Langham Hospitality Investments, the first yield-focused trust to seek a Hong Kong listing since the end of 2011, kicked off the management roadshow yesterday for an initial public offering of between HK$3.96 billion and HK$4.57 billion ($510 million to $589 million).
The hotel-focused trust, which is sponsored by Hong Kong development and property investment company Great Eagle Holdings, is offering investors a yield of 5.65% to 6.5% for 2013. This is roughly on par with a couple of Singapore-listed real estate investment trusts (Reits) that also focus on hotels.
Investors who are more interested in getting exposure to a traditional real estate developer and the potential growth in Hong Kong property prices should get their chance in a couple of weeks when Hopewell Hong Kong Properties is expected to hit the market. The company is being spun off from Hong Kong-listed Hopewell Holdings and will comprise its entire Hong Kong property portfolio, including its new landmark hotel and conference project in Wan Chai — Hopewell Centre II — that is expected to be finished in 2018 and will cost about HK$9 billion to develop.
Hopewell HK Properties is expected to raise approximately $800 million from the sale of about 30% of its share capital. Bankers started the investor education yesterday and the institutional bookbuilding is expected to follow in about two weeks.
Unusually for a Hong Kong IPO these days, Langham Hospitality doesn’t have any cornerstone investors. However, several potential cornerstones have made investment commitments as anchor investors instead and sources said the deal launched with a message that there was enough anchor demand from long-only funds, pension funds, real estate specialists and hedge funds to cover the entire transaction.
And just before the investor luncheon in Hong Kong yesterday, the bookrunners confirmed that the order books were already fully covered, without counting any orders from private wealth-type clients. The latter is expected to be pretty strong given Langham Hospitality’s links to well-known Hong Kong tycoon Lo Ka Shui, who is the controlling shareholder of Great Eagle.
The lack of cornerstones suggests that investors were unwilling to accept a six-month lock-up on their investment. Yield-focused real estate investors have become used to the fact that there is no lock-up on Reits and business trusts in Singapore, which is where most of these vehicles have listed in the past few years, and hence it may be difficult to convince them to accept the stricter requirements in Hong Kong.
But as long as the same investors are still participating in the transaction, it shouldn’t really matter that they aren’t actual cornerstones. In fact, it may actually help improve the liquidity in the units in the first few months if these funds are allowed to trade their units. That said, anchor investors are unlikely to be able to provide the same level of comfort as cornerstones to other potential investors since their identities are not disclosed in the prospectus. Also, they do not have to commit to buy shares across the price range.
As reported earlier, Langham Hospitality will not list as a Reit, but will use a structure known as a fixed single investment trust or a share stapled unit structure that is similar to a business trust. Hong Kong doesn’t have regulations in place to list business trusts, but this 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. And like both Reits and business trusts, it allows dividends to be paid from cash flow as opposed to from accounting profit, hence increasing the yield compared to a normal company.
The structure was pioneered by PCCW when it spun off its telecom assets in November 2011.
Langham Hospitality is selling 852.174 million new units through the base deal, which is equal to 42.6% of the trust. There is also a 15% greenshoe that could increase the portion of the trust in public hands to 49% and the total proceeds to as much as $677 million at the top of the price range, if exercised in full. The remaining 51% will be retained by Great Eagle.
Ten percent of the IPO will be earmarked for Hong Kong retail investors and another 5% will be set aside for a preferential offering to Great Eagle’s existing shareholders. The shareholders will be entitled to one unit in Langham Hospitality for every 15 shares they own in Great Eagle on the record date, which is tomorrow (May 15). Excess applications will be honoured if other shareholders do not subscribe to their assured entitlements in full. The remaining 85% of the deal will be offered to institutional investors.
The units are offered at a price between HK$4.65 and HK$5.36, which translates into a clean yield of 5.2% to 6.0% for 2013. However, the yield will be increased slightly to the 5.6% to 6.5% mentioned earlier as Great Eagle will waive a portion of its dividends in the next five years.
Investors typically don’t like dividend enhancements, but this waiver is designed to offset the dilution of the dividend distribution due to the fact that a portion of the IPO proceeds plus some additional funds will be set aside to cover asset enhancements, including the potential replacement of furniture, fixtures and equipment (FF&E). Once the money is put to use it should have a positive impact on earnings and the dividend waiver will be reduced gradually to reflect that.
According to the preliminary prospectus, the distribution is estimated to increase by about 8.1% in 2013 and 2014 due to the waiver, by 5.3% in the following two years, and by 2.6% in 2017.
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, debt servicing and covenant compliance, as dividends for the rest of 2013 and 2014, and at least 90% thereafter.
By comparison, Singapore-listed CDL Hospitality Reit and Far East Hospitality Trust trade at 2013 yields of about 6.0% and 5.4% 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 and about three-quarters of CDL’s portfolio are also located in Singapore, where the growth of new hotel rooms will be about twice the 2.4% per year that is projected for Hong Kong until 2018. This implies less ability to increase room rates and potentially lower occupancy rates, and as a result CDL and Far East Hospitality should in theory see slower asset growth and therefore trade at a higher yield.
Langham Hospitality will have three hotel properties in its portfolio at launch — The Langham, Langham Place Hotel, and Eaton — which are all located on Hong Kong’s Kowloon peninsula. They have a combined valuation of HK$17.746 billion ($2.29 billion), but will be acquired by the trust at a price of between HK$15.3 billion and HK$16.7 billion depending on the final IPO price. The fact that they are acquired at a discount to the estimated valuation will help increase the dividend yield.
For further details on the hotels, the dynamic of the Hong Kong hotel market and the growth potential for Langham Hospitality, see our story published on April 30.
The institutional order books will remain open until May 22 and the price will be fixed shortly after that. The trading debut is scheduled for May 30.