First REIT (SGX: AW9U) is a healthcare REIT that invests in a portfolio of diversified healthcare assets in Indonesia, Singapore and South Korea.
The REIT’s portfolio comprises 20 properties consisting of 17 hospitals in Indonesia and South Korea and three nursing homes in Singapore.
For its fiscal year 2020, the REIT reported a dismal set of earnings.
Rental and other income fell 31% year on year to S$79.6 million as the REIT manager doled out rental reliefs to all tenants in May and June and Indonesian tenants in September and October.
As a result, distributable income plunged by 51% year on year to S$33.4 million, while distribution per unit (DPU) fell in tandem to S$0.0415, down nearly 52% year on year.
Faced with such a downbeat set of results, should investors throw in the towel?
A confluence of challenges
First off, investors need to understand the predicament that the REIT is in.
The manager is facing several concurrent challenges that may threaten the ability of the REIT to continue operating.
First REIT has 16 hospitals in its portfolio that are operated by PT Siloam Hospitals International Hospitals Tbk, a subsidiary of PT Lippo Karawaci Tbk (IDX: LPKR), or LPKR.
Trouble began when LPKR proposed a radical restructuring of the master lease agreements for its Indonesian hospital portfolio back in June 2020.
This restructuring was announced as LPKR is itself facing liquidity issues and the COVID-19 pandemic has worsened its situation.
If First REIT pursues legal action against LPKR, there is a high chance of losing up to 72.1% of rental income represented by LPKR hospital leases.
Should this occur, the REIT’s survival is at risk.
A real risk of loan default
To make matters worse, close to 40% of the REIT’s debt is coming due on 1 March 2021 and a total of 80% is due in the next 18 months.
A total of S$400 million needs to be refinanced, of which S$260 million can be successfully refinanced.
The shortfall of S$140 million is to be satisfied by a rights issue that was announced by the REIT in late December last year.
Importantly, the rights issue is one of the conditions imposed by lenders before they will agree to refinance the S$260 million.
Highly-dilutive rights issue
The rights issue is highly dilutive as it involves the issuance of 98 rights shares for every 100 existing units based on an issue price of S$0.20, a then 50% discount to the S$0.40 close.
Gross proceeds raised of around S$158.2 million will cover the shortfall of S$140 million that cannot be refinanced, thus averting a default for the REIT.
Investors should note that First REIT’s gearing level, at 49% as of 31 December 2020, was dangerously close to the maximum 50% threshold.
This rights issue, if conducted successfully, will reduce the REIT’s gearing down to around 34.4%, allowing it to extend its weighted term to maturity to 1.94 years with no maturities in the next 16 months.
Unitholders who are unhappy with the terms and conditions of the rights issue are free to sell their rights entitlements in the open market as this is a renounceable rights issue.
The whitewash waiver
However, before the rights issue can even proceed, unitholders need to vote in support of a whitewash waiver at the upcoming extraordinary general meeting (EGM).
The whitewash resolution will waive the right for OUE Ltd (SGX: LJ3), First REIT’s substantial shareholder, to make a general offer for the REIT.
OUE intends to underwrite the rights issue and will also subscribe for any excess units that are not taken up by unitholders, thus ensuring that the recapitalisation of First REIT can proceed smoothly.
Thus, unitholders must approve the resolutions such that the rights issue can proceed.
Otherwise, the REIT may face bankruptcy if it cannot look for alternative sources of financing should the resolutions not be approved.
Get Smart: Dim prospects
Even if all resolutions are passed, First REIT is still not out of the woods.
The ongoing financial stress for LPKR means that the restructured master leases may not deliver the upside that the manager seeks, even after a few years have passed.
Furthermore, the base currency of the leases will be in Indonesian Rupiah, which increases the currency risk for unitholders.
The manager is seeking out appropriate ways to hedge this and will inform unitholders in due course, but I believe it may be expensive to hedge as the Rupiah has been known to be volatile in the past.
Faced with continued pressure and dim prospects, there are no compelling reasons for purchasing this REIT until business conditions improve materially.
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Disclaimer: Royston Yang does not own shares in any of the companies mentioned.