Saizen REIT: AGM on 19 Oct 10.

I managed to take leave from work to attend Saizen REIT's AGM with a friend today. The AGM started on time and there were few surprises for me as I have been tracking this REIT for about a year now. Nonetheless, I picked up some interesting points which might not be apparent from the presentation slides.

The management took pains to impress upon unitholders that even if YK Shintoku were to suffer a foreclosure, the rest of Saizen REIT would not be affected. The DPU of 0.26c for the months of May and June 2010 did not have any contribution from YK Shintoku. We could expect this DPU to be sustainable. So, even if YK Shintoku's loan remains unresolved, we could expect a DPU of 0.26c x 6 = 1.56c per annum, ceteris paribus.  This is a yield of almost 10% based on a unit price of 16c.  However, I would expect this to be diluted somewhat if all the warrants are exercised. A 7% yield could be more realistic then.  When we take into consideration that Saizen REIT owns freehold properties, this becomes quite attractive.

Depending on whether YK Shintoku's CMBS is refinanced and the size of its portfolio at the point in time if refinancing happens, yield would be adjusted upwards but the magnitude of such an adjustment would remain guesswork for now, at best.

The management's energy is now focused on the re-financing of YK Shintoku's CMBS. The main difficulty in getting the loan re-financed is the cautious stance of lenders. This explains why they are gradually divesting properties in YK Shintoku to lower the absolute quantum of the loan. This is a preferred alternative to having the portfolio foreclosed by the CMBS holders.

A smaller loan quantum would also make it more palatable to potential lenders, of course. In fact, Mr. Raymond Wong mentioned that a bank in Tokyo is willing to lend them more money provided that they resolve the YK Shintoku CMBS first. A chicken and egg problem, it seems.

Mr. Wong further revealed that in the last two years or so, they met up with about 60 different banks and managed to refinance all but YK Shintoku 's CMBS. The absolute size of this CMBS remains a challenge although it has been reduced through divestment of properties over time from the original JPY 7.953 billion to the current JPY 5.9 billion. It was also said that YK Shintoku has a cash reserve of JPY 0.6 billion which would reduce the outstanding loan balance to JPY 5.3 billion.

The problem with CMBS is that it has to be fully repaid and there is no amortising feature. So, the challenge is now to find a lender willing to lend JPY 5.3 billion to refinance YK Shintoku's CMBS.

The management revealed that it collected $14.56 m from warrant proceeds as of 18 Oct. Potentially, it could receive another $30.18m if the rest of the warrants are exercised. If enough properties from YK Shintoku were divested to make the outstanding loan balance payable using warrant proceeds, we might not even need to refinance the loan. JPY 5.3 billion is (at today's rate of 1 JPY = 0.01575 SGD) equivalent to S$83.475m.  For such an option to work, it seems that Saizen REIT would have to divest another $40m worth of properties from YK Shintoku's portfolio.

Both Mr. Raymond Wong and Mr. Chang Sean Pey agreed that it is not the best time to sell properties in Japan. In fact, it is a time to buy properties in Japan (which could explain partially why GLP and MLT bought so many properties this year in the country). Unfortunately, the lack of willing lenders for YK Shintoku's refinancing bid leaves them little choice but to continue divesting properties until a time when it is no longer necessary. Like Mr. Wong said, it beats having the portfolio foreclosed.

The successful refinancing or discharging of YK Shintoku's CMBS would represent a bonus for unit holders since it would resume contribution to the REIT's distributable income. This is not, by any means, certain. Therefore, I would not buy Saizen REIT with this as the primary motivation. It is just a bonus that could very well materialise.

The management's tact to present the REIT as a safe income generating instrument was not lost on me. However, some unitholders were clearly not impressed and asked if there were plans to have greater coverage of Saizen REIT by brokerages and whether there would be further re-rating upwards by Moody's. It is a fact that Saizen REIT's units are trading at a huge discount to NAV and the yield is very high.  This was explained by Mr. Raymond Wong, quite candidly, because of the market's perception of the REIT which has remained unfavourable as well as the negative perception of the Japanese economy as a whole.

Having said this, understanding the need to have increased coverage for Saizen REIT, the management has met up with the largest retail brokerage in Singapore yesterday and will conduct a briefing for analysts today. Of course, positive coverage could give Saizen REIT's unit price a shot in the arm.  After all, it remains a strong value proposition.

Mr. Chang made a very good point that the depressed value of Japanese residential real estate is not because rental rates have plunged. Rental rates have remained relatively stable. It is because liquidity has dried up but this is slowly changing. The recent successful divestment of various properties in YK Shintoku shows that buyers are back and liquidity is returning. Things could only get better from here, in my opinion.

So, was there anything I did not like about the AGM? Resolutions 3 and 4: Allowing the manager to make or grant convertible instruments and to issue by way of placement at a discount of 10 to 20% of the unit price at the point in time. Although Mr. Raymond Wong assured unitholders that it is a formality and that they would not do any placements at such a steep discount to the current very depressed unit price, I voted against these resolutions.  I do not like share placements as they exclude small investors like me from taking part in the enlarged capital base.  I much prefer a rights issue.

In general, I enjoyed the AGM. Both Mr. Raymond Wong and Mr. Chang Sean Pey were polite and shared information freely. They answered questions candidly, acknowledging the difficult circumstances surrounding their efforts to refinance YK Shintoku's CMBS. Mr Arnold Ip, the Chairman, whom I have always imagined to be a Chinese gentleman but turned out to be Eurasian, said that they are now a lot more optimistic about the REIT and its future when, only a year ago, they were thinking of the worst case scenario.

After attending the AGM, I am more convinced than ever that Saizen REIT is a value proposition that is hard to ignore.  It is an income instrument that would continue to deliver a relatively high yield at the current price and the potential upside is more than any potential downside. I would continue to accumulate on weakness, if the opportunity presents itself.

AGM presentation slides here.

Related post:
Saizen REIT: Divestment of 3 properties.
Saizen REIT's properties: Would I buy?
Saizen REIT: Better than expected DPU.