Star Asia Taps Japan’s REIT Rule For First Time In Sakura Sogo Bid

The rule allows a unitholder with a 3% holding to propose changes and call for an extraordinary meeting. A separate provision regards non-votes to count as “yes” votes.

On May 10, Star Asia Group launched a takeover bid for Sakura Sogo, utilising for the first time a provision in the J-REIT legislation that allows a unitholder that has at least a 3% holding for a minimum of six months to table a proposal and call for an extraordinary meeting.

Star Asia Investment Corporation (SAIC), a J-REIT affiliated with Star Asia Group currently has 102.3 billion yen (US$952 million) of assets under management.  Star Asia Group has a 3.6% stake in Sakura Sogo REIT through its affiliate Lion Partners GK. The company said in its merger proposal that the combined group would add to unitholder returns, given Sakura Sogo’s declining distribution per unit (DPU) and high cost of operations. Star Asia Group did not provide merger terms at this point but proposed that Lion’s representative director, Toru Sugihara, succeeds Sakura’s existing executive director, and its asset manager be replaced by Star Asia.

Sakura Sogo, in its rebuttal, said the takeover is hostile in nature as assertions made by Star relating to Sakura’s management are “misleading and intended to deceive Sakura unitholders.”

At the centre of this bid is a provision in the J-REIT law that regards non-votes to count as “yes” votes. As at December 2018, Sakura Sogo has a 53.5% retail unitholder base, which could result in a vote count in favour of Star Asia Group if these unitholders do not vote.

In June, Lion Partners received regulatory approval from the Kanto Local Finance Bureau (KLFB) to move ahead with hosting the Sakura Sogo’s unitholder meeting. The meeting is scheduled on August 30, 2019.

The takeover bid, which challenges Sakura Sogo’s return performance, comes at a time when Japan is attempting to improve corporate governance.

We interviewed Malcolm MacLean, the Founder and Managing Partner of Star Asia Group about the proposed takeover.

Question: The takeover bid has been postured as a friendly merger. However, Sakura Sogo has come up with a rebuttal. Could you explain the context of this merger?

We’re obviously looking to continue to grow and add value to our unitholders through accretive acquisitions and dispositions and other creative activities. Unlike many J-REITs that are buy-and-hold entities, we have taken the deliberate strategy of trying to maximise value and drive dividends and NAV (net asset value) higher by being more active managers through the buying and selling of assets.

We are always acting in the best interest of our unitholders especially given that Star Asia Group is the largest unitholder of SAIC, owning approximately JPY11 billion ($138 million) or 18% of the outstanding units. We are perfectly aligned with our unitholders.

There are J-REITs, one being Sakura Sogo, that actually are not as focused on unitholder value. As you can see, they have not generated any value, their dividend has decreased since they’ve gone public. They’ve not been able to do any public offerings to raise more capital. They’re not growing, and the company is sort of stuck in a box. And our view is, while their portfolio is OK, there are some assets that we would look to sell opportunistically. Their cost of capital is much higher than ours.  They also have a much higher operating costs in that they have a higher asset management fee, and the combined company would result in increased dividends and increased value to unitholders.

Despite what Sakura says, this is not a hostile transaction. We are purely using a right that was given to unitholders under the J-REIT law. That right allows any unitholder that owns 3% of the company for a minimum of six months to make proposals to the unitholders of the other company and to hold an extraordinary unitholder meeting. We have deliberately asked the board of Sakura multiple times to hold that unitholder meeting. They have refused to hold the meeting. The regulators are involved and have recently granted us permission to hold the unitholder meeting. Sakura Sogo has little interest in what’s in the best interest of unitholders, and they’re more interested in what’s in the best interest of the asset management company and their fee revenue.

Our view is that this is a unitholder decision and discussion.

We’ll let the unitholders decide if they would rather keep Sakura Sogo, which hasn’t run the business well, hasn’t created value, has decreased the DPU, has charged them much higher fees, has a higher cost of capital and has an unimpressive track record. If they prefer to choose that, then that’s fine.

But I think it’s pretty safe to say the reason Sakura Sogo is fighting back emotionally is they know what the answer is—that unitholders will choose Star Asia over their management for many reasons. We think that this is a deal that’s in the best interest of both our unitholders and theirs to create the most value for both companies.

Question: I would like to understand the 3% ownership rule that allows you to call a meeting. Is that your absolute right or is it subject to Sakura’s agreement?

We have the right to put forth an agenda and hold a unitholder meeting. And that’s what we did on May 10th. We put forth a proposal with four items. One is to replace their current CEO with Sugihara san, who is the head of Lion Partners.

We would dismiss their CEO and would terminate the asset manager contract between Sakura Sogo and their asset manager and enter into a new agreement with Star Asia Investment Management, our asset manager. All four of those agenda items would require at least a 50% affirmative vote by the Sakura Sogo unitholders to effectuate.

They have rejected our request to hold the unitholder meeting. So, we have gone to the regulators and said well if they’re not prepared to hold the meeting, then we will hold the meeting. At this point the meeting will be held on August 30, 2019.  This provision is written in the J-REIT law.  The regulators have acknowledged that this is a right given to unitholders as is the ability to get the unitholder list from Sakura Sogo. They refused initially. However, the Courts in Japan have enforced that right, and they have finally given us the unitholder list. So again, they are being obstructionist and not allowing us to move forward on something that is our inherent unitholder right, and by the way, it’s every unitholder’s right if you own 3% of the company for a minimum of six months.

Question: We covered the PAG and Spring takeover in Hong Kong a few months ago. PAG had 16% of the target company before launching a takeover. While there are differences in the two markets, PAG’s bid failed because the sponsor had over 30% of the REIT, and they easily crossed the 50% bar with the support of other unitholders. With Star Asia owning just 3%, what do you think are the odds for success?

The two transactions are very different. What PAG tried to do was a hostile takeover. They bought a big chunk of stock, and they decided to take over the company. Our approach is entirely different. We have 3%. None of our friends has bought any units. And what we have done is: we’ve put forth the proposal to the unitholders. We’re letting the unitholders decide who they think would be better to lead the company. I think it’s very clear for the reasons that we’ve laid out. We can improve the value for unitholders for both sides by reducing fees, by having lower borrowing costs and by actively managing the portfolio. While we only own 3% of the company, we think that when the vote is brought to unitholders, there are very few people, if any, who will vote against it other than the asset manager. We’ve already spoken to some of their institutional unitholders, and they are very happy with this transaction. We’ve met with all of our institutional unitholders, both domestic and foreign, and they’re incredibly supportive.

There are far too many small J-REITs that are stuck in the box and not growing. We really need to have some consolidation to ensure the survival of the fittest. There is a provision in the J-REIT regulation called Minashi in Japan, by which if a unitholder does not vote, it is counted as an affirmative vote.

Question: You’re quite confident about the approval; what percentage of unitholders’ support do you think you will get?

The ones that we’ve met with have all said they are supportive. The interesting thing is Sakura Sogo has very low institutional ownership. Most of their unitholders are retail investors who are essentially buying it for the yield. Retail is a little bit harder to control; it is difficult to reach them. We have hired a proxy solicitation firm who is contacting all of the Sakura Sogo’s unitholders now.

Question: What percentage does Sakura’s sponsor have of the Sakura REIT?

The sponsor of Sakura Sogo is a partnership between Australia’s Galileo Group and Nihon Kanzai. They own 2.6% each. So, that is a total of 5.2% whereas Star Asia Group owns almost 18% of SAIC.

Question: I noticed that the portfolios of both Sakura Sogo and SAIC are diversified in nature. There is a view among investors that for such diversified portfolios, the different assets trade at different cap rates and yields. What that means is that there are different cycles among the property types, and the REIT could be channelled towards one sector at a point in time. What is your view on this?

One of the core strategies at SAIC since we went public three years ago is that we believe that it’s in unitholders’ interest to have a diversified J-REIT; well-diversified by property type, by tenants, by location etcetera. It creates stability, and we feel that if a J-REIT is just an office REIT or just a residential REIT, it’s quite limiting. It may not be the right time to own a residential asset in Osaka or Tokyo, and you’re basically a one-trick pony. We’ve had a very long history in the private real estate markets and a very solid track record of investing on behalf of U.S endowments, foundations and Japanese pensions, and we’ve delivered very strong returns. What they like about SAIC, and why we believe that we should continue to manage the portfolio actively is that we think investors pay us as the expert in Japanese real estate to decide which property type to buy, in which location, and in which part of the cycle.

It is also our job to sell property in markets that we think have the least value going forward. In the last two years, we’ve sold four properties at much higher values than their current net asset values. We were able to pay special dividends to unitholders and then redeploy that capital into a different property type which we thought had lower risk and higher returns.

That’s what J-REITs have not done in the past. They’ve been more into buy and hold and being just asset accumulators.

For us, having that ability to invest in various property types is really one of the most critical strategic points that we have.

Question: I hear your point about the value of active management. However, compared to the private market, there is a bit of a limitation for a diversified REIT in terms of assets you can buy and sell. In a private market, there is more leeway and flexibility. What is your view?

Clearly, in private markets, we have more flexibility. We can use more leverage. We can move more quickly. In the J-REIT market, when we sell an asset, we need to replace it with another asset. Whereas in the private market, you just sell an asset and you move into cash. J-REITs can’t sit on cash because that’s a drag on DPU. What we can do is we can improve the quality of the cash flow, improve the stability of the cash flow, upgrade the locations, upgrade the quality of the assets by doing this asset replacement strategy. So, when there is a downturn, we should be able to weather the storm better than other companies that have continued to own the same assets, and when markets have changed, they haven’t changed with it. I think it is more limiting being in a public market, but at the same time, that doesn’t mean that we shouldn’t look to maximise asset values and unitholder returns by applying this asset replacement strategy.

Question: What is the strategy for Star Asia or the combined SAIC and Sakura group going forward?

Our view is that interest rates are very low, there’s still a positive spread between funding cost and cap rates. There is lots of capital coming into the market. There is some overbuilding in certain parts of Osaka with hotels and logistics around Narita, but there are always little pockets of dislocation. Generally speaking, the property market in Japan is quite robust. Unlike most other large cities in the world, rents are still below pre-crisis peak. Rental values are currently 30% below the 2007-2008 levels. There’s obviously been positive visitor flows into Japan. Japan’s gone from about six million visitors to over 30 million this year in six years. Obviously, the economy is not growing significantly, but there is enough activity, and there’s a level of confidence in the market. This positive sentiment will underpin things for the next 12 to 24 months.

At Star Asia, we have become slightly more defensive over the last twelve months. We’ve been looking to extend the duration or the maturity of our debt. While we don’t think interest rates are going up anytime soon we do want to lock in these rates so that we don’t have as much volatility in our earnings. We’ve also been expanding our banking relationships with some very well-known banks coming into the syndicate. We are seeing rental growth. If you look at the type of apartments we’re buying, which are those that are 15 to 25 square meters in size, even during the Lehman crisis, rents for these were very stable. As for occupancy, these are apartments in which working class, domestic people live.

Even though Japan has a demographic issue, there’s been this urbanisation trend, and the populations in the cities have been growing. Residential is getting some growth now, so we’ve been moving more into residential. We’ve also acquired over the last couple of years more industrial assets that are within 30 km of central Tokyo. These assets are integral to industrial businesses looking to distribute to their customers.

We’ve looked at several retail transactions, and we would not make a retail acquisition unless it is located on the high-street in central Tokyo or in the central Osaka business district. But most are way too expensive.

Sakura Sogo has four very large regional retail assets. Those are assets that we will look to sell very quickly in the combined company. We think that is a fair amount of tail risk. We would exit those assets over the next year and look to redeploy the funds into more stable, better growth prospect assets.

While urban retail is doing ok, we are concerned with regional retail due to the rise of e-commerce.

Since the publication of the interview, Sakura Sogo has also announced that it is in merger talks with Mirai Corporation. (Please read the press release here.)