Regular readers would know that I have shifted to a more income approach over the past year and as part of that strategic shift, it involves purchasing more REITs for my portfolio. Also, I have in the past espoused my love of rights issues / preferential offering as seen in my participation in the Frasers L&I Trust preferential offering.
Unfortunately, just as stocks are not born equal, REITs are also not born equal. Whether a rights issue is value accretive or destructive very much depends on the structure of the deal, with that heavily influenced by the REIT Sponsor and Manager. If you invest in a REIT that has a Sponsor who’s interest is not aligned with the interests of minority shareholders, you can get shafted with some pretty bad deals.
Today, I’ll examine one such example – OUE Commercial REIT’s proposed acquisition of OUE Downtown from its Sponsor, OUE Limited, and its associated rights issue.
“Art” of the Deal
Here’s a summary of the significant effects of the acquisition and associated rights issue:
Right out of the gate, you can see that the rights issue is ridiculously dilutive to your investment, with your distribution yield falling from 7.02% to 6.21% if you only take your own entitlement of rights. Pay you my hard earned cash and I get less dividends as a result?
The market rightfully recognised this and the REIT’s price corrected over the past week.
How low must the price be before you get the same yield post acquisition as pre-acquisition?
Let’s work this out backwards, pre-acquisition distribution yield was 7%, as such for distribution yield to remain at 7%:
Target TERP = $0.0354 / 7 x 100 = $0.505.
Target Price cum rights
= (0.505 x 2,852,129k post acq units – $587,500,000 proceeds) / 1,546,769k pre acq units
That is a whopping 17.3% drop from the 10 Sep price and a further 9.1% drop based on yesterday’s closing price of $0.605!
The worst part of this, this is of no fault of the REIT’s existing property portfolio performance. It’s like passing the ball to your soccer captain and he takes the ball, turns around and scores an own goal, leaving you wondering what you did wrong.
Moral of the Story
Investing in REITs require close examination of Sponsor and Manager behaviour, and not just studying them from a numbers perspective. Some REITs tend to have management and sponsors who couldn’t care less about minority shareholders and it is important to understand management before investing. If not, you risk being exposed to such value destructive behaviour.
For those invested, I feel you and I hope the rights issue works out well for you (ie you get a lot of excess rights, and I mean A LOT). For me, I’ll avoid this REIT like the plague until it is at a much much cheaper price.
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