It’s almost a month since the IPO of Eagle Hospitality Trust and I thought I’ll take a look at it again given the price performance. Here are some thoughts regarding the 2 main concerns I raised in my IPO review – Trust in management and the Queen Mary.
About trust and alignment of interest
One issue that I think most people have is trust in management and the Sponsor as they are relatively unknown to us. But I think there are some indications based on their behaviour that the IPO is thought out and pro-actively managed to maximise investor upside.
Renovations and RGI
The Sponsor and owners obviously decided to renovate all their hotels prior to IPO so that the REIT will only enjoy the ramp up phase and avoid revenue compression if the hotels need to be renovated soon after IPO. This was the main reason why Revenue Generation Index (RGI) was below 100 in the years prior to the IPO. This shows some thought was placed in preparation for the IPO.
REIT vs Business Trust structure
Another point was on the decision to design a master lease structure that is 66% fixed rent with the remainder based on a percentage of Room Revenue and GOP. Based on my understanding, this is above market standard (about 50%) for SGX listed hospitality REITs. It is at least better than ARA US Hospitality Trust which used a largely Business Trust structure. This gives investors additional stability in DPUs.
Alignment of Interest
This is mainly seen in how the Founders of the Sponsor chose to roll their equity into the REIT and that the CEO owns a piece of the deal. This also indicated the Sponsor’s interest be along as investors and not asset managers.
About the Queen Mary
There was a lot of smoke surrounding the Queen Mary and I wanted to know what was relevant and what was noise. The main issue that needed clarity on was who’s responsible for the Queen Mary’s repairs – the REIT or the Sponsor.
On re-review of the prospectus, this part ended up being rather clear cut as it can be directly referenced from the prospectus amid a wall of text.
The Sponsor is responsible for the capital budget and major capital improvements
This is kind of implied from the fact that the lease on the Queen Mary was on a triple-net basis. However, for the avoidance of doubt, it was actually spelt out in a line at the top of Page 377 of the Prospectus.
As such, even if the repair costs turn out to be massive, the REIT is not on the hook for the costs.
The Sponsor contributes to a Capital Improvement Fund (CIF) Reserve to fund capex
Additionally, if you are concerned about the Sponsor’s potential inability to fund capex, it is mandated in the Master Lease Agreement that the Sponsor contributes a percentage of each property’s Gross Room Revenue (Gross Operating Revenue for the Queen Mary) to a CIF Reserve quarterly.
The percentage is 2% in 2019 and 3% from 2020 onwards. Based on my experience in the hospitality industry, these contribution rates are mostly consistent with industry standard.
Through this method, capex is largely funded upfront, with additional funding if needed footed by the Sponsor.
Given these facts, I feel the only residual risk associated with it is that in the event that structural damage is so significant and the ship is forced to close, the REIT will not be entitled to any rent.
I feel that the likelihood of this happening is relatively remote though if what management says is true.
The investment case
EHT has performed rather poorly since IPO, with unit price down roughly 10% from IPO price. I like to think there are no bad investments, only bad prices. As such, here are some valuation calculations I did to see if there is a case to take a punt on the REIT.
I felt a good way to think about valuing the REIT was to develop a conservative / disaster valuation by excluding the effects of the Queen Mary from DPU and NAV. Do note that these computations are ball park estimates and do not take into account a whole host of knock on effects.
Looking at the base case, the REIT is trading at a decent discount to book of about 19% and yielding a juicy 9.1%. As for the conservative case, the REIT is trading at close to book while sporting a decent 7.1% yield.
Based on these valuation metrics, I can see a case for taking a punt at base case valuations. That said, it is certainly not at fire sale valuations if you are concerned about the Queen Mary.
Overall, on hindsight, I feel the Queen Mary issue is not that big an issue given the safeguards in place. What holds me back is that it’s too early to tell as we have no track record to rely on. The onus will be on management to prove their abilities in the coming years.
Do you agree with my assessment of the pertinent issues with EHT? Do let me know in the comments.
If you missed my previous post
CRCT’s planned acquisition of 3 malls from Capitaland