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ESR plans C-REIT and doubling down on New Economy; provides perspective on Sabana REIT

ESR Group reports lower Ebitda and Patmi, but higher fund management Ebitda, to double down on New Economy

During a recent results’ briefing by ESR Group, Executive Chairman Jeffrey Perlman was asked how the removal of Sabana Industrial REIT’s manager Sabana Real Estate Investment Management (SREIM) affects ESR.

In 1HFY2023, ESR reported an Ebitda of US$550 million, down 18% y-o-y. However, fund management Ebitda rose 14% y-o-y to US$329 million on higher fee revenues, cost efficiencies and economies of scale, and fund management margins rose by 400 bps y-o-y to 82%. Patmi declined by 26% y-o-y to US$304 million.

“Patmi was in line [at 51% of our FY2023 estimate of US$594 million] but down 26% y-o-y due to lower fair value gains, divestment gains, and higher interest expenses,” notes HSBC in a report. “The Ebitda for fund management which now makes up 55% of total segmental Ebitda compared with less than 25% at the IPO, managed to rise by 14.2% y-o-y or 19% y-o-y excluding promotes, given the higher fee revenue and Ebitda margin,” the HSBC report observes. And, despite the depreciation of key Asian currencies such as yen and RMB against ESR’s reporting currency in USD, AUM increased to US$147 billion as at June 30 compared to US$145 billion as at December 31, 2022.

HSBC has tweaked its target price and reduced it by 20 HK cents, based on an average discount of 26% (from 21%) to its revised fair value from the sum-of-the-parts approach of HK$24.70 from HK$24.90 previously.

ESR plans to “double-down” on its New Economy strategy, Perlman indicated. During the results briefing, ESR’s management pointed out it had increased its Data Centre Fund 1 to US$1.3 billion with eight seed projects across the Asia Pacific region, comprising over 560MW of capacity. Five projects with US$ 1.5 billion in development value were started in 1H2023; and an additional 1GW of projects are in the pipeline.

ESR has established its largest-ever income fund in mainland China with a total investment capacity of RMB10 billion, seeded by an initial portfolio of RMB2.3 billion from its balance sheet. ESR is also in the process of planning a C-REIT.

Contribution from SREIM less than US$1.5 million

On August 7, 56.4% of Sabana REIT’s unitholders voted for resolution 1, to remove SREIM, and 55.6% voted for resolution 2, to internalise the function of the REIT manager. Resolution 2 comprised many directions to Sabana REIT’s trustee including a number of changes to the trust deed.

“The materialness of [SREIM] to Ebitda is less that US$1.5 million, so it’s inconsequential,” Perlman says, referring to the $1.5 million of pre-tax profit reported by SREIM for FY2021 and around $2 million in FY2022 compared to ESR’s US$550 million Ebitda for 1HFY2023. ESR reports in US dollars.

“With reference to the internalisation, it has not been approved. That would require a change of the trust deed which would require 75% vote. From ESR’s perspective, we continue to remain the manager of the REIT pursuant to the guidelines for what MAS has given us,” Perlman explains.

The 75% vote refers to the many changes of trust deed that the requisionists have proposed in resolution 2, which “directs” HSBC Institutional Trust Services (HSBC Trustee) to internalise the function of the manager. Changes in the trust deed require extraordinary resolutions (ER).

“We think how this REIT is managed is very important. We remain the largest unitholder and we want to ensure that it is handled appropriately. The trustee has not removed us as the manager. Internalisation requires a 75% vote. We'll have to kind of see where it all goes from there on that basis,” Perlman says.

Among the various steps any trustee which is directed to internalise a manager, would be appoint a new external manager, with a new trust deed, and then work to staple the manager to Sabana REIT, with the unitholders owning the stapled security.

On August 8, HSBC Trustee said via SGXnet, “Consistent with the Trustee’s Statement, the Trustee will now proceed with identifying and appointing professional advisers to advise it on the implementation of the Resolutions, including the holding of Further EGM(s) to seek Unitholders’ approval on, among other things, the necessary and specific amendments to the Trust Deed by way of extraordinary resolution(s).”

The requests by the requisionists for many changes in the trust deed, and the necessary and specific amendments in the trust deed referred to by HSBC Trustee which required extraordinary resolution(s) are what Perlman is most likely alluding to in his answers.

“During the transition period, the Trustee will expect the Manager to continue to serve as interim manager until a replacement internal manager is appointed. 4. The Trustee will provide further updates as and when there are material developments in respect of the implementation of the Resolutions. Such updates will be in the form of announcements on SGXNet,” HSBC Trustee says in its August 8 announcement.

Sabana could be one-off because of unusual maths

Perlman says: “The extension is do we see an impact in how we think about externally managed REITs?  We think that there is not going to be a material change in thinking in Asia as it relates to externally managed REITS. Real estate is much more more closely held in Asia than it is elsewhere around the world. So the ability to grow REITs, the ability to secure financing, is highly dependent on the sponsor of said REIT.”

Perlman continues: “If you look at kind of the alignment that comes with the sponsor, being a meaningful unitholder of the REIT, you've already seen situations even just over the last couple of months with highly reputable internally managed REITs, doing things that honestly really surprised unitholders, to their detriment. And part of that was because of the misalignment necessarily of not having a true sponsor, who owns units directly in the REIT and is highly incentivised by the growth and long-term success of creating unitholder values.”

To Perlman, the Sabana issue is a one-off situation, “which is an unfortunate reality of some information put out in the market. When you parse through it, taking for example, that you could have $40 million in cost synergies by internalising the manager which makes only US$1.5 million today, would certainly require a lot longer than what was articulated to the market.”

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