Last week I attended the Keppel-KBS US REIT (KORE) AGM and left feeling a bit uneasy about some of the responses given during the AGM. As such, I gave myself a little homework to verify / cross check some of these responses. Here are my findings.
On Rights Issue Circumstances
It was represented during the AGM that the reason they had to issue rights at a huge discount to NAV was due to a “perfect storm of bad news”. This comprised of the trifecta of a US-China trade war, Aggressive Fed Rate Hikes and Potential tax regulation issues. So it was either miss out on a good investment opportunity or issue dilutive rights.
I decided to do some fact checking on this statement to evaluate management decision making prowess and here is the timeline I was able to verify.
Timeline of Events
- Mar 22 2018 – Brinkmanship in the US – China trade war begins, with Trump signing a memorandum on a list of Chinese Goods to consider imposing tariffs on.
- July 6 2018 – US and China slaps tariffs on each other
- August 23 2018 – Round 2 of tariffs hit
- September 24 2018 – Round 3 of tariffs hit.after about 1 month of deliberation. On the same day, KORE announces Westpark Portfolio acquisition and Rights Issue.
- The announcement showed 2 potential options: a preferential offering with exercise price of $0.78 and a rights issue with exercise price of $0.59.
- Oct 16 2018 – EGM convened for acquisition and rights issue
- Oct 23 2018 – Rights issue details released: 295 for 1000 rights at exercise price of $0.50.
- October 30 2018 – Offering documents lodged
- October 31 2018 – JP Morgan analyst publishes report on potential tax implications for KORE
- December 2 2018 – Temporary truce is announced
- December 28 – IRS clarifies there’s no tax implication.
If we were to map these issues timelines onto the price chart, we start to see a story.
Based on these timelines and charts, we can see that the US-China trade war had an initial impact, pushing unit prices from 80+ cents to about 75 cents.
Subsequently, from the launch of the acquisition on September 24 to the finalisation of rights issue details on October 23, unit prices depressed further till a low of about 68 cents.This could be attributed to peaking US-China tensions (final round of tariffs was launched on the same day as acquisition announcement), Fed Rate hikes (possibly but no consistent evidence to show this) and uncertainty over rights issue details.
Finally, post rights issue details release, unit prices plummeted to 57 cents, before the JP Morgan analyst report on tax issues hit on 31 October. This ultimately brought unit prices to bottom at 54 cents.
Based on 68 cents prior to announcement of rights issue details, the 50 cents exercise price represents a huge 26% discount. Also notably, the tax issue only truly blew up on them after most of the damage has been done to the unit price.
Going through this exercise raised some rhetorical questions I had:
- Why do a rights issue instead of a preferential offering? Is it because you are scared of poor uptake?
- Why do a rights issue at such a huge price discount? Is it also because of fear of poor uptake?
- Was the acquisition really so urgent that they have to do it then and there?
- The tax issue was clearly not really the radar of investors so I don’t think you could use it as an excuse.
Given this sequence of events, if the acquisition was that urgent and hard to come by, I think management could have done better by at least issuing rights at a smaller discount to reduce the dilutive effect of the acquisition. There may be good reasons for doing so (demand management maybe).
As such, while I feel management could have handled the situation better, I’m still inclined to give management benefit of doubt. I’ll still be keeping them on a tight leash though.
On Property Expenses and Taxes
A unitholder noted that property expenses make up 40% of revenues, a significant proportion of it being related to property taxes. I made a note to compare it to Manulife US REIT’s financials (a REIT with a similar profile and a more reliable management) to verify that this is the norm in the US. Here are my findings:
KORE’s property operating expenses cost roughly 39% of revenue. Property taxes cost roughly 12% of revenue.
Manulife US REIT Expenses
Manulife US REIT’s property operating expenses cost 37.2%. Property taxes cost about 12% of revenues.
Given that the margins and taxes are largely similar, I feel more comfortable in accepting the management’s response that this is in line with business fundamentals in the US office space.
On Corporate Governance
One thing I did not mention during my original article was that during the AGM, I noted that the Board seemed rather small with only 5 members. As such, it is even more important for the Board members to have the right composition and skill mix to provide effective oversight over the REIT manager. This made me look into the Board members backgrounds’ as well as the Corporate Governance report within the Annual report. The exercise produce some very interesting insights.
If you study the backgrounds of the directors, you notice a uniformity to them. They all come from Fund Management and Real Estate Management backgrounds ie Operational Backgrounds.
For me, I would have liked more diversity. I see a distinct lack of directors with audit / accounting and legal backgrounds. While Mr Soong has impressive credentials, he isn’t accounting / audit trained. As such, in my mind, he wouldn’t be a perfect fit for the Audit and Risk Committee Chairman role.
After learning that the Hyflux Board only had 1 – 2 Risk committee meetings a year, I’ve begun to look more closely at Committee Meeting attendance in my annual reports. After all, you will want to know that the Board’s directors fees are well spent.
Nothing too out of the ordinary here, I would have expected the Audit and Risk Committee Meetings to be 4 times a year given the need for quarterly reporting, but 3 times is close enough.
After going through this fact checking exercise, I feel slightly conflicted. Top of mind is the rights issue decision making process. While not perfect, I can understand why management potentially made the decisions they made. However, at the same time, the Board composition concerns me, as Fund managers is notoriously “sharky” and may not do what’s best for investors. They have already exhibited a bit of this in the rights issue outcome.
For now, I can only give them the benefit of the doubt and keep this investment on a tight leash.
Other related articles
Keppel-KBS US REIT AGM 2019 Highlights
If you missed my previous post
Hype, Trust and Greed do not make good investment strategies