Will Datapulse Shareholders Be Haunted By The Seoul Hotel?

By Mak Yuen Teen

On 14 March 2019, Datapulse Technology Limited’s (“Datapulse”) shareholders will vote on the company’s proposed acquisition of Hotel Aropa in Seoul, together with six other resolutions.

Before going into the resolutions, we should reflect on what has taken place up to now. In November 2017, Ms Ng Siew Hong (NSH) bought 29 percent of the shares at 55 cents per share, at a more than 50 percent premium. Soon after, Datapulse bought Wayco, which it is now selling back after incurring considerable fees and expenses. This was a deal recommended by NSH. Did NSH pay 55 cents per share to get Datapulse to buy Wayco (and possibly the other Way Group companies) because she truly believed that Wayco and the hair case business was the future for Datapulse? In my opinion, the answer is no, given the aged assets, past profitability and future prospects of Wayco.

In July 2018, Mr Aw Cheok Huat (ACH) bought 10 percent of the shares from NSH at 55 cents per share, at a premium which is even higher than what NSH paid. On 15 August 2018, ACH was appointed as non-executive director and on 27 August, he became Chairman. The former directors all left in November 2018. Why did ACH pay 55 cents a share to NSH? Why was he able to be appointed as Chairman and procure the resignation of the former directors and the appointment of new independent directors with a 10 percent stake?

The relationship between ACH and NSH has not been clarified. Will NSH and/or any of her associates have any role to play in the company and the proposed new business? Will there will be transactions with NSH-related entities or associates and/or will they receive any remuneration or fees from the company and its subsidiaries?

In analysing the proposed acquisition of Hotel Aropa in Seoul or any other transactions, Datapulse shareholders should bear the above context in mind.

In this article, I talk about resolutions 1,2 and 7 for the coming EGM. These three resolutions are most directly related to the hotel acquisition. Resolution 1 relates to the proposed expansion of the business to hotels and hospitality assets; resolution 2 to the acquisition of the hotel in Seoul, and resolution 7 to the interested person transactions (IPTs) with ICP Ltd (“ICP”).

Ordinary Resolution 1: Proposed Business Expansion

That:

(a) approval be and is hereby given, for the Company to expand its Property Business to include Hotels and Hospitality Assets as an asset class for acquisitions or investments, and for all necessary steps to be taken to obtain the necessary approval for the Proposed Business Expansion; and

(b) the Directors of the Company and any one of them be and are hereby authorised to complete and do all such acts and things (including without limitation, execution of all such documents as may be required) as they and/or he may consider desirable, expedient or necessary or in the interest of the Company to give effect to this resolution.

Let’s consider the experience of the board and management in the proposed business of hotels and hospitality assets.

For the Chairman ACH, the circular states that he has “more than 25 years in the hospitality sector both in an advisory role as well as in investments in this sector, both privately and as consultant for investor groups.” For Mr Sin Boon Ann (SBA), it says he is “an independent director in OUE Limited, a Singapore listed company that is involved in hotel investment”.

Therefore, ACH has advisory/consulting and investment experience in this business while SBA has experience as an independent director in a listed company involved in hotel investment. Neither has management experience in this sector. Granted, they are going to be directors rather than management in this new business, but it still raises the question as to how much they know about this business.

For ACH, he is chairman of ICP, which has diversified into “the ownership, leasing, operation and management of hotels and franchising of hotel brands”. ICP started in this business in Q3 2015 with the Travelodge brand and has entered into other joint ventures in this business. However, as I will point out later, it is currently a very small player and has not been profitable in this business.

For SBA, his role as an independent director of OUE Limited, which is involved in hotel investment, may give rise to conflict of interest.

There may be occasions when ACH and/or SBA may have to abstain from participating in decisions in this business, and ideally recuse from discussions too. It is important that there are robust procedures for handling conflicts of interest and the small board may make handling such conflicts more challenging.

The circular also states: “Assuming the Proposed Business Expansion is approved by Shareholders at the EGM, the Expanded Business will be overseen by Mr Lee, the Company’s interim chief executive officer and chief financial officer. Mr Lee will remain as the Company’s chief financial officer and will be supported in this role by the financial controller. Mr Lee has experience in the real estate sector from his previous roles at Yoma Strategic Holdings Ltd and Yoma Strategic Investments Ltd. In addition, the Group has recruited (a) a senior vice president of operations who has more than 20 years of experience in real estate investment and asset management industry, (b) a financial controller who has experience working for various global and regional real estate funds and has been involved with property investments in the region; and (c) a vice president and an associate of investments who have experience in hotel investment and asset management.”

While these recent appointments may bring relevant experience, they have been made before shareholders have approved the proposed business expansion.

Questions:

Should these appointments only have been made after shareholders have approved this expansion?
If shareholders do not approve the expansion, will the experience of these individuals still be relevant?
Are there onerous termination terms in the event that the proposed expansion is not approved and the individuals have to be let go?

My View on Resolution 1:

In my view, it is better for shareholders who wish to invest in the business of Hotels and Hospitality Assets to invest in those companies with a long and solid track record. It is better for the company to return the cash to shareholders for them to do so. Therefore, I will vote against this resolution.

Ordinary Resolution 2: Proposed Acquisition

That:

(a) approval be and is hereby given, for the purpose of Chapter 10 of the Listing Manual for the Proposed Acquisition of a hotel located in Seoul, South Korea, operated under a local hotel brand called “Hotel Aropa” for a consideration of KRW35 billion, on the terms and subject to the conditions of the RPA and the ATA; and

When deciding how to vote on Resolution 2, shareholders may want to consider at least three things:

Reasonableness of the purchase price;
Clarity of certain terms and conditions e.g., management fees; and
Substance of the proposed structure.

The detailed analysis, together with assumptions made, can be downloaded at the bottom of this article. Here, I will summarise the key points.

Reasonableness of the purchase price

The acquisition cost for the hotel is KRW35 billion (about S$42.7 million). In addition, estimated professional fees and other transaction expenses will amount to KRW2.4 billion (about S$2.9 million). Within 12 months of completion of the proposed acquisition, the company will spend an estimated KRW5 billion (about S$6.2 million) on refurbishing the hotel over a 3 to 6 month period. Based on the FY2019 Q1 results, the company has a cash balance of about S$75 million, which will increase to about S$78 million if Wayco is sold back (under resolution 3). Therefore, a substantial part of the cash balance will be committed to the hotel.

At first glance, the proposed acquisition seems like a good deal. Reviews for Hotel Aropa on travel websites such as TripAdvisor (276 reviews over the period July 2013-Jan 2019) are generally positive. In addition, Datapulse will be paying KRW 275 million per room, which is lower than the range for recent transactions provided by CBRE Korea Co., Ltd (“CBRE”).

However, the following valuation inputs need to be considered:

Occupancy rates: Page 26 of the circular shows Datapulse expects occupancy rates of 82% (Year 1) to 92% (Year 10) over the forecast period, which appear high relative to historical occupancy rates of 57% and 68%. A Savills report published for the first half year of 2018 shows the supply of hotels and rooms in South Korea has been increasing, and more is expected in areas such as Jung-gu, Dongdaemun-gu, Gangnam-gu, and the Mapo-gu area. The same report mentions that roughly 10,000 AirBnb rooms in Seoul have not been included in hotel stock statistics. These may explain the decline in average daily rates and occupancy rates from 2011 to 2017.

Net property income (“NPI”) yield: We have taken EBITDA for 2017 (KRW 646.6 million) and annualised 1H2018 (KRW 846.7 million) as proxies for NPI. Against the KRW 35 billion purchase price, the NPI yield and earnings multiple fall in the ranges of 1.8% to 2.4%, and 41x to 54x respectively. Compared to the NPI yields (earnings multiple) of 4.1% (24x) and 4.6% (22x) disclosed by Ascendas Hospitality Trust for its 2018 hotel acquisitions in Seoul, the NPI yield for Hotel Aropa is much lower and the earnings multiple much higher.

We have done some sensitivity analysis. Based on these analyses and Hotel Aropa’s historical EBITDA (NPI) margins, achieving the type of margins that would result in earnings multiples that are close to that achieved by Ascendas for its recent Seoul hotel purchases would require increased room rates and/or aggressive cost management and/or consistently high occupancy rates – in the face of what appears to be an oversupply of rooms in Seoul. Increasing room rates may require improved service levels, which may increase costs and/or hurt occupancy rates. In short, it is difficult to improve one of these without negatively impacting the others.

In addition, public information lists Hotel Aropa’s address as 17-1, 17-2 and 17-7 Bukchang-dong, Jung-gu, Seoul, South Korea. The map below shows the actual location of the hotel in Bukchang-dong.

Yet the initial announcement dated 17 December describes the hotel as being “located in the bustling shopping and tourist area of Myeongdong/Namdaemun”. However, Daniel Voellm, the Asia-Pacific Managing Partner of hotel consulting firm HVS commented on the purchase as follows: “Overall, the valuation is attractive as Seoul hotels go, though the location in Bukchang-dong is not as prime as nearby Myeongdong…Any active asset management could help to enhance yields for the buyer further[1].” (Link to article)

In the circular, the location for Hotel Aropa is described as: “…a 127-room multiscale hotel located near the Myeongdong district in the prime Namdaemun area of Central Seoul…”

Therefore, while the original announcement said the hotel is “located in the bustling shopping and tourist area of Myeongdong/Namdaemun”, the circular says it is “located near the Myeongdong district in the prime Namdaemun area of Central Seoul”. There is a difference between “in” and “near”.

Clarity over terms and conditions

Little is known about the master lease agreement (“MLA”) signed between REF Trust and RK One. But we do know that RK One may procure the services of ICP to manage Hotel Aropa.

ACH, Datapulse’s Chairman, is also the Chairman of ICP. He and his son own 23.8% of ICP shares and ACH owns 10% of Datapulse shares. This means that, economically, his family’s interests are more aligned with ICP than Datapulse.

The lack of details also raises the following questions:

Quality of the hotel manager: Being new to the hospitality business, Datapulse should work with an experienced hotel manager. ICP has only been in the hospitality business since 2016. Revenue from ICP’s hospitality segment only grew from $80,000 in 2016 to $1.8 million in 2018, and over the same period, ICP incurred losses of $1.9 million on average. To ensure Datapulse has availed itself to the best services on offer, we would like to understand the Board’s process of sourcing, selection, evaluation, and justification for selecting vendors;
MLA terms: What are the terms in the MLA? REITs such as CDL Hospitality Trusts typically sign MLAs to mitigate the volatility of the hotel industry, whereby they receive minimum fixed revenue plus a variable part that is linked to the hotel operator’s revenue and gross profits; and
Fees payable to managers: Other than the disclosure that hotel management fees are typically between 1% and 3% of gross revenue and incentive fees are between 5 and 9% of gross operating profit (excluding base fee), the Datapulse circular does not provide further details on agreements between the REIT and service providers.

Historical EBITDA for Hotel Aropa may be lower once we account for the additional costs of the REIT structure. We believe these details are important as Datapulse has never owned or operated a hotel, and shareholders would be keen to compare agreement terms with industry peers.

Substance of the proposed structure

Last but not least, shareholders should consider the substance of the proposed holding structure for the hotel and its operations.

Datapulse has incorporated three wholly-owned (directly or indirectly) subsidiaries in Singapore and one in South Korea as a holding structure for the proposed acquisition. it appears the holding has been structured as a Corporate Restructuring REIT (“CR-REIT”). Under a CR-REIT structure, individual unitholders are not required; a property can be sold at any time; and there is no requirement to distribute profits as dividends to unitholders.

The intermediate holding companies between REF Trust (the real estate fund established in South Korea, which will be the owner of the Hotel Aropa land and building) and Datapulse provide additional layers of distance between the REIT and Datapulse, and may help to ring-fence potential investment risks (although if they lack commercial substance, the “corporate veil” may be pierced and those layers will not achieve their intended purpose).

However, Datapulse shareholders would not have control over what happens at the intermediate holding companies and ultimately, the REIT, e.g., director fees of intermediate companies may not require approval of Datapulse’s shareholders; there may be “management” in these intermediate companies who are paid remuneration; or fees or charges may be paid to other parties through these intermediate companies.

Shareholders should ask the following questions about the proposed structure:

The purpose for each layer of intermediate company;
Why the ownership of REF Trust will be split between two companies;
Who will be appointed as directors of these companies, whether anyone will be managing them, and how much the directors/management will be paid;
The types of transactions that will be taking place between these companies, Datapulse, and the REIT, or with other parties; and any fees and charges involved;
Whether these intermediate companies will remain wholly owned by Datapulse or its wholly-owned subsidiaries, or whether there will be other shareholders (once there are other shareholders, any management charges between the companies will no longer be a “zero sum” game for Datapulse shareholders);
If the additional layers have been created for tax planning, has the Board obtained advice that this is legal and supported by commercial reasons; and
How the REIT profits will be utilised, i.e., how much will be retained for investments, and the proportion to be distributed as dividends. Will Datapulse shareholders receive dividends (if any) from REF Trust?

The Board has only focused on the commercial viability of Hotel Aropa. Without a complete understanding of the impact of the proposed structure on shareholder’s economic interests, shareholders would not be able to make an informed decision.

My View on Resolution 2:

In my view, there are many concerns about the price, terms and conditions, and the proposed structure. Therefore, I will vote against this resolution.

Ordinary Resolution 7: New IPT General Mandate

That:

(a) approval be and is hereby given, for the adoption of the New IPT General Mandate for interested person transactions in respect of Hospitality-Related Transactions entered into with the ICP Group; and

I have earlier touched on the experience of ICP in the business of hotel management. Its track record is very short in this business, having only started reporting revenues from this segment in FY2016. In FY2017, it had revenue of $210k and a loss of $2.3 million. In FY2018, the loss was $1.86 million on revenue of $1.8 million.

Even if Datapulse diversifies into the hotel and hospitality business and acquires Hotel Aropa, it should be looking at a more experienced hotel management company with a long and solid track record as a partner.

Further, as pointed out earlier, ACH has greater economic interest in ICP than Datapulse.

My View on Resolution 7:

In my view, the company should be looking for a more established hotel management partner if it goes into the hotel and hospitality business. Therefore, I will vote against this resolution.

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Significant assistance was provided by Jonathan Lim, especially in the financial analysis aspects. Jonathan has over 10 years of experience in valuations and accounting with major accounting firms. Inputs were also obtained from several individuals who are knowledgeable about the real estate and hospitality industries, valuation and tax.

[1] Article – Singaporean Investor buys Seoul Hotel for $31 million

Detailed analysis of the proposed purchase of Hotel Aropa

Download (PDF, 1.11MB)