Sabana Share Issue Mandate: Say “No” and Learn from Manulife

We are calling on Sabana unitholders to protect their interests and vote against the mandate for the Reit manager to issue new shares.  Sabana’s AGM will take place on 25 April, and Sabana is asking unitholders to allow the manager to issue as much as 20% of the existing units outstanding.

While we are generally not against a share issue mandate to give the management some flexibility in case a buying opportunity comes its way, we think a mandate to issue as much as 20% is “excessive”, uncalled for and can potentially be detrimental to unitholders as it dilutes their stake in the Reit.

Sabana’s performance has deteriorated further over the past months, mainly because of the poor way the Reit is managed. Its DPU has fallen 7% YoY to 1.46 Singapore cents underperforming its S-Reit peers which saw flat or increasing DPU. Also, the occupancy rate at key properties such as NTP+ has fallen, while its industrial property at 1 Tuas Avenue 4 has now been vacant for more than six years.

Instead of seeking approval for the acquisition of new properties the manager of Sabana Reit should focus on improving its existing portfolio through asset enhancement initiatives and reducing vacancy.  

Interestingly there is a similar case, which could serve as a cautionary tale of how the manager and its owner, who is eventually responsible for “mismanagement” and value destruction can emerge unscathed while unitholders bear the brunt of poor decision making: 

Singapore-listed Manulife US Real Estate investment Trust (MUST), with 12 office properties in the U.S., has been badly managed over the past years. Since its IPO, the Reit manager has bought more than US$ 1.4 billion of assets from the sponsor. Almost all assets have fallen in value, with the valuation of the flagship Figueroa asset falling by more than 25% to US$ 211 million, resulting in the Reit to lose close to S$ 75 million in a single transaction with the sponsor.  

The transactions resulted in a massive increase in leverage, which stood at 49 percent at the end of 2022 – just shy of the 50% regulatory limit of Singapore listed real estate investment trusts. 

As a consequence, MUST units have declined about 70% since the IPO in May 2016 and underperformed the Singapore FTSE All-Share Real Estate Investment Trusts Index by more than 73%. 

In our view, the best way out of underperforming assets and overleveraging would be to sell some of the assets and return cash to unitholders. The MUST sponsor could also go the whole hog and wind up the Reit as it is trading below book value, hence unitholders would receive more in cash than the value at which the units are traded. 

But the MUST manager seems to choose another option through a backdoor, which unitholders actually opened for him: Get new capital and reduce leverage through share issuance.  

At the AGM in April 2022, MUST unitholders approved the issuance of as much as 20% of its outstanding units via a private placement (as part of the mandate to issue the massive amount of 50% of outstanding units).

According to recent media reports, MUST now seems intent on using this mandate to do a private placement to Korean money manager Mirae Asset Global Investments. And given the massive losses of the Reit’s unit price, we assume that the private placement, through which Mirae will obtain a share in MUST, will be at a serious discount to the current unit price and potentially dilute the other shareholders. 
 
Many MUST unitholders may now regret the permission to issue shares and in particular to the private placement (where there is not only a dilution in DPU but also in the unitholder’s stake).

And that’s why we are recommending Sabana Reit unitholders should vote down resolution 4 of the upcoming AGM and not allow Sabana to issue new shares (even when the mandate the Sabana Reit manager is seeking is smaller than at MUST: total mandate 20% of units outstanding, 10% via private placement).

Sabana should focus on its existing portfolio rather than on new acquisitions. And in case the management wants to buy property it can tap the banks as it’s leverage at 32.4% is among the lowest among Singapore listed Reits. No need to issue shares.  

Still, there is more to the planned MUST transaction which could serve as a warning to Sabana unitholders as it showcases the problems which can arise when the interests of the Reit manager and the sponsor are not aligned with the interests of unitholders.  

On 15 March 2023, the MUST Reit manager said it is “currently in discussions with Mirae Asset Global Investments to explore a potential transaction which might involve the acquisition of shares of Manulife US Real Estate Management Pte. Ltd. (MUST’s manager), and the subscription of new units in Manulife US Reit.” 

In other words, the planned private placement is part of a larger deal, which in our opinion is unfair to unitholders and a violation of good corporate governance: Sell a stake in the Reit at its low price (supported by a private placement) but fill your pockets by selling the Reit manager at a high price.  

The private placement, through which Mirae will obtain a share in MUST, might be at a serious discount to the current unit price and dilute the other shareholders. But since the manager is wholly owned by the sponsor, buyer and seller can agree on whatever price they want. While lowering the price for the stake in the Reit, the seller (sponsor of the Reit) can ask for a high price for the manager.

We doubt whether this is the appropriate reward for the sponsor and its poor management of the Reit. But one thing is clear: The transaction puts the other unitholders at a big disadvantage!

This is possible, because most listed Reits in Singapore are still run by an external Reit manager, while in the US and Australia more than 90% of the Reits have moved to a model, where the Reit manager is internal.  
 
An external Reit manager is owned by the sponsor (who started the Reit and in most cases develops and sells property to the Reit). An internal manager is part of the Reit and as such owned by all Reit unitholders, including the sponsor.  
 
And there lies the conflict of interest. Any salary paid to the internal manager is just a cost to be borne by all owners, sponsor and other unitholders alike. But any fee paid to the external manager becomes a profit (after paying the salary for the Reit manager staff) to the sponsor, however it reduces the distribution to other unitholders.  

Sponsors like external managers, because it allows them to extract money at the expense of other unitholders. This is not possible with an internal manager.  

Why is all this relevant to Sabana unitholders? Because Sabana has exactly the same external-manager structure as MUST.   

Sabana Reit is managed by Sabana Real Estate Investment Management, which is wholly owned by the sponsor, Hong Kong-listed ESR Group. ESR also indirectly owns a 20.5% stake in Sabana Reit.  

In other words, there is a strong incentive for the Sabana Reit manager and the sponsor to extract high fees from the manger (and indeed, the Sabana Reit manager salaries are among the highest in Singapore). The higher those fees, the lower the DPU.

There is also a strong incentive to increase the portfolio size, even if the acquisitions might not be yield-accretive. The bigger the portfolio (even if it performs poorly) the higher the salary for the manager and the lower potentially the DPU.

And lastly, there is a strong incentive for the sponsor of a poorly managed Reit, such as Sabana, to make a private placement and sell the stake cheap while selling the manager at a high price. Again: The sponsor wins, the manager wins, the unitholder loses.

At the April AGM, Sabana’s unitholders can throw a spanner in the works of the unfair value distribution: “Say no to the share issue mandate!”