Investors in Sabana REIT have experienced a downward ride since its peak in 2013.
The REIT has been facing a continuous downward trend, marked by a series of sagas. One of the most recent events was the rejection of a proposed merger with ESR REIT in 2020, thanks to shareholder activists Quarz Capital and Black Crane, who claimed a rare victory.
Today, Quarz Capital is making headlines again, attempting to remove Sabana REIT’s current managers while pushing for future management internalization. In this article, we’ll explore the reasons behind the ongoing clash between Sabana REIT managers and Quarz Capital.
A Long-standing Feud
To better understand the recent saga involving Sabana REIT managers and Quarz Capital, it’s essential to delve into the circumstances surrounding the merger attempt in 2020, where both parties last clashed.
At the time of the merger attempt, Sabana REIT was facing poor performance and was actively seeking to turn its investment trust around. During this period, ESR REIT, which shared the same parent company as Sabana, agreed to a merger – a move that Quarz Capital had initially desired. However, the activist group criticized and expressed dissatisfaction with the merger proposal due to the undervaluation of Sabana REIT. The proposed price for the REIT was significantly lower than its book value, a major point of contention that Quarz Capital vehemently opposed.
Another concern raised by Quarz Capital was the potential conflict of interest arising from both REITs operating under the same parent company and having overlapping investment mandates. They believed that this conflict could compromise the fairness and transparency of the merger process, ultimately leading to the collapse of the merger.
Looking back at the report, in the eyes of Sabana REIT holders, one might understandably feel taken advantage of when a larger REIT tries to acquire you during a time of distress. Even considering the notion of unlocking value, the proposed amount represented only a 5% premium to the last trading price, which may not have been enticing enough for some investors. Waiting for a better deal might have seemed like a more favorable option, to be honest.
In hindsight, judging who was right in this situation remains subjective. However, it is worth acknowledging that Quarz Capital’s actions to fight for better returns for Sabana investors were admirable, even though it is understood that their interests were also at stake. Their efforts highlighted the importance of fair valuations and transparency in merger processes.
Quarz Capital’s Return to the Spotlight
Three years have passed, and Quarz Capital is once again making headlines. This time, are they the Guardian Angel that Sabana investors need or a Devil’s Advocate?
For a start, Quarz Capital, which holds 14.01% of Sabana REIT, has filed a requisition to remove the current External REIT Manager, Sabana Real Estate Investment Pte Ltd, and replace it with a newly set-up Internal REIT Manager owned by all unitholders. This process is known as internalization.
An Extraordinary General Meeting (EGM) will be convened on 7 August to pass two resolutions:
- Remove Sabana Real Estate Investment Management as the manager of Sabana Reit.
- Internalize the management of the REIT, meaning it will be run internally without external managers.
Why is this happening?
Quarz Capital has presented several points, but these two are the only noteworthy ones:
1) Cost Savings
According to Quarz Capital, internalizing the management could result in an increase of more than 7.2% in dividends paid to unitholders. The primary driver of this increase would be the cost savings from management fees that unitholders currently pay to External Managers.
Moreover, Quarz Capital argues that internalization would likely eliminate other fees, such as performance, acquisition, divestment, lease, and property management fees currently incurred by unitholders under the External Manager.
Source: Quarz Capital
While I partially agree with Quarz Capital’s argument, it’s essential to note that the potential savings might have been overestimated. Even with internal managers, there will still be a need for compensation. Consequently, while cost savings could be realized, they may not be as significant as projected, especially considering the compensation required for the internal management team.
2) Elimination of Potential Conflict of Interest
Source: Quarz Capital
Quarz Capital has also presented a significant argument regarding the elimination of potential conflicts of interest with the current external manager. This concern was previously discussed during the merger attempt between Sabana and ESR REIT back in 2020.
The potential conflict arises due to ESR Group, the parent company, holding 100% ownership in the External Manager of Sabana REIT and simultaneously being the 99% owner of the manager of ESR Logos REIT. Additionally, ESR Group holds the largest stake in ESR Logos REIT at 16.4%.
Normally, having multiple REITs under a single sponsor may not be an issue. However, in this case where both ESR Logos REIT and Sabana REIT focus on the same Singapore industrial properties, the potential for conflict of interest becomes apparent. This overlap in investment mandates raises concerns about potential conflicts if ESR prioritizes the entity that benefits itself the most, including recent merger attempts where Sabana was proposed to merge into ESR Logos REIT at a depressed price or even in future investment pipelines.
Indeed, addressing potential conflicts of interest becomes crucial for Sabana REIT to ensure transparency, integrity, and unbiased decision-making in its management, which is what Quarz Capital is advocating for.
Nevertheless, I feel that the valid reasoning ends here.
Quarz Capital provided additional reasons to support their case, including the potential increase in occupancy rate, completion of AEI projects, and the possibility of new acquisitions under new management. These factors indicate a significant potential increase in DPU by 0.69 cents, in addition to the 0.22 cents mentioned earlier from the cost savings of an internal manager.
That said, the current management is already implementing the measures mentioned by Quarz Capital, like AEI projects. As a result, I remain skeptical about the additional value a change in management would bring in this context.
Source: Quarz Capital
Weighing the Uncertainties and Risks
On the flip side, if this vote is successful, there are significant risks for Sabana REIT that need to be carefully considered.
Uncertainty
The first major concern is the uncertainty surrounding the resolution. Currently, there is no clear plan regarding who will take over and how the internalization of Sabana REIT management will be achieved.
The lack of a timeline means that even if investors successfully dispose of the current management, it remains uncertain how long it would take for the new management to take control and establish stability.
This could lead to a prolonged interim period, potentially lasting for months or even years, with no existing blueprint for internalized management for S-REITs, making it difficult to simply replicate a proven approach.
No Backers
Removing the current manager may also result in Sabana REIT facing higher borrowing costs, as they will no longer have a sponsor to back them.
Additionally, this change could trigger an unwinding of existing interest rate hedges that have been put in place, further increasing borrowing costs for the REIT.
Source: Sabana REIT
In this case, I strongly believe that the advantages of internalizing the REIT management are not sufficient to offset the negative consequences arising from the uncertainties during the management handover and the potential lack of sponsor backing for the REIT.
What should you do now if you are a shareholder?
Firstly, I must clarify that I do not own any shares in Sabana REIT or any related company involved in this dispute. Therefore, I have no personal stake in the matter. However, I hope to offer some perspectives to help you make an informed decision about your course of action.
In my view, the internalization of the REIT manager does not seem to be favorable. The risks involved in this move appear to outweigh any potential benefits. This, however, does not imply support for the current actions of the existing REIT manager. Instead, if I were in your position, I would seriously consider cutting my losses.
Quarz indeed has raised some valid concerns, and as shareholders, these points should be carefully considered.
That said, it’s crucial to understand that the road ahead will be long and uncertain even if both resolutions are passed. Passing the resolutions does not guarantee an immediate and automatic internalization of management. Instead, the trustee will just be directed to take steps towards internalization, which will involve holding two or more EGMs to seek shareholders’ approval for the internalization process.
Moreover, it’s worth noting that the internalization can still be canceled if the later resolutions (Potentially requiring a 75% vote due to amendments to the Trust Deed) do not pass. This is in contrast to the current ordinary resolution, which only requires 50% approval. Considering that ESR and its Affiliate hold more than 25% of the shares, they could reject the later resolutions.
The lack of necessary regulatory approvals is another factor that could lead to the cancellation of the internalization process. Thus, I am doubtful that the internalization will ultimately take place.
For a better understanding of the potential outcomes, you can refer to the table and flowchart provided by Sabana REIT, which outlines the possible scenarios resulting from the Resolutions tabled at the EGM.
Source: Sabana REIT
In conclusion, I hope this information helps you make a wise decision when voting in the upcoming EGM.
Dear Zhi Rong,
Thank you for your article and we appreciate your coverage of the Sabana case. The internalization will return power to all unitholders by enabling all unitholders to have full ownership of the manager. The cost savings and prompt executing of key catalysts by the internal manager which is fully aligned with all unitholders will potentially substantially boost DPU, unit price and corporate governance at Sabana REIT.
May we clarify some details. If ESR is potentially involved in the loans and interest hedges of Sabana REIT, this is an immediate and outright serious infringement of MAS regulation.
It is also interesting that while Sabana REIT manager claims that there might be change of control in loans and interest rate hedges, they have provided 0 example and are also unable to point to a single instance when this happened.
This is when we have already showed that there are more than 10 instances of change of control of the REIT manager in Singapore and the banks have consistently extended the loans and interest rate hedges to the new manager or new owners of manager. It is clear that the loans and interest rate hedges are backed by Sabana’s all-Singapore portfolio. This is the reason why we call the above ‘scare tactics’ and ’empty threats’.
The potential S$2.4million of cost savings which drives a projected 7.2% increase in DPU is already after staff cost. This is because Sabana REIT manager collects more than S$7.2m of fees from unitholders and the REIT. After staff and operating cost, the operation profit is S$2.4million in 2022. We are happy to share with you the financial statements of the Sabana REIT manager and its 100% owned property manager to confirm the above figures.
All these will now go to unitholders when the manager is internalized. In fact, we project that the cost savings to unitholders will be even higher as we believe that the salaries of the CEO and directors who are paid one of the highest in the S-REIT sector (when adjusted for market cap) needs to be adjusted.
The key management of Sabana REIT are paid more than S$1.6m (or 80%) of total staff cost.
The projected return from internalization is >50% p.a. due to the estimated S$2.4m of cost savings vs the S$3-5m of setup cost.
The return from internalization is potentially even higher if Sabana were to grow its portfolio by just 50% over the next 10 years. By not having to pay acquisition, divestment and incremental management fees, the internalization would potentially result in more than S$40 million of cost savings for unitholders.
The most important thing we believe is the complete alignment of interest of the internal manager. This ensures that no placement and rights will be done to potentially undertake value destructive acquisitions to boost acquisition, performance and management fees to the External Manager.
ESR paid more than S$35m for the manager while Croesus sold its manager to the REIT for S$50million. Unitholders will now set it up for a projected cost of S$3-5million which just takes 2 years of cost savings to recover. Current DPU will potentially not be affected and unitholders will enjoy permanent cost savings after internalization.
We will be engaging with MAS, SGX RegCo, Sabana’s bankers and the trustee to expedite the process of setting up the internal manager.
In light of the significant positive impact that Sabana REIT’s internalization could have on improving corporate governance, enhancing investor protection, and increasing the accountability of REIT managers, with the backing of the key stakeholders, we believe that the entire internalization process could potentially be streamlined to approximately six months.
We also refer to the Court case where ESR’s injunction to stop the EGM was completely dismissed by the Singapore Court which called its call ‘misconceived’, ‘without merits’ and order ESR to pay cost to both Quarz and Sabana External Manager. The ruling confirmed that the resolutions as tabled provided an unequivocal mandate for the Trustee to execute the internalization. The judge also referred to Clause 28.2 of Sabana Trust Deed which says that any amendment of the Trust Deed that is better for unitholders need not be subjected to a 75% vote if the Trustee certifies it.
We would highly appreciate if you can refer to the Court paper directly instead of the opinions of parties which might be potentially conflicted.
Many thanks again for your coverage of the situation at Sabana REIT. We are very happy share our views with you in this very important topic for all Sabana unitholders.
Quarz is a unitholder of Sabana REIT. Our interest is fully aligned with all Sabana REIT unitholders. We call on all unitholders to VOTE FOR Resolution 1 and 2 to build a stronger and better Sabana REIT together with higher DPU, unit price and corporate governance!
Thank you