☀️☕ Reading the rights on REITs - HK’s Link REIT

13 February 2023

Happy Happy Monday! 💥

📝 Focus

• Three Rs: REITing, RIGHTsing, and 'rithmatic... Hong Kong's Link REIT

📊 In the Markets

• ZIRP-it, Mr Ueda!

• UK Recession? No. Misery? Yes

• Activist now streaming on Spotify

📝 Focus

Three Rs: REITing, RIGHTsing, and 'rightmatic... Hong Kong's Link REIT

Hong Kong's Link Real Estate Investment Trust (Link REIT, HK ticker 0823) announced a 1-for-5 rights issue to raise HK$18.80 billion, or US$2.39 billion, at HK$44.20 a share (a price Elon Musk would undoubtedly find hilarious), a nearly 30% discount to Thursday's price before trading was halted. The new money will be used to repay existing debt, for general working capital and for future investment in retail, car park, office and logistics sectors across Asia Pacific.

What? Lots to unpack.

Link REIT is Asia-Pacific's largest Real Estate Investment Trust, or REIT 🎓, a stock market listed portfolio of properties managed by a separate company, with a market capitalisation (share price X number of shares) of US$17.1bn. It owns 151 rental properties, of which 129 are in Hong Kong, with the balance in Mainland China, the UK and Australia, with a mandate to pursue income stability and long-term growth. Its original properties were suburban shopping malls and car parks owned by the HK government and were injected into the newly created Link REIT in 2005. Since then, Link Asset Management has grown the trust's portfolio and the increased dividends paid out per unit by over 10% a year.

Rights Issues - a mini-explainer

• A rights issue is when a company offers existing shareholders the chance to buy new shares at a discounted price to raise money for the company. The company can use the money raised to pay off debts or grow the business (sometimes to dig itself out of a hole.)

• The shares offered are in proportion to the number of shares already owned. For example, if a rights issue is 1-for-5 (1 new for every 5 old shares) and a shareholder has 100 shares, they have the right to buy 20 new shares. This lets the shareholder keep the same percentage ownership of that company.

• If the shareholder chooses not to subscribe to the rights issue, they can usually sell the right to subscribe ("nil-paid rights") itself on the market, or just let the offer lapse. Their shareholding as a percentage of the company will fall.

  • (Nerd Corner: Rights shares are almost always issued at a discount to the existing pre-rights share price to look more attractive to the shareholder. Mathematically, it doesn't matter as long as the amount raised is the same and the shareholder can subscribe to rights shares in proportion to ownership, but when issued at a premium to the latest closing price and the "Theoretical Ex-Rights Price" -TERP- can look like an instant losing proposition to a casually ignorant shareholder.)

Link REIT is the largest constituent in the property subsector of the Hong Kong Stock Exchange's benchmark Hang Seng Index (HSI) of 58 companies from Hong Kong and China. It is dwarfed in terms of outright market value by property developer Sun Hung Kai Properties at US$42bn, but Link REIT's higher weighting comes from having a higher "free-float adjustment factor" (FAF) of 100% vs 40% for SHKP since the HSI adjusts for the number of shares actually available in the market by excluding locked-in shares, such as those held by major shareholders like insiders, promoters, and governments. (Both are dwarfed by the largest HSI component, China gaming and social media giant Tencent, at US$470bn market cap, with a 65% FAF.)

📊 In the Markets

The S&P 500 managed a small gain Friday (unlike the poor old NASDAQ) but still suffered the worst weekly loss in nearly two months. Despite floods of quite interesting news on the earnings front, overall market action was dominated by worries about what the US central bank, the Federal Reserve would do. The conclusion drawn by traders (for last week, anyway) seems to have been "we thought we were clever and that the Fed would be wrong about interest rates being 'higher for longer', but now that more people from the Fed have repeated what they've been saying over and over for several months about interest rates, we're still clever but now think interest rates WILL be 'higher for longer.' Keep paying us, please."

Some of the market weakness, though, came from earnings coming in a bit on the light side, with the number of companies beating the forecasts of Wall Street's Finest lagging the historical average. That could be at least partly from Americans burning through the "excess savings" they built up earlier in the Covid-19 pandemic thanks to stimmy checks and not going out. Estimates vary but JP Morgan Asset Management calculated that of the peak US$2.1 trillion built up in “excess savings”, over a trillion has already been spent (p.24). This still leaves a huge cushion for consumer spending into an economic downturn, but for many lower-income consumers, that cushion may have all but disappeared, and evidence of cutbacks (kitty litter, mattresses) are building. Some economists suggest that this has already reached the bottom 40% by income.

ZIRP-it, Mr Ueda!

Meanwhile, over in Japan, PM Fumio Kishida's Friday nomination of an economist, dark horse outsider candidate Kazuo Ueda (actually a former Bank of Japan board member from when the "Zero Interest Rate Policy" was adopted) to be the next central bank governor seems to be either a finely-calibrated decision or the result of nobody else wanting the "hospital pass" position.

The job of the new BOJ governor will be to balance the need to control inflation, now at 4% -double the target rate- by exiting deflation-busting negative interest rates and yield curve controls (called "Abenomics") without tipping Japan into another several "lost decades" of feeble economic growth. Markets took it as a sign that monetary easing would end sooner rather than later, and the Yen and Japanese government bond (JGB) yields surged in a knee-jerk reaction.

UK Recession? No. Misery? Yes

UK fourth quarter GDP data showed 0.0% quarterly growth in the economy, beating estimates by The City's Finest that the country would clock a second successive quarter of negative growth after shrinking 0.3% in the third quarter, which would register as a recession.

That's the technical definition "dodged"... cue breathless, crowing headlines about the UK "escaping recession by the skin of its teeth", but in reality, the economy fell by 0.5% in December, after growing by 0.1% in November and 0.5% in October, and is still the weakest in the G7 group of major world economies, with the IMF recently axing its 2023 growth forecast to minus 0.6% against plus 0.3% expected last October. (And how is it not "a recession" when four in five UK teachers had to give toothbrushes and toothpaste to students, according to a survey by hygiene poverty charity Beauty Banks and the British Dental Association... and toothbrushes becoming a “luxury item” for some families?)

Strikes and the World Cup break in Premier League football hit the economy in December. Despite the cost of living squeeze in household incomes, restaurants, bars and travel agents had a strong year. In 2022 as a whole, UK GDP growth was 4%, compared with a 7.6% expansion in 2021.

Gross Domestic Product (GDP) - a mini-explainer

• The GDP is the value of all goods and services produced in a country within a given time period, usually a year. It is used to measure the size and growth of a country's economy. It is calculated by adding up consumer spending, government spending, investments, and net exports, or in economist-speak: C+I+G+(X-M).

• A strong GDP can lead to job growth and increased consumer spending, while a weak GDP can lead to budget cuts and unemployment.

• While a higher GDP is generally seen as a positive indicator of a strong economy, it doesn't take into account factors such as income inequality and environmental sustainability.

Activist now streaming on Spotify

Activist investor ValueAct has bought a stake in Swedish audio streaming giant Spotify, arguing that costs had “exploded” as it built out its podcast and audiobooks business, with operating expenses growing at twice the rate of its revenue.

"We welcome ValueAct as an investor in Spotify," a spokesperson for Spotify said on Friday.

The announcement comes several weeks after the music streaming group had already announced job cuts and a restructuring in an effort to reduce costs and stem losses. Typically, ValueAct acts behind the scenes unlike other activist investors (like Nelson Peltz or Carl Icahn) which tries to rally public shareholder support by openly attacking the target's current management, often seeking a seat on the board of directors.

Examples of successful (for the activist investor) activist investor actions

• Carl Icahn and Apple Inc. - In 2013, Icahn Enterprises bought a large stake and pressured the company to increase its stock buyback program, which helped boost the stock price.

• Bill Ackman and Allergan Inc. - In 2014, Pershing Square Capital Management successfully pushed for a merger between Allergan Inc. and Actavis, resulting in a substantial premium for Allergan shareholders.

• Nelson Peltz and Procter & Gamble Co. - In 2017, Trian Fund Management successfully pushed for changes at P&G, including the appointment of new board members and the sale of underperforming businesses, which helped boost the company's stock price.

Spotify, incidentally, debuted on the New York Stock Exchange (NYSE) in 2018 in a relatively unusual way... not an IPO (an "Initial Public Offering") but an introduction, where unlike most companies that float, the company did not issue any new stock. Spotify simply allowed existing shareholders to sell their shares to anyone interested in buying them -- without any clear offering share price to base their decisions on (or even any profits at the company, at that stage.)

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