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Potential rescue by acquirer Mirae could dilute Manulife US REIT's DPU; DBS halves TP to 24 US cents

A US$175 million ($236.09 million) capital injection could be the lifebuoy Manulife US REIT (MUST) needs, say DBS's analysts.

A US$175 million ($236.09 million) capital injection could be the lifebuoy Manulife US REIT (MUST) BTOU needs to bring gearing back down to 40%, say DBS Group Research analysts Rachel Tan and Derek Tan.

However, the rescue from potential acquirer Mirae Asset Global Investments could be dilutive to distribution per unit (DPU) by some 42%-47%, add the analysts. “In addition, assuming a further 5% decline in distributable income (DI), we estimate that DPU dilution would be 45% to 49%.”

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Hence, in a May 18 note, the DBS analysts maintain “buy” on MUST with a lower target price of 24 US cents, down from 45 US cents previously.

“We see an optimal target gearing ratio of 40% (from current 49%) for MUST in order to better defend itself against possible asset valuation declines in the future. We estimate that US$175 million of capital is needed, implying a rights issue,” say the analysts.

While dilutive, it will be the likely way out for the REIT, they add. “Based on our estimates, assuming capital raised at 10% discount to current price will still see MUST offering a fully diluted FY2023 yield of 19%, compared to 28% currently, but still way above its historical mean. Every 10% discount in the new issue price will mean a further 3% percentage point (ppt) decline in yield.”

MUST’s management said on May 11 that due diligence by Mirae is “substantially completed” and the parties are currently negotiating key terms. Mirae will subscribe for more than 9.8% of new units to recapitalise MUST, reduce gearing and provide stability and growth, subject to unitholders' approval.

The REIT’s manager targets to complete the sale by early-3Q2023, with sponsor Manulife retaining its 9.1% stake. “All eyes are on the announcement of the potential Mirae deal,” write the DBS analysts.

DBS speculates on next course of events

While yet to be confirmed by the manager, assuming that earlier media reports of Mirae intending to acquire a stake in MUST and the REIT manager for US$150 million were true, DBS analysts estimate 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), they add.

Following that, MUST would undertake a new issuance of shares valued at US$11 million, or a 3.2% stake of the enlarged entity, to Manulife, in order for the sponsor to retain its stake of 9.1% in the enlarged entity.

With the estimated US$41 million in proceeds from the sale of the REIT manager, sponsor Manulife will likely channel the proceeds to fund the acquisition of Tanasbourne and an additional placement to retain its stake in MUST.

In a bid to bring down gearing, MUST divested its Tanasbourne property in Oregon in April for a consideration of US$33.5 million to a wholly-owned subsidiary of its sponsor.

MUST may need to raise further capital to bring gearing to a more comfortable level of less than 40%, says DBSD05.

The analysts posit an additional capital of US$55 million could bring gearing to 40%, “a level that brings much flexibility to the REIT”.

While the above is sufficient to bring gearing to a level that is below both the MAS gearing level of 50% and 45%, if ICR is below that of 2.5x, the DBS analysts believe a gearing of above 40% is still not a comfortable level for investors, in view of the potential valuation decline considering the challenging US office market.

“As such, we take a step further to evaluate if a rights issue should be considered to bring the gearing a notch lower to ensure a sufficient buffer. In addition, this could be an opportunity and equity solution for existing shareholders who could look to average down on their stake, given the significant decline in the share price,” add the analysts.

Further rights issue?

Could there be a possible one-for-six rights issue? DBS says a rights issue of US$55 million to bring the total capital injection up to US$175 million could be executed via a one-for-six rights issue.

“Any additional amount from the rights issue above US$55 million would bring gearing down to a more comfortable level of below 40% with ample buffer for a potential asset valuation decline, which we believe would be a win-win scenario to all parties,” they add.

With new equity capital raised to bring gearing to a more palatable gearing level of 40%, DBS believes this will provide MUST with sufficient flexibility to defend against further asset declines in the future, which will need an assumed further 20% decline in asset values to bring gearing back up to 50% level.

“This implies that MUST’s balance sheet can withstand a possible ‘through-cycle’ asset devaluation of 32% or a further 120 basis points expansion in cap rates from FY2022 levels,” they note.

DBS has dropped their FY2023-FY2024 DPU by 9% and 21% respectively, to factor in higher vacancy, higher cost and higher interest cost, to 4.3% and 5% from 4% and 4.5% previously. “We have yet to factor in any potential capital injection until further details are revealed.”

At the release of MUST’s results for 1QFY2023 ended March, the manager says the team is working “expeditiously” with Miae and aims to update unitholders with the finalised proposal by 2Q2023.

As at 1.50pm, units in Manulife US REIT are trading 0.2 US cents lower, or 1.4% down, at 14.1 US cents. Its units reached an all-time low of 13.3 US cents on May 16.

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