Spring REIT Rejigs Financing to Revive Stalled Mall Acquisition

The company has agreed to buy a majority of an upscale shopping mall using debt, after its original plan to finance the deal using equity failed due to a major investor’s objections

Key takeaways:

•      Spring REIT has agreed to acquire 68% of Huamao Place, an upscale shopping mall in the Guangdong city of Huizhou, for about 1.6 billion yuan

•      Spring originally agreed to buy the property in 2018 but the deal collapsed over a dispute with one of its own major investors over the financing

By Warren Yang

Shareholders don’t like being diluted.

Spring Real Estate Investment Trust (1426.HK) has learned that lesson the hard way and come up with a new financing plan in a second bid for a major shopping mall in South China’s affluent Greater Bay Area. The deal comes as China’s broader property market experiences one of its worst downturns since its inception in the 1990s, though commercial properties have so far been less affected that residential ones.

The real estate investment trust (REIT) said last Friday that it agreed to acquire 68% of Huamao Place, an upscale shopping mall in the central business district of Huizhou in Guangdong. Spring will pay about 1.6 billion yuan ($248 million), which represents a 9.3% discount based on the whole property’s appraised value. The transaction is subject to approval by unit holders of the REIT. Unit holders are the equivalent of stock shareholders for publicly traded REITs, which invest in real estate and distribute their profits as dividends.

Spring, which has been listed in Hong Kong since 2013, originally agreed to buy Huamao Place in September 2018. But private equity firm PAG, a major investor in the REIT, threw a wrench into the mix by offering to take over the REIT shortly after the deal was signed. One of its conditions was that unit holders veto the Huamao Place acquisition.

PAG disliked the deal because it was not pleased with Spring’s expansion strategy, calling it “erratic and dilutive.” In 2017, Spring purchased a network of 84 car repair shops in the UK and took the dilutive step of issuing new units to partly fund the acquisition. This move prompted PAG to start pushing for a management change for the REIT.

In 2018, Spring planned to finance the Huamao purchase partly by issuing new equity as well, another dilutive move that apparently wasn’t to PAG’s liking. This latest time around it plans to use debt to cover the entire cost, which should help to boost its return on the investment. Spring emphasized at least three times in its newest announcement that the new funding plan will provide a higher yield for its investors without ownership dilution.

The REIT said the acquisition would boost its dividend distribution per unit (DPU) for investors by 13% to about HK$0.248 compared with the amount for last year. The pro forma DPU translates into a dividend yield of more than 9% based on the REIT’s Wednesday closing price, a pretty good rate that makes investment vehicles like Spring enticing in the current climate of low interest rates.

Healthy financials

Spring certainly has ample room for more borrowing – so why not pull the trigger? Its debt-to-equity ratio was 30% at the end of last year, not an overly high level, while its earnings before interest and taxes (EBIT) for last year amounted to more than five times its cash interest expenses.

Compared to developers of residential properties that are in a deep slump, Spring and most other REITs tend to focus on commercial real estate in China that is faring better. That’s partly because demand for fancy spaces in big cities like Beijing from technology and financial companies has helped to prop up the office market. But that could also change, as even those companies have recently turned to mass layoffs in the face of China’s slumping economy.

Apart from the UK car repair outlets, Spring currently owns two office towers in Beijing. The average monthly occupancy rate for those surpassed 93% last year, up slightly from 2020.

Still, Spring needs some new assets to bring in more income. Since the office buildings in Beijing are almost fully occupied, they don’t offer much potential for additional revenue. In fact, even though occupancy rates rose last year, revenue from these properties declined as rents declined, probably as tenants demanded reductions when their leases expired. Similarly, the UK shops are all locked into long-term contracts, meaning they won’t bring in additional income anytime soon.

A high-end shopping mall like Huamao Place can be an attractive proposition. Spring says Huamao Place’s operating performance has improved since its original deal, adding the property’s value has appreciated by nearly a third since June 2018. Development plans for the Greater Bay Area, centered on Hong Kong and adjacent Guangdong, have helped Huizhou’s broader retail market flourish. And Huamao Place has used its high-end status to sign up international brands that are hard to find in other malls in the city, helping to set it apart from rival malls and e-commerce platforms.

At the same time, no retail business will be immune from outbreaks of the highly contagious Omicron variant of Covid-19. China’s retail sales fell year-on-year in March, marking the first such decline since mid-2020. Yet retailers stand to benefit from policy efforts to boost consumption, such as tax cuts and subsidies. On top of that, well-off shoppers that Huamao Place targets tend to be less likely to curb their spending during an economic downturn, unless they are forced to stay home due to new Covid-19 outbreaks that lead to lockdowns.

Spring’s shares rose a bit after the latest acquisition plan’s announcement but are still rather depressed. The REIT is down by about 30% from its 2013 IPO price and its market cap is more than 50% below its net asset value.

Compared to 10 other Hong Kong-listed REITs, Spring is a clear laggard in terms of valuation, with the lowest price-to-earnings (P/E) ratio of 6.3 for a profitable member of the group, according to data from the Hong Kong Stock Exchange. Among the others, the Hong Kong-focused Link REIT (0823.HK), which has the largest market valuation and more than 100 assets, commands a P/E ratio exceeding 12.

Perhaps the dilutive new equity issuance for the UK investment and the PAG saga are still weighing on Spring after all these years. If that’s the case, then the revamped plan for the shopping mall acquisition, with a more agreeable financing plan for investors, could represent a breath of fresh air for the REIT’s stock.

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