Above image shows Sakura Sogo’s real estate portfolio in central Tokyo

Sakura Sogo: Approach taken by Star Asia creates dangerous precedents for the J-REIT sector

Peter Murphy

REIT AsiaPac interviewed Peter Murphy, Head of Asia – Sakura Real Estate Funds Management Inc., about his views of Star Asia Group’s unsolicited takeover bid for Sakura Sogo REIT.  To follow the events, please click here

TIMELINE: Tracking the developments of Star Asia’s controversial bid for Sakura Sogo.

 

 

What is your view of Star Asia’s takeover bid?

Star Asia’s hostile takeover strategy is a blatant attempt to exploit a loophole in the regulations that govern J-REITs here in Japan. Their approach is one where they are attempting to deny Sakura unitholders the opportunity of pursuing any potential business restructure, including a merger that will be negotiated on arm’s length bona fide terms and approved by investors with normal voting thresholds.

Star Asia have used a wholly owned affiliate (Lion Partners) to accumulate the minimum unitholding (3%) to convene a meeting of unitholders to replace the existing Executive Director and Asset Manager with a Star Asia employee and the Asset Manager of Star Asia REIT. This requires a simple 50% majority vote to pass.

At the same time, Star Asia has referred to a potential merger with Sakura. However, the fact is there has never been any dialogue or discussion with Sakura about a merger and nor has Star Asia done any due diligence relating to the Sakura business or its property portfolio. Any merger proposal requires a two-thirds vote in favor to be approved. Star Asia owns 17.9% of Star Asia REIT but only 3.6% of Sakura. So, if it is successful in replacing the existing manager, there would exist significant conflicts of interest given both REITs share the same investment mandate and the disproportionate ownership stake.

Furthermore, should the manager be replaced, Sakura unitholders would find themselves in a position where they would have no alternative but to accept whatever merger terms were offered by Star Asia. They would lose all optionality to consider alternative strategies to optimize their investment or have the terms of any merger negotiated on independent arm’s length terms.

Sakura has never stated that it opposes merger or consolidation within the J-REIT sector but has serious concerns with the approach adopted by Star Asia.

In stark contrast to Star Asia, Sakura is recommending to its investors a merger with Mirai Corporation where normal protocols will be adopted. In this context, we mean that both sides have acknowledged that the terms of the merger will be negotiated in good faith, proper due diligence will be completed and the benefits from the merger will accrue fairly to all unitholders. Importantly, Sakura and Mirai are happy to present their full merger proposals to a meeting of unitholders who can decide to support this with a two-thirds vote.

The J-REIT sector has been one of the best performing in a global context and continues to benefit from strong investor demand both domestically and internationally. One of the principle reasons for its success is the stability the sector offers which is attractive to yield-focused investors.

The precedent that may be set, if Star Asia is successful, represents a serious threat to the stability of the J-REIT sector and may undermine its medium-to-long term success.

 

What are your next steps?

On Friday 19th, July Sakura entered into an MOU for a proposed merger with Mirai Corporation. Sakura, with the assistance of its independent financial advisor (SMBC Nikko), has identified a merger with Mirai as the best alternative to maximise Sakura unitholder value. This recommendation followed an extensive process, which identified a broad cross-section of alternative transactions and potential partners.

In the short term, the key steps are to complete due diligence, enter into definitive merger agreement including determining a merger ratio, and then present this to a unitholder meeting scheduled for 30th of August.

It is encouraging that the market has responded in a very positive way to the announcement that Sakura is pursuing a merger with Mirai. The relative share price movement has been strong since that announcement. We believe the benefits to Sakura investors relating to our proposal far outweigh the significant uncertainty and clear conflicts of interest that exist under the Lion Partners/Star Asia proposal.

The strength of our proposal is obvious. Investors who consider the facts will easily comprehend the benefits of a merger with Mirai, primarily that of increased scale post-merger which should translate into enhanced liquidity, lower cost of capital and stronger medium-to-long term growth prospects. Mirai enjoys the benefits of an extremely strong and credible dual sponsor support in Mitsui & Co. and IDERA Partners, as well as a very strong financial base including the backing from major lending institutions, longer than average loan maturity profile, lower borrowing costs and an A+ credit rating.

The Sakura and Mirai portfolios are complementary and both enjoy a high weighting to the strong Tokyo office market. This characteristic is not shared by Star Asia REIT which has a relatively low weighting to the Tokyo office market which is widely acknowledged as offering the strongest growth prospects of any sector in Japanese real estate over the short-to-medium term.

 

What did your investors say about the bid?

Our investors have reacted in a very positive way to the proposed merger with Mirai and are pleased to have the opportunity to consider what we believe is a superior, and more tangible option than the Lion Partners proposal. Most investors welcome consolidation in the sector and see merit in that dialogue continuing but the strong sentiment is that this should happen in a manner that first, does not threaten value of some investors over others and second, does not manifest in a way that could cause unnecessary volatility and instability in the sector because they recognize that will be counterproductive to the wellbeing of the sector overall.


How have Star Asia’s statements about your performance been misleading?

Their statements are designed to achieve their objectives. That is to convince investors they should replace the existing Executive Director and Asset Manager. The fact is, that Sakura REIT has outperformed Star Asia REIT over the last four fiscal periods in terms of compound growth in net asset value per unit (Sakura +2.22% vs Star Asia +1.27%). This is the best measure of determining which manager is adding value for their investors and which isn’t. In addition, Sakura’s portfolio has consistently outperformed Star Asia’s in terms of occupancy since IPO. Star Asia has seven assets in their portfolio with unrealised losses, six of these acquired from the Sponsor which raises questions on pricing for those assets. In contrast, Sakura does not have a single asset with an unrealised loss.

The debate over Sakura’s management and whether or not those statements are misleading is now a moot point because both proposals, including the merger with Mirai which Sakura supports, will lead to the termination of the current management agreement if approved by unitholders.

 

What do you think will be the outcome?

Ultimately, unitholders will have to decide which alternative represents the best option. We believe that choice is relatively straight forward. Our proposal will offer clear, tangible benefits with a new credible and strong dual Sponsor support coupled with attractive future growth potential. The Lion Partners or Star Asia proposal offers no certainty or clarity and is clouded by significant conflicts of interest.

Investors who consider the options carefully, will in our opinion, support the proposed merger with Mirai and we obviously feel strongly that that is in their best interests to do so.

 

What are your thoughts about the J-REIT provisions that have allowed this bid?

We believe this is a loophole that has been taken advantage of by Lion Partners and Star Asia. It represents the abuse of minority unitholders rights to complete a hostile takeover. The reason why minority unitholders have these rights is certainly not to achieve the outcome set out by Star Asia.

 

The rules that govern the J-REIT sector have been drafted in a manner to avoid conflicts of interest like those that would be created if Star Asia is successful.

This is a unique situation. It has never happened before, in fact since the J-REIT sector was established in 2001 there has never been any hostile activity. Given the circumstances, I have a great deal of sympathy for the regulators. I suspect they never envisaged a competitor using this approach in an effort to complete a takeover, and without pre-empting their reaction, I would not be surprised if they are considering a review of the existing regulations and are contemplating possible revisions to prevent this from happening again.

There are clear merger protocols that exist to preserve and protect the interests of unitholders and any departure from these principles should be scrutinised by all key stakeholders in the sector.

 

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