One of the most traumatizing experience for shareholders of Keppel KBS REIT was the announcement of the acquisition of Westpark Portfolio in Redmond.
Keppel KBS is a Singapore listed real estate investment trust (REIT) which owns 11 office assets in 7 key regional markets in the USA.
Westpark is a portfolio of 21 buildings located in the Redmond area, most famous for being where the original Microsoft resides. Keppel KBS proposed to acquire this portfolio for US$170 mil.
By all accounts for their first acquisition, things should not be so traumatizing. I am not sure if its due to the rather negative overall market sentiments or what but the share price of Keppel KBS have fell 23% since the announcement of the acquisition.
At one point it was 3 cents away from the price the rights was priced at (US$0.50).
I think analysts and bloggers have written enough about it. What I would like to do is to gather some personal notes on what transpired so as for me to revisit next time.
Attractive Dividend Yield Even Before the Acquisition
The chart above shows the timeline of all the events that happen till now (the rights issue have not been concluded yet)
Keppel KBS’s dividend yield was rather attractive since it went IPO. The share price was hovering, for a long time, around US$0.84.
Given that they released their third quarter results on 17 Oct, they announced a DPU of US$0.015.
If we annualized this, it gives a dividend yield of 6/84 = 7.1%.
For a freehold portfolio in different markets, this looks attractive to most of us.
KBS share price took a beating together with a lot of the REITs with foreign assets.
On the day of the acquisition, the share price was US$0.76 (#a in the chart above). This bring the dividend yield to 7.89%.
I would contend that without the acquisition, and if the portfolio is really good, that is a splendid return for the risk we are subjected to.
The share price probably baked in some really fast growth in 10 Year US Treasury Rates.
The acquisition came at not a right time. They were really adventurous to seek funding for an acquisition now.
More so if you are trying to tap retail money.
If you have strong institutional support, such as the support for the bigger Singapore REITs, this would be less of a problem.
The Westpark portfolio, as a whole, look OK for layman investors like myself.
I have to admit, I couldn’t tell the difference between Class A or Class B, Suburban or CBD in the USA let alone just how good or bad this portfolio is.
I have to get schooled by the Investor Relations of a competitor to understand how things work over there.
My sensing is that, at most, this portfolio is overvalued, but this is still property assets, so they cannot be so bad.
But Keppel KBS didn’t have it easy. If you see the chart above, the share price just kept falling during this whole exercise.
The reasons are due to:
- Stock market was tanking
- Higher interest rate environment is not conducive for REITs share price
- Heavily discounted rights issue
- Tax Clarification scare in KBS’s Offer Information Statement
Planning for these stuff should not be a one or two day affair, but some of the reasons they could not control, but I do think that they can have control over whether to delay things.
How Accretive is this Acquisition (Explaining the Difference in Dividend Yield Accretive & DPU Accretive)
If you have read my materials at REIT Training Center here, you would realize that I devoted a section to link you to my past right ups on rights issues, placements done by various REITs.
External capital financing by REITs is a feature of the REIT. It might not always be easily understandable but you got to force yourself to learn about it.
When Keppel KBS announced the acquisition they have 3 ways of financing this deal:
- debt and renounce-able rights issue
- debt and non-renounce-able preferential offering
- a combination of #1 and #2
We know by now that KBS took the option of #1. During the announcement of this acquisition, KBS illustrated this acquisition would be accretive if they did a rights issue at US$0.59 and raised 130 mil more units on top of the existing 630 outstanding units.
The EGM was held on 16 Oct and the share price went down further to US$0.73 (#b)
Based on the original acquisition illustration, both the preferential offering and the rights issue is dividend yield accretive.
This means that if you compare the dividend yield derive with DPU and share price at US$0.84 (that was much higher before the announcement when it fell to US$0.76), versus the dividend yield after the preferential offering , or the TERP (theoretical ex rights price) after rights issue, the dividend yield would have increased.
Based on the illustration it was 7.1%, and after that it would become 7.2% for both.
The dividend per unit though, was not always accretive. Before the acquisition the DPU was US$3.82 cents and after the preferential offering DPU is US$3.86 and rights issue is US$3.64.
The preferential offering resulted in the DPU higher but not the rights issue.
You may ask what is the difference between dividend yield accretive and dividend per unit accretive? Which is more important?
I think it depends on how you look at it. I would look at both DPU and dividend yield accretive together.
Dividend yield accretive means that if I do what the management wants me to do by dutifully buy the preferential offering, or subscribe the rights issue, my dividend yield after this will be higher.
But if you do not do what you are told (that is don’t subscribe to preferential offering or rights issue), would you get a lower overall return?
This is where DPU accretive comes in.
And this is perhaps the best measurement of manager quality in REIT investing.
Why is that?
It is up to your REIT manager to decide in your best interest as a shareholder, which type of financing protects your returns per unit risk best.
The manager can do a debt issue, rights issue, placement, preferential offering, perpetual.
However at the end of the day your DPU should go:
- ….. you get the idea
After the preferential offering, the DPU would have went from US$3.82 cents to US$3.86 cents. If enough people subscribe, even if you do not subscribe to the preferential offering, your DPU you get, should still go up.
In the case of the rights issue, the DPU went down from US$3.82 cents to US$3.64. If you did not subscribe to the discounted rights, you lose out. However, if you dutifully subscribe to the discounted rights, when you add what you have before and the discounted rights, you didn’t lose out (which is what the dividend yield accretive illustrate)
The table above shows the before and after of Keppel KBS, based on the original acquisition illustration. This is usually what I used to show before, the financing and the aggregate after. (Note: ignore the Raise 300 mil part… that is wrong. It was a previous calculation)
KBS would raise 170 mil with 102 mil from equity and 67 mil from debt. After the costs such as AUM fee, debt interest, the asset yield of the acquisition is closer to 4.9%.
We can compare the DPU and dividend yield with the 4 green arrows. The dividend yield would increase from 7.14% to 7.3%. However the DPU will go down from 6 cents to 5.74 cents.
The Actual Rights Issue Announcement
The share price was rather stable during and after the EGM on 16 Oct (#b in the chart). Keppel KBS announced their third quarter result on 17 Oct (#c).
The result was a little lower than forecast result but nevertheless we still see pretty good lease renewed, or new leases, with respectable positive rental revision.
On 22nd Oct, KBS announced that they would do a 295 for 1000 rights issue at $0.50 (#d). This is lower than the original illustration of $0.59.
This means that they either have to use more debt, or you have to raise more units, which will prove to me more dilutive.
The share price at #d was $0.71.
Then, the share price starts falling, on heavy volume. This gives me the indication that those who held a lot of KBS shares were selling at that point.
It is likely they want to buy back at a lower price.
The table above shows the same before and after situation for KBS, but taken on the announcement date of 22nd Oct. The share price was roughly $0.715.
The dividend yield before the rights issue was a whopping 8.39%. With a lower price of US$0.50, KBS had to use more debt ($76 mil) and less equity raised ($93 mil)
The deal was still DPU not accretive and dividend yield accretive. The new dividend yield if you purchase on 22nd Oct, and subscribe to the rights thereafter, was 8.48%.
The TERP price became US$0.67.
KBS share price fell on heavy volume daily, until after the ex rights day on 26th Oct (#e on the chart).
The share price gap down from $0.67 to $0.615.
The above table shows the before and after on the day before the Ex-Rights.
Strangely, the dividend yield went down from 9.09% to 9.06%. The TERP price was at $0.62.
The Section 267A, 30% Withholding Tax Scare
Normally, it is at this point where bargain hunters would start coming in, since the dividend yield, with or without the rights is nearly 9%.
However on 30th Oct, KBS share price fell from $0.60 to $0.565 (#f on the chart). This was getting a little crazy.
Why are shareholders selling down KBS until like that??
That evening near 5 pm, Keppel KBS released their Offer Information Statement.
In the document, one risk factor statement stuck out:
What does the above mean?
I am no tax expert, but I think this spooked a lot of investors.
And I wonder if it is leaked, because this was released after 5 pm yet before that, there was massive selling.
To put it simply, KBS expects that there was some tax clarification that were imminent. If the clarification is not favorable to how Keppel KBS structured their REIT, the dividends would be subjected to a US withholding tax of 30%.
Now a companies value is an aggregate of the discounted future cash flow. If your future cash flow is going to be cut by 30%, it means your value is worth much less.
Keppel KBS is not the only REIT with this structure. Manulife US REIT also uses something similar.
JP Morgan on 31st October came up with a note based on what they saw on Keppel KBS OIS with the title “New US Tax Rule Could See 30% downside Risk to SG-listed US REIT Income”
Keppel KBS share price was rather stable on 31st Oct, but Manulife US REIT took a 2 day hit.
This scared the shit out of me (considered my position in it).
A 30% hit on dividends is no joke. It basically meant that KBS and Manulife have lost any advantage as a Singapore REIT listing, when positioned against other REITs listed in Singapore.
Tax risk is not something I ignored and in my previous article on Manulife US REIT, I have highlighted some of the details of the Manulife US REIT structure.
However, it is one thing to understand the probability of it happening and its another thing when you see it happening. I think I really got hit by “what if there is some gaps in your understanding of this tax situation”.
I think someone at Manulife US REIT had a briefing with the analysts because on 31st and 1st November, you see JP Morgan put out a new note, and both DBS and Deutsche also have their take on the tax situation and how it affects Manulife US REIT.
The following were taken from the DBS report:
In the report, Manulife US REIT explains that in the worst case scenario, dividends could be impacted by at most 15% and not 30%. 15% is definitely better than 30%, but its still a pretty big shave. Judging by Manulife US REIT and KBS share price after this, some confidence is restored.
I think that, until the tax clarification happens (whenever it happens), this will always be an over-hang.
In Manulife US REIT’s latest results, they also put out the lawyer speak:
I think is a little more strategically worded than KBS’s risk statement.
This tax thing, for layman like myself is very confusing and I do have some thoughts about it, but if i laid them out here, this article would be too long.
Anyway on Nov 8, we see KBS incorporating a new subsidiary:
KBS did hinted that they might do another acquisition but I don’t think they have the guts to do another one.
However, what was surprising is that one day later, Manulife US REIT did this:
Coincidence that both of them are acquiring at this climate? Usually these incorporation of subsidiary is a pre-cursor of some acquisition.
If not, could this be related to some tax planning?
We will see in due time.
At this point, if you are not invested, whether rights issue or not, the dividend yield is like 10%.
Other than Lippo Malls, this is probably the highest yielding REIT out there (versus the rest).
I do wonder, is this portfolio that lousy, or the manager that big of a suspect. I think a lot of respected investors I know questioned how Keppel REIT was managed, but Keppel DC was pretty decently managed.
To a certain extend, I can understand the need to give the new Keppel KBS management the benefit of the doubt.
To be honest, I was pretty disappointed of what transpired, and really feel for the existing shareholders. They have seen their share price of the REIT go down and its not easy for the dividend to make up for this loss of capital.
What is going through my head is that:
- based on what I understand about REITs, I do not detect much red flags
- the reason why I couldn’t detect much was because the history is rather short. It is too short to make an assessment about manager’s quality or the property portfolio’s operating environment
- the portfolio while short lease, at worst can’t be worse than the industrial properties in Singapore, so should this trade at a greater dividend yield then industrial REITs in Singapore?
- the other elephant in the room is that this REIT seem to be pricing as if the US 10 year treasury yield would be near 5-6%. Would that be the new normal?
I thought about whether I could have prevented myself from taking such a big capital loss.
And I think from a portfolio perspective, my Expected Return Model would help a lot.
Keppel KBS, can be considered a new REIT and it comes with a few uncertainties:
- we are not familiar with the operating environment
- we are not sure about the motivations of the sponsor
- we are not sure about the quality of the manager
- we are not sure of whether there are some things we are not sure
We could model a few future scenarios, and some are positive and some are negative.
And just like the Straco illustration above, the unknowns can have positive and negative return. The probability of a negative outcome could be rather large (50%) such that a seaming good investment’s expected return is very low due to the potential negative outcome.
Going back to Keppel KBS, if the expected return due to the unknown is low, then our position sizing of Keppel KBS, with respect to our portfolio, should be low.
When could we increase the position size of Keppel KBS?
When all the unknown knowns, are addressed, and when you get a better picture about the quality or lack of quality of Keppel KBS.
Your biggest position, will also be your greatest conviction positions.
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