Great Eagle Holdings looks set to become the first Hong Kong property investor and developer to spin off some of its hotel assets through a separate listing after bankers kicked off a two-week investor education process yesterday.
The company, which is controlled by local tycoon Lo Ka Shui, will tap into the current appetite for yield by putting its three Hong Kong hotels into a dividend-paying trust under the name of Langham Hospitality Investments Group.
According to sources, the trust is looking to raise between $600 million and $700 million by selling up to 49% of its total number of units.
The listing vehicle will comprise three hotel properties: The Langham, Langham Place Hotel and Eaton, which are all located on Hong Kong’s Kowloon peninsula and have a combined valuation of HK$17.746 billion ($2.29 billion).
If successful, it will be the first yield-focused vehicle to list in Hong Kong since PCCW spun off its Hong Kong telecom business in November 2011 and the first property trust to launch an IPO since renminbi-denominated Hui Xian Real Estate Investment Trust went public in April that same year.
However, New Word Development has earlier said that it too is planning to spin off part of its hospitality portfolios. Together with Langham Hospitality, it will give yield-focused investors an alternative to the steady stream of Reits and business trusts that are lining up to go public in Singapore. Meanwhile, Hopewell Holdings is planning to spin off its entire Hong Kong property portfolio for a separate listing.
Real estate investment trusts, or Reits, have never really taken off in Hong Kong, partly because Reits here lack the tax advantage that they have in Singapore and partly because valuations of office and retail properties in Hong Kong are typically too high relative to rents to generate an attractive enough yield. So far there are only eight Reits listed in Hong Kong, compared to 30 in Singapore.
During the first wave of Reit listings in Hong Kong in late 2005 and 2006, sponsors tried to compensate for this by using various forms of financial engineering to artificially boost the yield in the first few years. To begin with, that did kind of work, but once those measures fell out of the equation and the yield dropped, investors started to abandon them. And since then investors have shown again and again — both in Hong Kong and Singapore — that they do not like temporary yield-enhancement measures.
Langham Hospitality will not list as a Reit, but rather it will use a structure similar to a business trust that was pioneered by PCCW when it spun off its telecom assets. Unlike Singapore, Hong Kong doesn’t have regulations in place to list business trusts, but this somewhat complex structure, which is known as a fixed single-investment trust or a share stapled unit structure, allows issuers to list an almost identical vehicle within the framework of Hong Kong’s existing listing and takeover rules.
Like business trusts, a fixed single-investment trust is more flexible than a Reit in terms of what kind of assets can be included and how much debt it can take on. It also allows dividends to be paid from cash flow as opposed to from accounting profit, hence increasing the yield compared to a normal company.
The latter was one of the key reasons why PCCW was so keen on pushing the new structure, while for Great Eagle the increased flexibility versus a Reit may have played a bigger role in its decision to go for this slightly more complex structure.
Syndicate research reports suggest that Langham Hospitality should be valued at a clean 2013 yield of between 5.2% and 5.8%. By clean yield they mean a yield that it not enhanced by any form of financial engineering.
However, Langham Hospitality may not be completely free from yield enhancements. In a preliminary listing document published on the Hong Kong stock exchange website yesterday it said that will set aside HK$500 million of the IPO proceeds as a reserve to cover asset enhancements, including the potential replacement of furniture, fixtures and equipment (FF&E), in the next five years. It will add another 1.5% of the hotel operation income to this FF&E reserve annually.
While this money is tied up in the reserve fund, sources say the sponsor may waive a small portion of its dividend to compensate other unitholders for the fact that it is not available for distribution. Once the money is put to use it should have a positive impact on earnings and the dividend waiver will then be reduced accordingly.
In addition to that, the hotel management fees and licence fees will be settled through the issuance of new share stapled units until the end of December 2017, which will also help to slightly increase the amount of cash available to pay dividends. From 2018 onwards, the manager can elect to receive either cash or units.
One source said the potential dividend waiver will boost the distribution by no more than 50bp.
The yield suggested by the syndicate analysts would put Langham Hospitality roughly in line with CDL Hospitality Reit and Far East Hospitality Trust, two hotel-focused Reits that are listed in Singapore and trade at forward yields of about 5.7% to 5.8% and 5.1% respectively. The two aren’t viewed as directly comparable, however, as their portfolios are split between mid-market and upscale hotels, while Langham Hospitality focuses solely on four- and five-star hotels. All of Far East Hospitality’s hotels are also located in Singapore, as is about three-quarters of CDL’s portfolio. The rest of CDL’s hotels are in Australia, New Zealand and the Maldives.
Hong Kong-listed Regal Reit, which focuses on hotels in Hong Kong, is trading at a 2013 yield of 5.7%, although sources say the fact that its hotels are three-star makes Regal Reit the least comparable to Langham Hospitality — even though the two trusts are exposed to the same underlying market dynamics.
Chief among those, one source said, is the fact that the number of visitors to Hong Kong is expected to continue to increase at a compound annual growth rate of about 10% in the next few years, while the number of hotel rooms is expected to increase at a significantly slower 2.4% per year until 2018. The supply of four- and five-star hotel rooms will be particularly low, the source said.
This should support the occupancy rate at Langham Hospitality’s three hotels, which is already averaging close to 90%, and help boost the room rates.
The three hotels will continue to be managed and operated by the Great Eagle group under a 14-year master lease agreement. As per the agreement, the trust will receive an aggregate base rate of HK$225 million per year, plus a variable rent of 70% of the gross operating profit at the three hotels.
Langham Hospitality said the majority of the rent is expected to come from the variable component. According to backdated proforma numbers, the variable rent accounted for approximately 70% of the total rent in 2012 and 67% in 2011.
The trust will pay 100% of its net profit adjusted for non-cash items as well as cash retained for the FF&E reserve, capex and debt servicing and covenant compliance, as dividends for the rest of 2013 and 2014, and at least 90% thereafter.
As reported earlier, Great Eagle’s existing shareholders will be able to participate in the IPO via a preferential offering. The terms for that have yet to be determined, but a source said it is expected to account for about 5% of the institutional portion of the deal. Like on most Hong Kong IPO, the institutional tranche will account for 90%, while the remaining 10% will be earmarked for local retail investors. However, the latter may be increased in case of strong demand.
The record date for the preferential offering will be May 15.
Great Eagle, which is approximately 60.6%-owned by the Lo family, will not have direct ownership of any hotels in Hong Kong following the spin-off of Langham Hospitality, but will continue to own an extensive international hotel portfolio under the luxury Langham brands.
All of these hotels are located outside Asia, except for the Langham Xintiandi in Shanghai, in which it owns 33.3%, and a hotel development project in Dalian in China, which is part of a multi-purpose development that is still under construction. Great Eagle holds a 50% interest in the Dalian project.
Langham Hospitality will have a mandate to invest in hotels across Asia. It will have a right of first refusal to acquire completed stand-alone hotels in Asia that are managed under the Langham brands and in which Great Eagle owns at least 75%. It will also have the right to acquire other hotels developed by the parent and to participate in investment opportunities offered to the group. These rights will last for five years or until Great Eagle’s stake in Langham Hospitality falls below 30%, whichever happens first.
The trust will be managed by an indirect wholly owned subsidiary of Great Eagle.
The management roadshow and bookbuilding will start on May 13 and the final price will be set after the order books close on May 22. The trading debut is scheduled for May 30.