Sabana Reit's dogged dissident unitholders are not the only ones in need of a new approach

QUARZ Capital Management said in a letter to The Business Times last week that it disagreed with views I recently expressed about its adversarial approach to engaging the manager of Sabana Shari'ah Compliant Industrial Real Estate Investment Trust (Sabana Reit).

It argued that Sabana Reit's manager, which recommended a merger with ESR-Reit last year on terms that were plainly unfair, has continued to pursue initiatives in recent months that are not in the interest of minority unitholders.

In particular, it appointed Chan Wai Kheong an independent director (ID) in June.

Quarz contends that Mr Chan faces substantial conflicts of interests. He holds a stake in a competitor - Aims Apac Reit. He also sold units in ESR-Reit to ESR Cayman in 2017 at substantial premium to the prevailing market price. ESR Cayman controls the managers of both ESR-Reit and Sabana Reit.

Quarz has twice requisitioned extraordinary general meetings in order for Mr Chan's appointment to be endorsed by independent unitholders. The manager of Sabana Reit refused both times. It said unitholders will be given the opportunity to endorse Mr Chan's appointment at the annual general meeting next year.

In its letter to BT, Quarz expressed its determination to continue leaning on the manager of Sabana Reit and encouraged its fellow unitholders to take "active action" to ensure that the manager acts in their best interests.

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To be clear, I did not say that Quarz's mistrust of Sabana Reit's manager is unwarranted. Or, that the appointment of Mr Chan as an ID of Sabana Reit's manager should not make unitholders nervous.

My view was - and still is - that Quarz and other dissident unitholders ought to modify their strategy and tactics with changing circumstances.

Since the merger with ESR-Reit was scuppered in December, units in Sabana Reit have climbed nearly 24 per cent. The discount at which they trade to Sabana Reit's net asset value (NAV) has narrowed to 15 per cent currently.

Based on its H1 2021 distribution per unit (DPU) of 1.48 cents, Sabana Reit offers an annualised yield of 6.7 per cent.

There may yet be more upside for Sabana Reit's units as its manager pursues further asset enhancement initiatives and offloads underperforming or mature properties - in keeping with its so-called "refreshed strategy".

At some point, however, Sabana Reit will need to raise funds and make acquisitions to renew and expand its portfolio. This will be difficult if its manager and the wider ESR Cayman group are in constant conflict with key minority unitholders.

If this avenue of future growth is likely to remain closed, unitholders of Sabana Reit should look to sell their holdings and reinvest the proceeds in Reits with better track records.

No regulatory reproach

Of course, it isn't just the dissident unitholders of Sabana Reit who should shift their approach with changing circumstances.

One key reason Sabana Reit's manager has been seemingly immune to pressure from the likes of Quarz is that it has kept to the letter of the rules in everything from the appointment of Mr Chan to its handling of the proposed merger with ESR-Reit.

Certainly, there has been no reproach from Singapore's market regulators - despite the best efforts of Quarz.

In an open letter dated Aug 17, 2020, addressed to the Monetary Authority of Singapore (MAS) and Singapore Exchange Regulation (SGX RegCo), Quarz and other dissident unitholders of Sabana Reit pleaded for "guidance, clarity and support" in resolving the conflict of interest risks they faced as a consequence of ESR Cayman owning the managers of both Sabana Reit and ESR-Reit.

The dissident unitholders also highlighted that the proposed merger with ESR-Reit, which valued Sabana Reit well below its NAV, "raises concerns on whether the fiduciary duty of Sabana's board and management to act and protect all Sabana Reit's unitholders' interest has been potentially compromised".

On Aug 28, 2020, in a statement addressing "media queries" regarding the proposed merger of Sabana Reit and ESR-Reit, MAS said its regulatory framework does not prohibit a shareholder group from owning the managers of two separate Reits that are invested in the same property class.

MAS listed the regulatory safeguards in place to mitigate potential conflicts of interest. It also noted that additional measures to address specific risks had been put in place at Sabana Reit and ESR-Reit.

MAS went on to state that the regulatory framework governing mergers and takeovers is well-established and ensures that investors are provided with sufficient information, independent advice and time to consider the offer.

In short, the message from MAS seemed to be that the dissident unitholders had no grounds to complain about the proposed merger - even though such a lopsided deal would arguably never have been recommended if the board of Sabana Reit's manager was truly independent.

Fit for purpose?

When I first began researching and investing in stocks in the early 1990s, corporate governance was not a term I often heard.

Instead, there were companies with competent and honest management, which often garnered premium market valuations; and there were companies with managers who were inept and could not be trusted, whose shares were "cheap for a reason".

Over time, I would learn that strong economic growth and bull markets create a veneer of competence and honesty across the corporate sector. It is also when markets are hot that companies are most receptive to the demands of minority investors, because being receptive immediately drives stock prices higher.

Many companies only show their true colours in the face of recessions and bear markets. This is when the excesses of management come to light. It is also when controlling shareholders are most likely to expropriate minority investors.

This is perhaps why there has been so much angst about corporate governance standards in the local market in recent years.

Over the past decade - in the face of widespread technological disruption, slumping commodity prices and property cooling measures - the Straits Times Index has performed abysmally. A large swathe of the local market is now trading below book value.

Against this backdrop, it could be a mistake for MAS and SGX RegCo to assume that existing regulations and the prevailing attitudes of boards to corporate governance are still fit for purpose.

The failed Sabana-ESR Reit merger last year exposed some of the problems. For one thing, determining "independence" cannot be treated as a mere compliance matter. To maintain the confidence of investors, there needs to be transparency in the selection and appointment of IDs.

Also, with depressed market valuations, the current practice of enlisting an independent financial adviser (IFA) to evaluate takeover and merger proposals lacks credibility.

Indeed, Sabana Reit's appointed IFA was bound by terms of reference that strongly suggest it did not consider whether the pro-forma accretion in its DPU as a result of the merger would have been any better than the standalone DPU growth it would have achieved anyway.

Instead of forcing investors to bear the cost of useless advice, IDs ought to be expected to solicit alternative deals whenever a takeover or merger is proposed.

Regulators should be consistent and steadfast in formulating and enforcing the rules, but they should also recognise and respond to shifting investor demands in order to ensure that the local market does not lose its relevance.