Verdict: Not to be occupied

IPO Snapshot:

Mindspace Business Parks REIT is entering the primary market on Monday 27th July 2020, with a Rs. Rs. 4,500 crore IPO, comprising a fresh issue of units in the real estate investment trust (REIT, different from a company issuing shares) of up to Rs. 1,000 crore and an offer for sale of up to Rs. 3,500 crore by promoter K Raheja Corp and PE giant Blackstone, in the price band of Rs. 274 to Rs. 275 per unit. Singapore’s GIC, Fidelity and few other strategic investors have committed Rs. 1,125 crore (at Rs. 275 per unit) to the issue, reducing the net offer size to Rs. 3,375 crore. Representing a total of 27.6% of the post issue paid-up units, 75% of net issue is reserved for institutional investors and balance 25% for non-institutions (HNIs and retail) with minimum ticket size of Rs.55,000 (200 units at Rs. 275 each). Issue closes on Wednesday 29th July and listing is likely on or about 12th August.

 

Introduction to REITs:

Before evaluating the issue specifics, it is important to understand key traits of a REIT:

1. REITs are real estate properties bundled together, with minimum 80% in value of the assets rent-generating. Unlike equity shares, REITs do not carry any face value. There are only number of units.
2. SEBI regulations require minimum of 90% of net distributable cash flow (NDCF) to be compulsorily distributed among unit-holders, once every 6 months. Like already listed REIT of Embassy Office Parks, Mindspace REIT also aims at 100% payout at quarterly intervals, improving yield marginally.
3. Distributable surplus will not be taxable in the hands of the unit-holder, as it has guided that all SPVs of Mindspace REIT will continue to operate in the old corporate tax regime, under section 10(23FD) of the Income Tax Act, 1961 (updated in Feb 2020 budget). Hence, dividend will not be taxed in the hands of unit holders.
4. Capital Gains (on sale of units) to be taxed at 15%/10% for STCG/LTCG respectively. However, holding period for LTCG is minimum period of 36 months (which is a disadvantage vis-a-vis listed equity shares for which holding period is 12 months).
5. Minimum application size in this IPO has been lowered from Rs. 2 lakh a year ago when Embassy REIT hit the primary market. Minimum application now stands at Rs. 55,000 (200 units based on Rs. 275 per unit) and trading lots is also 200 units.

 

Business Overview:

Mindspace Business Parks REIT, 85% owned by K Raheja Corp Group and balance 15% by PE giant Blackstone, owns 29.5 million sq ft (msf) office portfolio as of 31-3-20, comprising 23 msf of completed area, 2.8 msf of under construction and 3.6 msf of future development area, in Mumbai, Hyderabad, Pune and Chennai. Of the 172 tenants, no single tenant accounts for more than 8% of gross contracted rentals. The trust continued to collect ~95% of contracted rent in April and May 2020 (similar to Embassy REIT) since these are long term leases to global companies, some with lock-in clauses. Hence, the pain, if any in the commercial real estate sector, will be felt more gradually probably when the leases come up for renewal.

In end of June 2020, CRISIL has assigned Provisional Corporate Credit Rating of AAA. Here ‘provisional’ implies that rating centrally factors in the strength of specific structures, and will be supported by certain critical documentation by the issuer, without which the rating would either have been different or not assigned ab initio. These caveats are not too comforting, especially so for real estate companies. Anyways not much credence accorded to rating agencies which have lost both investor and regulator faith over the last few years (case in point IL&FS, Yes Bank etc.)

 

Objects of Issue:

Fresh issue proceeds of Rs. 1,000 crore will be used for Rs.900 crore debt repayment (of total Rs. 7,400 crore as of 31-3-20), Rs. 33 crore to purchase preference shares of SPV Mindspace Business Parks Pvt.Ltd. holding Mindspace Airoli East property and balance towards general corporate purposes.

Of the OFS portion of Rs. 3,500 crore, Rs. 2,700 crore from K Raheja Corp’s portion will be used to reduce debt of Mindspace REIT to about Rs. 3,600 crore post listing.

We are skeptical of this structured debt reduction via routing through the promoter, instead of plain vanilla method through fresh issue proceeds (when Rs. 900 crore is already being retired through fresh issue). This brings to mind Aug 2019 IPO of Sterling & Wilson (SWSolar) wherein Shapoorji Pallonji Group adopted a similar approach - they committed to investors during the IPO that OFS proceeds will be used by promoters to reduce debt, but they horribly failed to keep their commitment due to over-leverage, and the share price has tanked over 70% in less than 11 months. While we are not pre-empting a repeat of this, the risks must be well understood, raising questions on poor corporate governance standards, besides having financial implication such as interest burden not reducing, impacting potential distribution to unit holders.

Moreover, current times are highly uncertain and evolving, especially for players like K Raheja Corp with business interests in hospitality, retail, real estate – all sectors facing acute stress due to covid-19. Needless to state that listed group companies Shoppers Stop and Chalet Hotels (which also has a part of the promoter holding pledged) have lost over 50-60% in market cap since Feb 2020.

In April 2020, Embassy group pledged its holding in Embassy REIT to raise Rs. 1,350 crore in debt. Thus, real estate sector has been under stress even before the covid-lockdowns, which has now been deeply aggravated. All these factors raise underlying risks, and likely returns may not be commensurate with them.

 

Shareholding Pattern:

Current shareholding is split as 85% with K Raheja Corp Group and 15% by PE giant Blackstone. Post IPO, holding of promoters K Raheja Group will shrink to 65% whereas Blackstone will own 10%.

 

Financials:

For FY20, the trust’s revenue grew 23% YoY to Rs. 1,766 crore, as new properties started contributing, yielding average rent of Rs. 52 per sq ft at portfolio level, leading to EBITDA of Rs. 1,378 crore and PAT of Rs. 514 crore. For FY22, growth in revenue and facility rentals is assumed at 23-25%. Due to slower lease up of vacant properties and delayed completion of under construction properties going forward, this 23% growth projections appear very aggressive and optimistic, given current macro uncertainties.

 

Returns to Unit holders: comprises of 2 components:

1. Pure yield which is computed as net distributable cash surplus, divided by price per unit.

On FY21E financials shared in the RHP, the yield works out to about 7.5-8.0%, on issue price of Rs.275 per unit. If the price of the units changes post-listing, this yield will obviously change, similar to bond/g-sec yields. This returns are tax-free in the unitholders’ hands as per point 3 above in Introduction to REITs.

While this yield of 7.5-8.0% is higher than bank FDs, it is not a guaranteed return unlike FD or NCDs. Also, this yield is after pricing in the positives such as contracted escalation, mark-to-market potential during renewals etc. For example, when in-place rents for the trust has grown at 6% CAGR between FY16-20, going forward, 7% projected growth rate has been considered in the RHP. Moreover, over a 10 year period, gold has delivered 9% CAGR returns and Nifty 14%. Hence, while yields are higher than bank FD, it is not commensurate with the risk.

2. Capital appreciation: Since the value of the assets the trust holds may change, price of the listed units may also fluctuate. Although lumpy, commercial real estate returns are estimated at 3-5% p.a. over the long term. However, price of units on the stock exchanges may fluctuate swiftly. RHP states the fair value of assets at Rs. 23,675 crore. But, not much credence to be given to this, as these properties are not being monetized, while difference between theoretical and actual realisable value may be high, especially so in real estate market. Also, capital gains tax is applicable as per point 4 above in Introduction to REITs.

 

Valuation:

At Rs. 275 per unit, post-listing equity value stands at Rs. 16,308 crore, based on 59.30 crore units post IPO. NAV (as of 31-3-20) stands at Rs. 320 per unit, which leads to 14% discount to issue price of Rs. 275. Peer Embassy REIT, which has risen about 7% in the past 4 days, is currently ruling at 3% discount to its 31-3-20 NAV of Rs. 375. However, during Embassy’s IPO in March last year, it had priced the offer at 20% discount to its then NAV. Thus, Mindspace REIT’s 14% discount is not attractive enough.

Comparison with Embassy REIT highlights few other headwinds for the issue:

• Mindspace REIT lacks geographic presence in an important Bengaluru cluster
• 75% of current IPO is OFS portion, which is not bound to come into the trust. Embassy REIT on the other hand was a 100% fresh issue with the sole object of debt reduction.
• Embassy REIT has complete backing of US PE giant Blackstone, having USD 150 billion in real estate AUM globally and also India’s largest commercial property owner. In this REIT, Blackstone is only a minority shareholder, 15% currently, which will shrink to 10% post IPO. At present, Blackstone holds 46% stake in Embassy REIT after trimming 8% holding in June 2020, which is very assuring from the corporate governance point of view.  

Factors such as covid-easing, global socio-economic-political policies, domestic policy rate changes, etc. will play a vital role on where commercial real estate in India is headed, with risk of volatility in returns remaining high.

 

Conclusion: 

REITs falls in between debt and equity as:

• Risk higher than Debt with returns not guaranteed unlike bank FDs or non-convertible debentures (NCDs)
• Returns lower than equity which has delivered ~14% in last 30 years. REITs are likely to return lower than this, although more stable (quarterly or half-yearly).

Given systemic risk as well as those at sector and promoter level highlighted above, the returns do not appear favourable. Hence, we recommend an ‘avoid’ to the issue of Mindspace Business Parks REIT.   

 

Grey Market Premium of Mindspace REITs:

Grey Market Premium (GMP) of Mindspace REITs is an unofficial figure, against guidelines of SEBI. We strongly recommend investors against following the grey market premium. To know more about grey market premium and how it operates, read our article on ‘grey market premium’ in the Pathshala column.

 

Disclosure: No interest.