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OUEHT unaffected by OUE’s issuance of convertible and exchangeable bonds

Goola Warden
Goola Warden4/16/2018 07:30 AM GMT+08  • 12 min read
OUEHT unaffected by OUE’s issuance of convertible and exchangeable bonds
SINGAPORE (Apr 16): On March 14, OUE announced that it was issuing $154.75 million of 1.5% convertible bonds due 2023, convertible into ordinary shares in the company; and $150 million of exchangeable bonds, exchangeable into stapled securities (units) i
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SINGAPORE (Apr 16): On March 14, OUE announced that it was issuing $154.75 million of 1.5% convertible bonds due 2023, convertible into ordinary shares in the company; and $150 million of exchangeable bonds, exchangeable into stapled securities (units) in OUE Hospitality Trust. The EBs bear a coupon of 3%. OUE holds 659.2 million units, or 36.34%, of OUEHT. The issue date for both tranches is April 13, and their maturity date is April 13, 2023.

The initial conversion price for the convertible bonds is $2.112, which is a 10% premium to OUE’s closing price of $1.92 on March 13. The number of conversion shares to be delivered based on the initial conversion price is 73.27 million shares, or 8.12% of the existing shares in issue.

The initial exchange price for the EBs is 95.7 cents per unit. The number of units exchanged will depend on $150 million divided by the prevailing exchange price of OUEHT units, or 156.7 million at the initial exchange price. The initial exchange price is a 10% premium to the closing price of 87 cents on March 13 (the day before the announcement). OUEHT’s price has fallen to 80 cents since the announcement, for a loss of around 9%. In the same period, the Straits Times Index lost 11 points.

“The proceeds will be used for general corporate purpose and refinancing of existing debt obligations,” an OUE spokesman says. OUE is controlled by the Lippo Group’s Riady family, which holds around 68.7% through various entities in Hong Kong. OUE in turn owns 55.7% of OUE Commercial REIT (OUECT).

OUEHT’s fundamentals intact

OUEHT is the most followed REIT in the OUE-Lippo Group stable. The REIT owns Mandarin Orchard Singapore, the Mandarin Gallery (a high-end shopping mall) and Crowne Plaza Changi Airport (CPCA). For FY2017, OUEHT’s revenue and net property income (NPI) 2017 rose 7% and 5% y-o-y respectively to $131.1 million and $112.7 million. Its distributable income rose 12.7% y-o-y to $92.9 million. Distribution per security rose 11.5% y-o-y to 5.14 cents, translating into a historical yield of 6.4%.

The REIT’s 2017 master lease income and NPI from the hospitality segment grew 7.1% and 5.5% respectively to $96.3 million and $87.4 million. The increase was due to better operating performance from Mandarin Orchard and full-year contribution from the enlarged 563-room CPCA. Mandarin Gallery recorded higher revenue of $34.7 million last year compared with 2016’s $32.6 million as a result of higher average occupancy of 95.5% OUEHT compared with 86.3% the year before. Its NPI at $25.3 million was higher than 2016’s $24.5 million. This is despite average psf rents falling to $23.30 a month compared with $24.20 psf a month in 2016.

In a recent report issued in the wake of the EB announcement, Vijay Natarajan, an analyst at RHB Securities, reiterated a “buy” recommendation for OUEHT. He feels that the decline since March 13 was unwarranted, given the improving outlook for the hospitality sector this year.

In February, the Singapore Tourism Board (STB) announced that visitor arrivals for 2017 rose 6.2% y-o-y to 17.4 million and tourism receipts were 3.9% higher at $26.8 million as the arrivals were from high-spending markets such as China, South Korea, the US and UK.

Natarajan says the Singapore Airshow in February saw a 10% jump in trade visitors compared with 2016. “We believe CPCA, being the nearest hotel in the vicinity, would have seen a corresponding positive impact. While the latest official visitor arrival data has not been released, Changi Airport’s passenger traffic for the first two months of 2018 was up 3.1% y-o-y, implying visitor arrival growth is on track,” he adds.

For this year, STB is forecasting a growth in visitor arrivals of 1% to 4%, to between 17.6 million and 18.1 million, and tourism receipts to grow by as much as 3% to $27.6 billion. If visitor arrivals come in at the higher end of the forecast, it would be positive for hotels because net new rooms are likely to grow by just 1.1%. Howarth HTL is estimating a supply of 769 new rooms for 2018. A total of 426 rooms are undergoing asset enhancement initiatives (AEIs) at Swissôtel The Stamford and have been removed from overall supply this year. Howarth has added back 329 rooms for 2019, taking overall estimated supply next year to 1,664.

In the meantime, the recent hefty fines of $60,000 imposed on two Airbnb rental hosts will probably deter growth of short-term rent al services, Natarajan notes. With hotel supply having peaked last year, revenue per available room (RevPAR) will increase 3% to 7% in 2018, he reckons.

Chong Kee Hiong, CEO of OUEHT’s manager, was more cautious during the REIT’s FY2017 results briefing earlier this year. Although the outlook for 2018 is better than that for 2017, it is “not that strong, otherwise we won’t forecast +2% to 3% growth in RevPar”, he said. Chong is focused on yield management — that is, getting higher rates for rooms. Mandarin Orchard has around 400 newly renovated rooms that he believes can obtain higher rates.

Changi Airport’s Terminal 4 commenced operations in 4Q2017, and the airport recorded its 60th million passenger within a calendar year for the first time. However, Chong points out in OUEHT’s annual report that the market has to absorb the additional rooms that came on stream in 2H2017. Hence, the market environment remains competitive. Also, challenges in Singapore’s retail scene remain, with tenants being more cautious and taking a longer time to renew or commit to leases, he adds.

The major positive about OUEHT is that all its assets are in Singapore, its properties are well known and well visited and it does not have foreign-exchange rate risk, unlike other hospitality REITs.

However, its bond-like behaviour was disrupted and units in OUEHT have underperformed the market since the EB announcement, Natarajan says. He points out that there will be no change in OUEHT’s number of units, which will stay at 1.814 billion, notwithstanding new units to be paid for management and other fees.

“The key thing to note is that the EB will have no dilution impact on OUEHT’s DPU [distribution per unit] and NAV [net asset value], and would only result in a potential reduction of the sponsor’s stake to 29% from 36.4% if fully exercised. We also highlight that OUEHT’s exchange price is above our target price of 95 cents,” Natarajan says, implying that the EBs are unlikely to be converted into OUEHT units.

Following the recent selldown, Natarajan believes OUEHT’s DPS yield has become more compelling, with forward yields for this year and next year estimated at 6.7% and 7.2% respectively, which are more attractive than S-REITs’ average yield of 6%. A positive upside surprise could come from stronger-than-expected visitor arrival growth, he says.

Unease about OUE

Convertible bonds are a relatively cheap way to raise debt and OUE’s financials appear pretty strong. Although net profit fell 31.5% y-o-y to $98.9 million for FY2017, this was due to non-recurring income from the sale of CPCA to OUEHT during FY2016.

Its balance sheet remained resilient. As at Dec 31, 2017, OUE had some $2.94 billion in net debt compared with $2.66 billion as at Dec 31, 2016. This translates into a debt-to-equity ratio of 0.6 times versus 0.57 times a year ago. These ratios are not demanding for a property company.

Moreover, OUE’s debt includes the consolidation of OUECT’s $1.26 billion of debt. OUE holds around 55.7% of OUECT, which has a gearing ratio of 37.3%. On Jan 2, OUECT redeemed 100 million convertible perpetual preferred units at $1 a unit.

In addition to OUECT, OUE also owns OUE Downtown, which completed AEIs last year, and US Bank Tower in Los Angeles, which it acquired for US$367.5 million in 2013. The free hold US office building was valued at US$605 million ($794.7 million) as at Dec 31.

In April 2017, OUE completed its acquisition of International Healthway Corp (IHC), which was renamed OUE Lippo Healthcare. “The Group’s expansion into the healthcare real estate sector is a strategic fit with our existing asset portfolio comprising commercial, hospitality, retail and residential properties,” said chairman Stephen Riady in OUE’s annual report. “With the goal of transforming lives through the provision of better healthcare and asset management, OUE Lippo Healthcare is poised to capitalise on the tremendous growth potential of this sector, given the rapidly ageing populations and growing affluence across Asia, and the consequent rising demand for quality healthcare.”

OUE Lippo Healthcare owns and manages 12 nursing homes in Japan and a hospital in China. There are plans to expand the existing hospital as well as develop a second hospital in China and a wellness and medical integrated mixed-use development in Malaysia. In January this year, Itochu Corp took a 25.3% stake in OUE Lippo Healthcare through a private placement that raised $78.8 million.

Litigation from IHC continues

The acquisition of IHC brought with it litigation cases with Enterprise Fund III, Value Monetization III and VMF3 — collectively known as the Funds — which had appointed receivers to four subsidiaries of IHC back in April 2016. OUE Lippo Healthcare commenced proceedings against the Funds to challenge the sum claimed under notices of default and the Funds have countersued for damages.

Separately, in 2013, IHC acquired 74.97% Health Kind International (HKIL) and its subsidiaries, Health Kind International (Shanghai) Co (HKIS) and Wuxi New District Phoenix Hospital Co (WNDH). In 2014, HKIS was sued by the previous shareholder of WNDH, Health Kind (Shanghai) Investment Management Co (HKIM). As at Dec 31, 2017, the legal proceedings are still ongoing. The outcome of the proceedings remains uncertain, the annual report says.

On Nov 1, 2017, OUE announced that OUE Beta and OUE Coral had subscribed to stakes of 99.98% and 0.02% respectively, in Alpha Sentra Prima, which at the time was a dormant company. Subsequently, Alpha Sentra Prima acquired some Indonesian companies. On March 30, OUE announced that OUEBeta and OUE Coral had entered into a conditional share sale and purchase agreement with Megafeat Internasional Indonesia and an individual, Mas Agoes Ismail Ning, to sell Alpha Sentra Prima to Megafeat for $228.9 million.

OCBC Credit Research said of the March 30 transaction: “In our view, given the sizeable amounts of $228.9 million to be due from PT Megafeat Internasional and the current lack of information, counterparty risk may be introduced.”

OUE’s NAV as at Dec 31 was $4.46. The stock is trading at just 0.4 times its book value, a reflection of uncertainty over the Indo nesian acquisitions and disposals by OUE Beta and OUE Coral, and the exchangeable bonds. Few property stocks with such a robust balance sheet trade at such steep discounts to NAV. In an April 3 report on the residential property sector, OCBC Investment Research had a “buy” rating on OUE.

Moody’s is negative on Lippo Group

Moody’s Investors Service issued four negative reports on OUE’s sister companies based in Indonesia this year— one each on Lippo Karawaci and Lippo Malls Indonesia Retail Trust and two on Matahari Putra Prima (Matahari). Lippo Karawaci is sponsor and 29.9% shareholder of LMIRT and sponsor and 27.9% shareholder of First REIT.

On March 5, Moody’s Investors Service downgraded the corporate family rating for Matahari to B3 from B2 and placed the B3 rating on review for further downgrade. During 3QFY2017, Matahari increased its debt by around 50% to IDR1.3 trillion ($124.06 million) to help fund its operations. As a result, debtto-Ebitda (earnings before interest, taxes, depreciation and amortisation) ratio increased to 6.7 times for the 12 months ended Sept 30, 2017, from 4.4 times in the previous quarter.

“The downgrade reflects the heightened liquidity risk and reduced financial flexibility, given [Matahari’s] non-compliance with some covenants, combined with weaker-thanexpected operating performance, large nearterm debt maturities and limited availability to draw down further under its existing debt facilities,” says Maisam Hasnain, a Moody’s analyst. With negative earnings and increased debt, Matahari’s credit profile is likely to weaken, Hasnain reasons. “The rating remains on review for downgrade, given the potential for [Matahari’s] liquidity and credit metrics to deteriorate further, following its announcement to delay its planned rights issue.”

According to Moody’s, Lippo Karawaci’s B1 rating outlook was changed to negative to reflect an increase in the developer’s execution and financing risks, underpinned by a shift in its strategy where it concurrently sells and constructs Meikarta — a residential development project in the east of Greater Jakarta that targets the lower middle-income group —instead of pre-selling the project before construction.

Moody’s withdrew its rating for LMIRT on April 2 after downgrading to Ba1 on March 15. LMIRT’s rating was downgraded to Ba1 to reflect a weakening in the trust’s financial metrics and its significant exposure to the key entities within the Lippo Group, whose credit quality is deteriorating, Moody’s had said. There is also considerable exchange-rate risk because revenues are in rupiah and distribution per unit is in Singapore dollars.

On April 11, LMIRT’s manager announced that Indonesia has passed new tax regulations on income earned from land and building leases in the country. Such income will be subject to a 10% tax on the gross amount of the value of the land or building lease, which comprises the total amount that is paid by a tenant in any form, including service charges and utilities recovery charges.

The new regulation is effective Jan 2, 2018. If the new regulations had been in effect on Jan 1, 2017, the REIT manager calculates that FY2017 DPU would have been 7.2% lower at 3.19 cents pro forma instead of the reported DPU of 3.44 cents.

OCBC Investment Research says this could prompt selling pressure on the REIT.

Although OUE is related to the Lippo Group, it operates independently. However, the downgrades in Indonesia, coupled with the issue of exchangeable bonds, has added to a feeling of unease, especially at a time when markets have turned volatile. Analysts remain positive on OUE Hospitality Trust.

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