Embassy REIT: Is this "Blackstone" promoted REIT is real diamond?

Stock Opportunities
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Hi Mahesh, thanks for your inputs.

I am trying to arrive at NDCF (Net Distributable Cash Flow) from PAT. My calculations are rough, but should majorly explain NDCF from PAT.

I am not trying to derive CFO, however, agree, working capital changes will have impact on NDCF.

However, I see working capital changes are small, and cannot explain movement of 400+ Cr.

Similarly, as explained in my previous post, Embassy golf Links is not part of P&L (only proportional profit of 50% equity is added to P&L), so NDCF would be higher. Hiwever, Alagain 400+ Cr is big number to justify the movement.

May there are more factors which we are not able to catch.

@dd1474 please share your views

Amit

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@Amit2saxena @mahesh_s
Thanks for seeking my view, although not sure how much it would be useful. I have gone through your postes and the past release of Embassy REIT for Q4FY2023. They have provided detail calculation including most of heads to derive at NCDF for Q4FY203 and FY2023.
I am enclosing same for everyone reference. I find this relatively simple to understand rather than working on my own from financial given my limited understanding. One can easily get understanding of what contribute positively and negatively in NCDFC from P&L and Cashflow .

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While it may oversimply, I can not understand complex things and try to keep my life simple.
Total EBITA in P&L for FY23 is Rs 26,884.99 mn as displayed in message 259 as against Rs 27,856 Mn as shown in enclosed table. The difference is around Rs 971.44 mn can be attributed to Dividend income from Golflink being Rs 920 mn. So unexplained difference of Rs 51 mn, which is not very large given the operating matrix in my view.
Embassy REIT FY23 Reconciliation of NCDF with P&L.xlsx (9.6 KB)

Disclosure: Embassy REIT is my third largest holding in Debt portfolio and hence my view may be positively baised. I may change my allocation (increase/decrease/exit) from Embassy REIT wihtout informing forum. I am not SEBI registered investment advisor. I am not recommending any investment action. I am not CA and hence my understanding about accounting may not be correct.

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I attended earning call for Embassy REIT Q2FY24. After long time, management sound positive about prospect. They also increased leasing guideance for FY24.
Key positive factors:
Higher operating leverage from hotel business
Increased under construction area coming for completion during FY24 and FY24, signficant portion being pre leased and hence contibuting to cashflow of the company
Expected MTM gain realisation on renewal
Expeced policy decision on SEZ, which would result in higher occupancy for the trust in medium term.
Most important, GCC now being main class of tenants, with nearly 70% of leasing in Q2FY being to GCC clients.
Negatives:
Interest rate increase
Selling by sponsors

While there was no increase in guieance for FY24 distribution, I found management being confident to increase distribution in FY25 onwards. Based on my understnading, I have sold nearly 1/3 of my investment in IndiaGrid and invested in Embassy REIT in last 7 days.

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Disclosure: I am not suggesting any investment action. I am not SEBI registered advisor. I have very great track record of being wrong, I was very optimistic about investment during April 2021 period. Embassy price decline from Rs 340 to Rs 300 since then. My view may be positively biased. I may change my investment (increase/decrease/exit) from Embassy REIT without informing members.

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Thanks for the summary. I have one question here, They upped their FY24 gross leasing guidance to 6.5 msf from 6.0 msf last quarter. This was on the back of an early renewal of 0.6 msf which essentially would have happened next FY anyway. Adjusted for this, their leasing guidance is actually down 100 k sqft compared to last quarter. Any particular reason for this?

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@Shrish_Vaze
Appreciate bringing out valid point. Find enlcosed Q1FY24 Transcript leasing area guidenace.

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In Q2FY24 Transcript, leasing are guideance get revised as under:

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So your point is valid that actually after accounting for 0.6 mn sq ft early renewal, guideance shall have been 6.6 mn sq ft. However, this are projections and 0.1 mn sq ft on 6.0 mn st ft account for less than 2% of total renewal area. In projection, which are volatile and uncertain, I would not consider this as singificant negative. In fact, the tenant of pedigree of IBM moved ahead and renewed early for 0.6 mn sq ft area, does give sense of optimism about lease rental in Bengaluru market. One may called this as my ownership bias, to see everything with positive perspective and ignoring adverse news totally.

Thanks once again to bring out valid concern. However, in my personal view, it is business as usual and not majorly negative. My undetstanding may be wrong.

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I am wondering about disconnect between office rentals and residential rentals in Bangalore. Later is shooting through roof. So office rentals will eventually catchup.

With strong GDP numbers it is unlikely that office rentals can remain subdued for long. It seems to be more of timing issue.

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Looks like there were lots of large deals in embassy Intraday Large Deals, Large Deals on NSE/BSE, Intraday Bulk Deals, Live Large Deals in NSE/BSE, Market Stats

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Indian stock market does not have depth. Sometimes 10 Cr is enough to punch this hole when the buy volume is not there.

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Yesterday’s accounced SEZ reform is welcomed by the REIT’s. Based on comments from Reit’s leaders, this will help increase the occupancy.

Infact, in the recent concalls, Embassy and Brookfield management were stressing, the need of this reform and were making representation to the government.

Link - Special Economic Zones: Central government amends rules to allow demarcation of non-processing area under IT SEZs, ET RealEstate

My naive question, why does it matter for the prospective leasor whether its SEZ area or non SEZ. What are the clauses in SEZ area that no one seams interested in leasing these assets now?

I understand SEZ do not offer export tax incentives anymore, but how does it matter if the prospective leasor is not looking for it anyways.

@dd1474 Can you provide some insights please?
Sorry, probably its a silly question, but I am not able to get the crux of the matter.

Amit

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@Amit2saxena
thanks for your message. In my opinion, the SEZ dedicated building are not attracting new tenants as they are not getting tax incentives. So only limited ITES related export service providers would be looking at that office area. As a result, the occupancy in SEZ for Embassy as well as Brookfield was lower than average occupancy.

While based on my understanding from con call, I understand that in Bangaluru office, Embassy was able to get approval for buildings denotification. However, now floorwise denotification from SEZ would provide better planning of SEZ area (consolidating SEZ clients in specific area) which would release new area for general purpose which would improve occupancy in medium term.

The problem is existing tenant would be seeing tax incentive being not avaialble and may not be keen to renew the lease. At the same, since the area is notified as SEZ (which mean can not be used for domestic market services and shall be exclusively for the exports), demand from new tenants (with no new tax incentives) is very low. Hence, occupancy in SEZ office was higher than non SEZ area. As per Q1FY24 con call, find enclosed management comment on same.

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Dislcosure: Embassy REIT is the second largest holding in my Debt/Hybrid portfolio. I have traded in Embassy REIT during last week to benefit from major price decline in 6 December 2023. My view may be positively biased due to my investment. My understanding on REIT instrument structure and market may be wrong. I am not reommending any investion actions to reader, I am not SEBI registered investment advisor.

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Will there be any impact, three non-independent directors resigned

https%3A%2F%2Fwww.bseindia.com%2Fxml-data%2Fcorpfiling%2FAttachLive%2F3f909eb6-9d4c-450f-acd0-2e39e1064c42.pdf

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Very unlikely. The folks who have resigned are the representatives of Blackstone. Blackstone had exited Embassy REIT completely back in December 2023 itself.

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https://x.com/embassy_reit/status/1757747973407092900?s=20

EmbassyREIT is to be included in the MSCI India Domestic Index

This seems to be reason of its recent Runup

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Manyata Promoters Pvt Ltd (100% subsidiary of Embassy REIT) giving ~Rs 200 Cr order to BL Kashyap for Construction of Block D1 and D2 to be completed in 19 months.

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https://www.reuters.com/world/india/indias-embassy-reit-plans-raise-up-400-mln-hires-banks-sources-say-2024-04-02/

Any views on this?

I don’t understand why REITs choose the QIP route for raising equity. Existing shareholders usually get screwed over from such raises - as was the case with BIRET last year. Why don’t they come up with rights issues?

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Embassy has recently announced the acquisition of an office park in Chennai, Embassy Splendid Techzone (ESTZ) from its sponsor. It has shared a press release and a detailed presentation for this acquisition. Highlighting here the grossly misleading disclosures in these.

To fund this acquisition, Embassy is looking to raise Rs2,500 crore via an institutional placement and it claims that post the placement and the transaction, this acquisition will result in a 2.9% accretion to FY24 NOI and DPU on a proforma basis.

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But from a long-term value creation perspective, the more important metric is the impact this acquisition has on Embassy’s NAV, on which the press release mentions nothing. This aspect is disclosed only on slide no. 8 in the presentation and as expected the acquisition by itself will increase the NAV by only Rs0.2.
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However, even these projections are based on highly aggressive assumptions. For the projected increase in NOI, DPU and NAV to materialize, Embassy’s manager has assumed that it will be able to raise the required capital from institutional placement at the then prevailing market price of Rs375.43 per unit. This is disclosed in the Notes to the slide no. 5 in the presentation.
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Despite the well-known fact that institutional placements happen almost always at a discount to the prevailing market price as otherwise the investor has no incentive to participate in one, Embassy’s management has slyly mentioned this important assumption in passing in the presentation. Naturally, Embassy’s unit price has crashed 6% since the announcement of the acquisition and in all probability the placement will take place at a discount even to this crashed unit price. As a result, instead of this acquisition being DPU, NOI, and NAV accretive, expect this acquisition to actually lead to a dilution in these metrics.

I don’t think so that Embassy’s manager would have been unaware of these basic facts then it begs the question, why did the management proceed with this equity funded acquisition despite enough debt headroom being available. A quick back of the envelope calculation shows that even if the acquisition would have been fully debt funded it would have resulted in Embassy’s LTV inching up only to about 32% from the current 30%, which would be still lower than that of the most levered REIT, Brookfield India REIT, which has an LTV of ~35% and still be below the regulatory cap of 49% LTV.

Inviting views from experts in this field on this.

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Here are my thoughts related to Chennai acquisition.

Crux - Its a minor acquisition (~1,300 Cr) compared to size of Embassy (~35,000 Cr). Nevertheless, the intention is much more important. Is it carried out in shareholders interest or not?

Details - Based on investors presentation, the acquisition involves acquiring 5 million sq ft of leasable area, 1/3rd of which is operational, 1/3rd under construction and 1/3rd for future development. A simple back of the envelope calculation will tell you that this cannot be a distribution accretive acquisition from day one, as you are buying only 1/3rd operational assets, that will add to the income immediately.

But :

  1. You need to get this transaction done, probably, from the pressure of promoter (Embassy),
  2. However, being a REIT, you also need to show that tranaction is distribution accretive to the shareholders.

How do you achieve the twin objective?

Right way (which Embassy will do):

  1. With acquisition, get rid of high cost debt that comes with property, and replace it with low cost debt at REIT level
  2. Take income support for sometime from Promoter

But you can’t show its NOI/Distribution positive just by doing that, then what do you do?
Do some tinkering, find out some way and that is:

  1. Do not use debt to fund the transaction as it costs 8.5% interest, and exceeds cash inflow from lease of acquired premise
  2. Raise equity (Rs 3000 Cr), on which you need to pay 6% distribution (based on Rs 375 per unit), and use part of it to reduce debt, which comes with 8.5% interest, and hence, reduce the ongoing interest outflow associated with it.

With this you may try to depicit the story as NOI/ distribution accretive. This looks like the game plan to ME.

Having said that, the acquisition may work out well in the long run, when entire 5 million area is built and leased. The cost of debt to construct the assets is less than 8.5%, an advantage that hardly any developer can compete with.

@dd1474 @Shrish_Vaze - please share your views

Note - These are the thoughts I have about the acquisition. I can be completely wrong in my assessment. I am invested in Embassy REIT. Its largest portion of my fixed income portfolio.

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Hi Amit. Thanks for your detailed analysis. You have highlighted some important points. I agree that it will be difficult for an asset that is only 1/3rd operational to be NOI/DPU accretive ordinarily. As I have stated in my response, these metrics are less important from longer-term value creation perspective and the better metric to track for this purpose is the impact that this acquisition will have on Embassy’s NAV. In the valuation report of ESTZ, the valuer has appropriately analysed the cash flow and discount rates for the operational, under-construction and future development parts of the asset to arrive at its gross asset value (GAV). I will also concede that the price at which the sponsor is offering the asset to the REIT is fair at a 6.7% discount to the average GAV arrived at by the two valuers. In FY22, BIRET had acquired sponsor assets in an equal partnership with GIC at a 5.6% discount to GAV.

My real concern is regarding the way the REIT is looking to fund this acquisition. The acquisition will only be NAV accretive if Embassy can complete the QIP at a unit price of Rs375 odd which looks highly unlikely given that the current market price is Rs350. Considering this, it is hard to see how the way that Embassy is looking to finance this acquisition is in the interest of its existing unitholders.

Coming to the point of debt vs equity tradeoff that you have highlighted in terms of their relative costs, I think it would be incorrect to compare the cost of debt vs the distribution yield on additional units that need to issued as the distribution is expected to increase as rent escalations kick in and MTM spreads are realized. More importantly, the 8.5% vs 6% cost argument assumes that dilution will take place at Rs375 which is unlikely as I have highlighted above. Moreover, with a lower unit price, the amount of units that will need to be diluted will be higher than at Rs375 which will further increase the absolute cost of equity financing.

The bottom line, in my opinion, is the dilutive impact that this acquisition will have on Embassy’s NAV which is not in the long term interest of Embassy’s existing unitholders.

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Thanks for the good pointers. Hoping for the shareholder base to reject this acquisition.

Do you think the FIIs/DIIs would be likely to do that?