Eagle Hospitality Trust - Time To Nibble?

by: Tam Ging Wien


All examples and stocks quoted here in this article and on the ProButterfly.com and REITScreener.com site are for learning purposes; it does NOT constitute financial advice or a Buy/Sell recommendation. Contents are reflective of personal views and readers are responsible for their own investments and are advised to perform their own independent due diligence and take into account their own financial situation. If in any doubt about the investment action you should take, you should consult a professional certified financial adviser.


The Edge publications released a very frightful story about Eagle Hospitality Trust (Eagle) on 23-Oct-2019 (Wed) after trading hours entitled “Eagle Hospitality Trust could get wings clipped as key asset The Queen Mary sinks into disrepair”. The story cites a series of “damning reports by an independent inspector hired by the City of Long Beach” and alluded to the fact that Eagle could potentially lose one of its largest revenue source – The Queen Mary Long Beach.

According to the article, John Keisler – the economic development director of the City of Long Beach had sent a letter on 01-Oct-2019 (Thu) to Taylor Woods, the CEO Urban Commons, alleging that the company had failed to meet its obligations to City of Long Beach to upkeep the ship. Urban Commons would have 30 days to respond to the allegations within 30 days or face the possibility of default. We attach the letter in question:

At the point of writing, Urban Commons may have less than a week to deliver formal reply to the City of Long Beach.

Prior to the story carried by The Edge, a news article by Long Beach Post (LBP) dated 06-Oct-2019 appears to have first broken the story to the public:

ProButterfly.com has previously written extensively about the decommissioned historical ocean liner that is that has now been converted into upscale hotel in California. The Queen Mary Long Beach was previously owned by Urban Commons, the sponsor Eagle and now injected into the trust. For an extensive coverage of the Eagle IPO and The Queen Mary we suggest readers refer to our previous article for background before moving on:

The Edge article made its rounds quickly spreading like wildfire and just before the open of the next trading day, Eagle requested for a trading halt on its units pending an announcement. The market was put in suspense as to the nature of the announcement. The manager finally releases its statement regarding the clarification of The Edge’s article close to 5pm on Thursday clarifying that it has seeked clarification from its sponsor Urban Commons that they are “not in default on The Queen Mary ground lease and that The Queen Mary remains safe and structurally sound”. The clarification announcement can be found in the link below:

The trading halt was lifted after trading hours, but the clarification statement failed to calm the markets. Immediately the next day, Eagle’s unit price plunged from 64.5c the previous day to close at 54.5c, a severe 15.5% decline in just a single day trade with over 32.8mil shares traded. In the last 1 year, Eagle is the worse performing REIT on the Singapore market, down almost 24% in the last one year.


Source: REITScreener.com

Was the steep fall justified or did the markets overreact to the news? We explore these questions this is article.

Eagle’s Valuation with and without The Queen Mary

Eagle’s counts 18 full service hotels around the US with a total valuation of US$1.27bil. The hotels target corporate and leisure travels as well as frequent travels who need accommodation close to airports.

We have done an analysis of key figures of Eagle and estimated the changes in these figures assuming the worse-case that Eagle has to write-off The Queen Mary. In the absents of breakdown of information in the IPO Prospectus and the latest financial results, we will make a series of assumptions where we will take the “worse-case scenario” where Eagle completely writes-off The Queen Mary. Here are a list of some our assumptions:

  • We assume straight line adjustments for all forecast taken from the IPO Prospectus without consideration for seasonal adjustments
  • The Queen Mary is on a triple-net-lease, we assume that the loss of revenue directly impacts the revenue, Net Property Income and Distributable Income by the same amount
  • The Queen Mary is completely written-off from the books but any debts on the asset is maintained on the books
  • We assume the amount of stapled securities is the same and do not consider changes to the management fees due to the loss of The Queen Mary

We admit that the assumptions used is certainly a worse-case, hence we think that the figures that we estimated without The Queen Mary is extremely conservative.


Source: REITScreener Research, ProButterfly Research, Eagle Hospitality Trust

The yield just prior to the sell-off is estimated to be at 9.86% and 9.00% while the P/B Ratio was at 0.72x and 0.77x with and without The Queen Mary respectively.

Looking at the figures, it almost seems as if the market sold down Eagle exactly assuming that The Queen Mary would be completely written-off! Observe the yield and the P/B Ratio just before the trading halt and after the sell-down, its approximately the same! Its almost as if the market was completely pricing it Eagle loosing its prized asset!

Should The Queen Mary be fully written off while the debts are retained, gearing of Eagle will increase from the present 37.5% to 42.5%. Fortunately, still below the 45.0% regulatory gearing limit. This is heartening to know as Eagle would certainly not be caught in any unexpected position to liquidate its assets in distress or needing to raise equity fund raising to shore up its balance sheet.

Overall, given our worse case scenario, we think that in any circumstances, should Eagle need to write-off the entire ship, at the current prices it seems like that possibility has already been priced in. This is not to say that prices will not fall further, but we think that we are likely close to some sort of valuation support floor.

Is The Queen Mary Likely to be Written-Off?

We think not.

Assuming that the content carried by The Edge is true, the more likely scenario in our opinion is that valuations of The Queen Mary will be reviewed downwards in light of the repairs and reworks necessary to maintain the ship.

Under the contract between Eagle and its sponsor Urban Commons, these repairs and reworks are the responsibility of the sponsor and not the REIT. Hence, there should be no additional funding from Eagle required.

As The Queen Mary is also leased on a triple-net-basis to Eagle, all taxes, insurance and maintenance cost it to be borne by Urban Commons.

So we established that the REIT will not bare any responsibility for these repairs and reworks and unitholders in Eagle will not need to be concerned with sinking any additional cost to keep the ship “afloat”… punt intended!

But, What if Urban Commons Fails to Meet its Obligations?

Well, that is a possibility and certainly not something we dare say will not occur. Unfortunately, we are not able to obtain financial details on Urban Commons current financial state, hence we cannot immediately determine if the sponsor is financially healthy at this point of time. Given that it would have raised funds from the Eagle IPO, we think that the sponsor should have a certain amount of funds in its reserve to spend on the ship (assuming they haven’t spent it all!).

Assuming that Urban Commons has some reserve funding or the ability to raise funding through the use of dent, we think that a negotiation with the city is the more likely scenario and a reasonable timeline would be allocated to Urban Commons to make good any obligations.

However, if the Urban Commons is indeed cash flow stressed, then the likely scenario is that it would need to look at raising funds through the sale of some of its existing portfolio assets. A quick check on Urban Commons’ portfolio list and IPO Prospectus, we identified two asset which is not currently owned by Eagle – The Wager at the Battery (New York, New York) and Ramada Hialeah (Miami, Florida).

Based on quick Google search we found that The Wager was acquired by Urban Commons in Oct-2018 for US$147.3mil partially funded by US$96mil loan from Westbrook Real Estate Fund. Assuming the valuations are still the same, selling The Wager could help Urban Commons raise US$51.3mil.

Ramada Hialeah on the other hand was acquired by the sponsor for US$13.5mil in Jun-2014 and presently being redeveloped. With the enhancement on the way and the appreciation of the last 5 years, we think the valuations of the hotel should have likely increased from the original purchase price.

So in conclusion, we think that it is likely that Urban Commons would be able to at lease sell one of its assets to raise funds if it is required to. The asset that it sells would likely be The Wager as Ramada Hialeah is presently undergoing refurbishment.

Could Urban Commons Sell to Eagle?

Certainly, both Ramada Hialeah and The Wager are named as pipeline assets for Eagle.

As of 30-Jun-2019, Eagle has on its balance sheet US$67.4mil, more than enough to acquire Ramada Hialeah without the need for additional debt. It won’t however be enough to fund the acquisition of The Wager, necessitating either debt or equity fund raising (or both).

The problem for unitholders in this scenario is that the share price of Eagle is currently trading at a heavy discount. Any form of equity fund raising is likely going to be dilutive in nature. No shareholder would at this time want Eagle to raise equity fund raising with such a depressed stock valuation! If it does, it will certainly add to the negative sentiments surrounding Eagle.

Where the Large Shareholders Already Aware of This Situation?

Possibly, given that 2 major shareholders has sold in the recent month perhaps they could have known about the details of this report before the news became widespread. Two major sale where declared by substantial shareholders in the month of Oct-2019:

  • Norbert Shih Hau Yuan – sale of 5mil units at US$0.675 via off-market transactions
  • Tong Jinquan – sale of 10mil units at US$0.650 via off-market transactions

While we cannot conclusively say for sure, but considering the timing of the sale, its certainly a possibility that they may have known something which isn’t apparent to the rest of the markets yet.

Conclusion

After having the long Deepavali weekend to consider and debating with ourselves, we think that based on the current closing price of 54.5c, the market has likely priced in the worse-case situation where Eagle is forced to write-off the entire stake in The Queen Mary.

We think this situation is very unlikely. The more likely situation is that Urban Commons would deliver a comprehensive plan with timelines as to how it intends to address the concerns of the City of Long Beach. It would likely involve deploying additional funding to deliver repairs necessary to maintain and upkeep the ship.

We were not able to assess the sponsor’s financial health, but assuming it is unable to internally fund the repairs of the ship, then it would likely have to sell one of the two assets it currently has in its portfolio. A possibility would be to inject the assets into the REIT. We cannot discount the possibility that Eagle will use equity to fund the acquisition which will lead to potential dilution to existing unitholders given the depressed unit prices at the moment.

Another prudent consideration for investors who are thinking able nibbling at Eagle could also consider waiting for more information from Urban Commons' formal response to the City of Long Beach before making a decision.

With the considerations above, we think at in exchange for the possibility of a double-digit yield at this current depressed valuations, we might consider nibbling at Eagle next week when the market opens after the long Deepavali weekend depending on the price action on the markets. However, we will reserve at least 30% of our investment budget into Eagle in preparation for a potential cash call by Eagle sometime in the future.

Certainly, news such as this will take time to blow-over for the REIT. 

 

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