter for other people to see and, hopefully, we are right. Nine times out of 10, we’ve made money,” he says.
Diversifying differently
To Moermann, diversification is not about having a lot of stocks in the portfolio but having different asset classes, such as bonds, convertibles and equity. He cites Bridgewater Associates’ investment style. “Ray Dalio [founder of Bridgewater Associates] said diversification is a matter of correlation. If you take stocks, and your portfolio has 600 stocks, you are less correlated than a guy taking 10 stocks and a property or a bond. So, we try to take more concentrated positions in fewer companies but we try to do deeper work on those companies and cover all their tracks, do due diligence on the companies and find out what’s happening,” he explains. “It is worth spending time and effort to catalyse the investment because it provides better upside to investors.”
Moermann sidesteps a question on the names of the pipeline of companies he is looking at. “We are facts-based and it’s fair to issue a letter with our analysis, and we can do fact-checking together and we appreciate the feedback we have received.”
The Singapore market is unique, he says, because of a preponderance of family- owned companies, no capital gains tax and no withholding tax on dividends. The S-REITs are on the whole well managed and transparent; some are undervalued; and they provide good yield. Singapore investors appreciate this, Moermann says.
And now, so do European investors like himself.
