Secondary fundraising - Rights issue (The tale of Keppel KBS USD Reit)

REITs are one of the favorite tools of investors, they give predictable dividends, easy to understand and generally have the nature of democratizing ownership of an otherwise very illiquid asset such as a shopping mall or malls.

Unfortunately REITs also have a strategy to grow its dividend and opportunity sets are limited due to only 10% of capital retained and a 45% gearing cap set by the regulator.

As such, to acquire new assets. A company needs to raise funds either by debt, equity or a mix of both (e.g. perpetuals).

In recent days, there were many destructive deals of the sort
1. OUE Commercial REIT
2. Kep KBS Reit
3. Cromwell Reit (not looking at this deal yet)

OUE Commercial REIT generally dragged its share price all the way down from the mid 60s to just 10 bps above its right issue price. You may also look at the NAV and DPU dilutive damage that the corporate action taken on its price - https://risknreturns.com/2018/09/15/oue-commercial-reit-rights-issue-a-case-study-of-value-destruction/

Kep KBS Reit represented the quickest destruction of value for its early adopters at USD 0.88 per share. Today it trades at USD 0.54. Taking into account its 3.82cents distribution, this represented a lost of 43% for the existing shareholders assuming they do not subscribe for their rights and do not sell it either.

Personally I was interested in USA assets because they are direct proxies to a growing economy and the resurgent economic power. But being very aware of the ground zero nature of rising interest rates. One needs to be very careful on this matter.

I did my calculations, and I do believe a lot of value is starting to emerge.

Pros:

1. Attractive yield at 10.355% compared with fund Nareit 3.32% yield, Manulife reit 7.89%

2. Macro trend of improving USA economy will bode well for assets

3. Semi-protected from aspects of trade war due to locality

Risks:

1. Manager may be impatient to offload other assets (another acquisition worth 10% of AUM is being looked at)

2. Large exposure to rising interest rates (3.47% effective IR. Increase is mitigated by 75% swop floating for fixed. Aggregate leverage relatively low at 33.3%) 

3. Large number of tenants (400+) could make it more challenging to manage. Also Tenant quality may not be too certain (not entirely well known names apart from Occulus)

4. Possible revision to USA Tax policy could result in 30% reduction in dividends received

Conclusion

It would be interesting to be able to get the shares as close to USD 0.50. And this taking into account the worse case scenario of 30% dividend reduction (result of dividend withholding tax) and 5% effective interest rate (additional 5.385m of interest expenses). We would get a DPU of 3.452 cents and this gives about 6.9% on USD0.50. If interest rate remains the same, we would get 7.8% yield even with the 30% dividend reduction

- Not too bad a deal if the max downside is 7% yield while the upside is up till 11.2% yield.

- Margin of safety appears to be pretty thick if we are income investors.

- Likely company is under-priced due to rights issue, size of REIT and lack of understanding by investors.

Certainly private placement (issuance to institutional) or usage of perpetuals (hybrid instruments that receive regular dividends) bodes well for shareholders. It is quicker, cleaner and the discount doesn't kill the share price. Unfortunately it is often not an option for small cap REITs.