Thursday, April 25, 2019

Eagle Hospitality Trust - Preliminary Prospectus IPO

Eagle Hospitality Trust (EHT) is currently preparing for their public offering issuance and has lodged their prospectus with MAS.

If you want to read their prospectus in detail, you can find them here.

If successful, it will be the very first US pure-play hospitality Reit we have in SGX. 

It's interesting to see the various pure play breed choosing to list their Reit vehicle here in Singapore but I guess that's a clear sentiment of how far the Reits industry have come so far.

Hotel's Portfolio

The Reit's portfolio is valued at US$1.27b which comprises of 18 full service hotels under the various different brands - Marriot, Hilton and InterContinental brands with a total of 5,420 rooms.

Out of the 18 hotel properties, 9 of them belongs to the "Upper Upscale" hotels, 5 belongs to "Upscale" hotels and 4 belongs to "Upper Midscale" hotels.

The way I see it it's easier to think of them as 5 stars, 4.5 stars, and 4 stars hotel.

The location of the hotels are spread across mostly on the West side of the country, with only two (New Jersey and Connecticut) at the East side and two (Atlanta and Orlando) at the Central.



All except one of the properties are freehold in nature, which is common in the US, so this compares differently to the pure hospitality play we have here in Singapore which are mostly at 60 years leases.

The only non-freehold asset in the portfolio is the Queen Mary Long Beach in California which has a balance lease tenure of 63 years.

Regardless whether or not the assets are freehold, the properties still need to undergo asset enhancement (AEI) from time to time on maintenance repair work for wear and tear, so that will work out to be similar.

Since 2013, the management has spent a total of $174m capex on these properties mainly on renovation and refurbishment to improve the working function of the properties.

Sponsor & Management Fees Structure

The sponsor of EHT is Urban Commons LLC, a privately held real estate investment and development firm which managed the USHI portfolio and has a focus on the US Lodging market.

The sponsor was co-founded by Howard Wu and Taylor Woods, both prominent figures in the real estate hospitality industry.

The sponsor will own 18.3% of the stapled security with a lock-up agreement 12 months after the listing date.

The management fees structure is a base fee of 10% of the distributional income and an annual performance fee of 25% of the growth of DPS over the preceding financial year.

This seems pretty high if you compare it across the local hospitality reits.

Tax Structure

This works out a bit differently to the recent case with Manulife Reit and Keppel KBS Reit on the Section 267 hybrid tax issues.

Although the interest income received by Cayman Corp is not subject to an entity level tax in the Cayman Island, the non-inclusion is not the result of hybridity but rather a result of the Cayman Island not imposing any direct taxes under the existing legislation.

The Managers believe that the interest rate on the loan from Cayman Corp is on an arm's length basis and as such the interest payments are expected to be fully deductible for US tax purpose.

The interest payment from the US vehicle to Cayman Corp will be free from US Federal Income Tax and 30% withholding requirement.

Investment Thesis

This is an interesting independent market research that shows the demand and supply for the US lodging accommodation dynamics in the past 10 years and the next 3 years forecast.

Apart from the obvious demand drop during the GFC in 2009, the demand growth has actually exceeded the supply growth in 2013 and they are expecting the trend to widen in the next few years.

One of the reason cited is due to the rapid growth of construction and material costs, which means there are lesser incentives to build for new lodgings in the area, thus supply for hotels is expected to be moderate.

As for demand, the lower US Dollars should help to attract incoming foreign tourists into the country while domestic tourists demand is also expected to trend up with a correlation with the low unemployment rate.

Being a very much spending play, this will be dependent on the strength of the US economy in the next few years and how a recession could mitigate the drop to what we've seen back in 2009.



We often talk about Revenue per Available Room (RevPar) when we talk about hospitality industry, which is essentially the hotel's Average Daily Rate (ADR) multiplied by the factor of occupancy rate.

The management can play out a simulation of optimally balancing ADR in order to maximize the occupancy, usually a strategy taken to balance out off-peak and peak demand since the industry is so cyclical in nature.

From the graph below, you can see how strongly correlated is the RevPar to the US economy, so the question will still be how they can cope when the US economy takes a dive under at some stage.


Forecast Uptick on RevPar is dependent upon the strength of US economy expectation

Master Lease Agreement Structure

Unlike other industry like retail or commercials, most hotels, if not all are under a master lease agreement structure.

You can imagine how difficult it is to work out over 5,000 rooms of hotels if they are being structured individually under direct operated assets.

The Master Lease Agreement is catered specific to each of the 18 hotels in the portfolio and under each Master Lease Agreement , EH-Reit will receive rental payments with fixed and variable rent components.

The Fixed Rent comprises of 66% of EH-Reit total rent which provides downside protection while the Variable Rent is pegged to the Gross Operating Revenue and Gross Operating Profit which provides the organic growth.

Capital Structure and Prospective Yield (%)

As at listing, EHT is expected to have an aggregate leverage gearing of 38%.

This gives them a debt headroom of about $170m to fund their next acquisitions or AEI before they reach the statutory limit of 45%.

The weighted average debt maturity profile stands at 4.2 years and 75% of the borrowings are fixed, given the current climate of the low interest rate.

They are also expected to list at a forecasted 2019 annualized yield of around 8%, which is way higher than the hospitality reit we have here in Singapore because of the higher cap rate and more advantage tax structure in the US (via Cayman Island).

Conclusion

Overall, I think 8% is a decent yield to have for a US pure-play hospitality Reit because of the savings they can get from the US Federal Income and Withholding Taxes.

By listing it in the US, they might be subject to the Federal taxes which can add up quite a bit.

Still, I think being very cyclical and dependent on the US economy, this is a play on the macro-side. If you think the US economy will continue to do well over the next few years, then the 8% yield might provide some good returns in the next 3 to 4 years.

For me, I'm a bit on the wary side and if I wanted a US exposure, I'd rather get Manulife Reit for a commercial play at 7% yield where the lease reversion outlook are more clearer so likely I will sit this one out.

Thanks for reading.


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14 comments:

  1. Hi B,

    Wow that fee structure seems rich. I also find it interesting that their historical RGI is less than 100, which means the hotels are underperforming the competition. Not sure if that's a sign a poor management.

    Regards,
    KK

    ReplyDelete
    Replies
    1. What is Historical RGI please ?

      CK

      Delete
    2. Hi CK

      RGI stands for Revenue Generation Index, it compares your hotels revpar across the rest of the other hotels revpar.

      If it falls below 100, means they are generally underperforming the rest of markets.

      Delete
    3. Hi Kk

      Yeah that is very odd because the hotels branding stands out amongst the big names themselves. I wonder if they are not extracting it fully to their advantage or management are playing the RGI game to fill their occupancy first.

      Delete
  2. Thanks very much for your research. One thing that I have noticed is that despite ipo demand and significant over subscription, the market price falls below the ipo price invariably. If you look at most of the REITs listed over the past 3 years, this has happened often, quite early in the few weeks to months after listing!
    However, to remember this fact and then buy later- seems easier in theory than in practice and the projected 8% yield is tempting. I will decide and maybe try my luck with a small application lot. If the price plunges and gives me a chance, might accumulate more.
    I hold small lots in both Manulife and Keppel KBS REITs. They are still not significantly away from their ipo price , if I remembered correctly

    ReplyDelete
    Replies
    1. The dpu will drop later when they do an EFR. The price then goes down in tandem. It's better to buy after an EFR has been announced.

      Delete
    2. Above reply was posted by : CK.

      Delete
    3. Hi Garudadri

      Yeah most overseas IPO drops within 1 year after listing but if we take a look at the longer run including dividends actually it's not as bad. I guess we can never predict things and try to bottom fish them but yeah there are some folks who might be attracted to the 8% yield out there perhaps.

      Delete
  3. Thanks for sharing your research work.

    ReplyDelete
  4. As in the normal behaviour exhibited by Manulife and Keppel KBS, EHT will need to do an Equity Fund Raising (EFR) when they come across any assets good for acquisition, or for performing AEI activities onto their hotels.

    At 38% Gearing Level, there is no doubt about this anymore. EFRs cause unit prices to drop.

    ReplyDelete
    Replies
    1. Yes I believe so any acquisitions will need to be funded via equity or placement I think their gearing level does not make them an attractive propositions at this point.

      I guess with the US interest at low now it also makes sense for them to gear up as much as possible at this point.

      Delete
  5. Above comment was posted by : CK.

    ReplyDelete
  6. Thank you for your analysis. Personally, I buy REITS for capital preservation and lower risk. So I rather go with Manulife like you say. IPO stocks have an intrinsic risk recently. Almost an oxymoron to say REIT IPO as an investment strategy. I will take your advise and sit this out. BTW, RGI means Revenue Generation Index and is used by hotel folk to see how your hotel compares to peers. I am not an expert obviously but it takes into account room utilization, rev per room etc.

    ReplyDelete

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