Yet Another Value Podcast - Atla Capital Management's John Haskell on international real estate + ESR Group thesis $1821.HK

Episode Date: July 15, 2024

John Haskell, CIO at Atla Capital Management, joins the podcast to share his thoughts on international real estate investing, emerging markets and ESR Group Limited ($1821.HK). For more information about Atla Capital Management, please visit: https://www.atlacap.com/ Chapters: [0:00] Introduction + Episode sponsor: Fundamental Edge [2:22] International public real estate investing [11:00] Taxation on global REITs / emerging markets [17:54] John's most interesting market(s) right now / Vietnam overview [21:58] ESR Group Limited thesis overview and why interesting to John [27:12] Why has the stock not worked (since it's high in 2021) / how did John get comfortable with owning ESR [36:06] Starwood investment / potential ESR buyout / how does John think ESR take out plays out [45:54] ESR valuation [55:54] Related party transactions and how do you have faith that they are done in fair value / final thoughts Today's episode is sponsored by: Fundamental Edge One of a kind, world-class training created for your team, your culture, your way. Fundamental Edge was founded with a mission to train the next generation of investors and a vision to create a platform that serves the learning and development needs of investment professionals throughout their careers. Through structured lessons and proven frameworks, Fundamental Edge aims to condense years of “learning via osmosis” into a masterclass for the equity research process. Funds looking to strengthen their internal training programs can visit fundamentedge.com/corporate-training to learn more.

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Hello, welcome to yet other value podcast. I'm your host, Andrew Walker. If you like this podcast, I mean a lot, if you could rate, subscribe, review wherever you're watching, you're listening to it. With me today, I'm happy to have on John Haskell. John is the CIO at Alta Global Management.

John, how's it going? Going well. Thank you. How are you? I'm really excited for today's podcast because as we were talking about before, we've got a really interesting, like, combination of a really interesting event and value situation.

but before we get there, let me just start this podcast the way I do every podcast, a quick disclaimer, which remind everyone, nothing on this podcast is investing advice. That's always true, but maybe particularly true today because John and I are going to be talking about the company in focus is ESR. The ticker there is 1821, but it trades in Hong Kong. So people should just remember, you know, international stocks obviously carry an extra degree of risk. Please consult a financial advisor, do your undue diligence, all that sort of stuff. This isn't financial advice. And then the second reason for that disclaimer is John and I were just going to kick it off, also global invests in international real estate. And I wanted to just kick it off with a few

questions about investing in international real estate to John. And normally I just dive straight into the stock on this podcast, but I thought that be different because international real estate is a different area. And I haven't really heard a lot of podcasts on people talking about international public real estate. So John, I'll just kick over to you, you know, focus of all to global is international public real estate investing. Like, why do you think that's an attractive area to kind of, you dedicated your career to it at this point? Why do you think that's an attractive area? I have dedicated my career. You know, so I founded ALA three years ago, just over three years ago. And I've been focused on emerging markets my, you know,

substantively in my career. And what's been sort of clear to me is that over time, you know, there are areas of the market that just become rich pools for value investment. because they're so under owned or under analyzed or misunderstood or out of consensus that if you're going to be hunting for value, you know, you kind of can do yourself a favor by going into territories where there are potentials for mispricings, like big ones, that people really, you know, persistent ones and ones that are have the potential to be real moneymakers. So in emerging markets generally, I start there and say that, you know, it has been a a decade plus of washout in EM.

People have done very well in developed markets over the last period of time and very poorly in emerging markets. And the perception of EM has really never been so pessimistic or there's never been such capitulation. And I'll touch on that first before I get into real estate. I mean, think about that the S&P has compounded now for 20, even 30 years at a rate that is double digits, right? Compound annual growth in S&P.

returns, and emerging markets returns have been half that. And that has really been... You're speaking to a... I focus mainly on small cap value stocks. Like small cap value and emerging market, there is basically no terms at this point. You're preaching to the choir. Yeah. And I think I'd also be preaching to the choir to say that the last few years have been this moment of accelerated divergence, right? I mean, this is not news to anyone. But since since I started Atlas Fund, Adler Global Urbanization Listed Fund in February of 2021.

Think about this. The S&P is up 50% in that time, cumulatively. MSCI emerging markets, and I was pounding the table to get going quickly because I thought it was an opportunity then, down a cumulative 14%.

And my sector that I focus on, which is emerging market real estate, cumulatively down 42% since I started the fund. And you know, we've done, well were up the inverse of that net of fees in that period because of stock picking. But the point is that there's a large pool of quite interesting opportunities.

And there were when we launched with high conviction and enthusiasm in 2021, and there's even more today just based on the kind of drawdown that we've seen. And I would characterize it as capitulation. When you look at the value investing community, almost nobody is like turning stones out in the rest of the world, everybody's been very focused on, on developed markets. So let me just international real estate, right? Like, people in domestic listeners, people who listen to this podcast will know, you know, even in the U.S., like publicly traded real estate, it's generally trading at a discount,

right? And that hasn't always been the case, as some of my friends have pointed out to me. But for the past 12 years, publicly traded real estate has traded at a discount to NAV. And I think there's a whole host of reasons for that. But I just want to ask, like, when I take, hey, U.S. publicly traded real estate with the best corporate governance in the world, and I say that loosely because, you know, some of these U.S. reits can have really loose corporate governance. But, you know, you've got property rights, you've got the best corporate governance of the world. If they're treating them a discount, if I go international and, you know, you don't really focus on, to my mind, like, hey, you know, international in terms of this is downtown London. And like, a lot of the stuff you're doing is in Asia or even more foreign emerging markets.

Like, if the U.S. stuff is treating at such big discounts, like what hopes you have if you're going international publicly traded real estate? Well, so the first thing to say is what hope you have is that often, you know, you can look at it as a discounted nav. You can also look at it as cash flow metric, right, like cap rate. And what that means is when you go to a place that's deeply discounted, you're getting paid to wait for a closing of that nav because you have such strong free cash flow. So, so, you know, it's an opportunity. Like, now is the time to dive into

EM real estate with a very selective focus on good governance and quality management and, and, you know, solid balance sheets and good assets. But you can really pick. I'm glad you said good governance because I was kind of like hinting at them in the first, you know, my worry is anytime a domestic person goes international, there's always the risk of like, why are you the person to buy, you know, Africa's next great startup when you're sitting at here in your apartment in New York City, right? Like, that tends to be the type of thing where you're the stock at the table. And with international real estate, like, I do worry without the U.S. standards and corporate governance, like, it's really hard to make money in U.S. rates,

but you go international, especially emerging markets, like, I worry about the selection bias, I guess. That might not be the right term, but, you know, I buy international real estate and It turns out that it's not as good as this stuff that, like, you know, all the Sions are keeping for themselves on their balance sheet. And then once I buy it, I'm getting hit with, hey, lots of crazy management fees, or there's always the risk the government just takes it back or doesn't distribute the cash undershare. Or it's like, how much do you think of those kind of downside risks when you're doing this?

I mean, all the time. I would say that primarily what we're doing is risk underwriting rather than, you know, rather than projecting out some bulk case. But there's an opportunity because there's just such. general malaise, such general skepticism like you're voicing on these issues, you know, when we look at governance, we analyze a management team's execution ability, their ability to allocate capital, their treatment of minority shareholders. Because they're public companies, they tend to skew towards quality. Like if you're in any given market, it's the leading players

that go public first, as opposed to staying fully private. And they go public like anyone, and IPOs anywhere, right? It's to achieve a more efficient cost of capital to access, you know, funds. And there's a family planning aspect. If you're a large sion somewhere and you want to have a multi-generational ownership structure for the rest of your family, then, you know, being public has certain benefits. And then, of course, reeds, when you get into the tax implications locally, there are lots of varying wheat legislations globally.

But there's rationales to go public if one can, if one has the, you know, better governance in order to go public, the better transparency, the better controls, the better auditing. And so, first of all, there's a kind of a skew towards quality, I would argue, among companies that go public because it's not easy to go public in the place. And then within the pool, you can absolutely find better and worse governed companies. But that's where, you know, one's focus or niche specialization can really kick in. Because I would argue that some of the biggest risks of permanent capital impairment for any investors in the M are very are very like archetypal right like we can find certain patterns of risk around the world and

losing your shirt in one market is a lesson that you can apply to other markets so that you don't lose your shirt there and and we're commonly commonly looking for those kind of red flags that we can exclude or at least very very you know steeply discount that into our our, you know, into our underwriting. But, you know, I would argue that the best opportunity globally is to find these best in class real estate offerings. I mean, you have to have a class A office tower where Morgan Stanley or J.B. Morgan or Coca-Cola or, you know, Microsoft can have their local premier office. And that office tower will have an office landlord. And those office landlords are often very institutionalized. So it's just, it's an interesting set of kind of

possibly the best in breed blue chip companies globally, and they offer a very, very different dynamic than developed markets. The irony is we spend all our time worrying about EM, but if you look at leverage levels in U.S. listed real estate, it's much, much higher than leverage levels in EM, for example. I was just laughing because you said the principles of when you get your shirt ripped off, it kind of applies from one market to all markets. And I will not name them because they are quite litigious, but there is a series of U.S. REITs that I don't think you are a value investor unless you've looked and said, like, these are trading for 10 tens on the dollar. That's too cheap. And then seeing them take the 10 cents a lot way and leave you

with the penny. I want to ask two last things on, you know, real estate is, in my opinion, I've always said if I run for office, my number one thing will be we're going to tax the real estate. We're going to tax the real estate funds. In the U.S. it is really, really advantageous. I want to ask you two questions. First, publicly. You mentioned international listed REITs. Like, U.S. REITs have a big advantage, right? You put yourself as a REIT. You can pay out all your earnings as dividends and you're not directly taxed. Is that pretty similar? Is that generally pretty similar globally? Do most markets kind of allow for that REIT status to kind of dodge taxes and pay out dividends? Well, it is true that, I mean, first of all, where there are REITs, there's a structure

that's similar to U.S. READs. The U.S. has been the model of kind of reits globally. And there's been a rollout of reits globally. It's really country by country as they adopt kind of reed legislation, right? So it's, it's rolled out. The oldest reits in Asia are about 20 years old, right? In Mexico, the first reed called a febara went public in 2011. That was yeah. And now it's a large universe there. So, you know, one of the interesting stories is is that proliferation of REIT kind of listings globally into EM? It's part of the reason I think why so few people are aware of it or have been analyzed or become specialized in REITs internationally

because it just hasn't been that big outside of developed markets until now, and now it is. And every market varies in their rules as to what percentage you pay out, et cetera. I wouldn't say that it's dodging taxes, right? It's just passing the tax burden onto the underlying recipient. And then in certain markets, there's treatments like, you know, exemptions for taxes for non-profit pensions, for example, in some markets. So that's- I hear you on passing the taxes on to individuals, but like it strikes me if

you, any cash cow company, pick your cash company, right? If Coke could be a cash cow, right? If they just dividend out all the earnings, Coke would pay taxes and then the dividend investors would pay taxes as well. But if you're Koch's landlord and you dividend out all your earnings, you don't pay taxes, is just your investor's pay taxes. So, you know, you dodge that degree of double taxation. One more question on real estate taxes.

You know, you look mainly emerging markets, X domestic markets. Again, in the U.S., you know, you've got 1031 exchanges to do. This is private, not public, but you've got 1031 exchanges to dodge taxes on capital appreciation if you roll it into a new building, accelerated depreciation, opportunity. It's all this that makes real estate such a liquid and attractive asset class overall. is that generally similar in most kind of emerging developed markets? Obviously, they're not going to have specifically opportunity zones, but you kind of get similar, hey, let's give the real estate people extra breaks because maybe some people would

say it's to encourage extra real estate development. Maybe some people would say a little bit of political capture. But is that similar in emerging markets? You know, I'd say it really truly does vary market by market. That's the short answer. I'm sorry, it's like an unsatisfying. Part of the whole situation is that there's really not one heterogeneous, one homogenous, you asset class that we're talking about it, it's so different market to market. And I would just

highlight that where there's been probably more development of capital markets in real estate in emerging markets so far has been in private equity, right? You've had lots of private equity locally in Asia and Latin America. And much more recent has been public equity. And so one point about liquidity is that, you know, obviously public real estate is more liquid than private equity real estate by definition, you know, daily liquidity, if there is volume. And yet often what you find is that in times of like deep dislocation because of a real estate cycle, the only properties for sale are those that are in distress. Because if you're not in financial distress, why would you offload a property at a cheap price, right? But in

And emerging markets you find in general that people run with low leverage, those who have been through the cycle or have seen the interruptions in credit availability over time have learned their lesson and generally run a more conservative, you know, conservatively financed portfolio. So there's not as much distressed selling as you see, for example, today and accelerating in the U.S. So in terms of liquidity, it's sort of doubly interesting because private equity is in general less liquid than public equity. But then specifically, transaction volumes tend to go down, in fact, halt when markets are dislocated and it's sort of the most interesting time to potentially enter. So you can go with your dollars to a country when they're in a moment of deep dislocation excited to put those dollars to work buying a building. And you may very well find that like CBRE or Jones LaSalle says there's very few buildings on the block because nobody's really selling right now because all the smart money is holding on. They're not distressed. So sometimes the only way you can actually take advantage of the dislocation, and this is something I lived through in Mexico after, you know, Trump and then the renegotiation of NAFTA and the Mexican peso depreciated substantially.

This is around 2016. there was suddenly like nothing for sale privately or very little for sale privately. And the only way to really enter the market to take advantage of the opportunity is to buy shares of listed real estate. So real estate is both listed in there for liquid, but also it's the only option and often a very attractive option when the dislocation in public real estate is for anyone's taking with a longer term or fundamental view. As podcast listeners, you've heard plenty about Fundamental Edge by now. If you've been holding off on taking their Analyst Academy, now is a great time to check back in. Fundamental Edge has rolled out a refreshed 2.0 curriculum and continues to add more and more content. There are now over 20 guest speakers' recordings with more on the calendar.

Recently, Fundamental Edge hosted Rich Falk Wallace of Arcana to discuss factor models and TransUnion Investor Relations VP Aaron Hoffman to give the company perspective on analyst meetings. For a 10% discount code to Analyst Academy, visit Fundamentedge.com slash YavP. That's Fundamentedge.com slash YAVP. Okay, we're going to switch to ESR one second, but I just want to ask, if listeners were like, hey, what is John's favorite market to look at right now? What do you think kind of the most interesting market overall, you know, is if I can just put you on the spot for one?

I mean, I hate choosing just one because right now we're in this moment of extremely strong U.S. dollar. Like go to the Big Mac index, but you mentioned investing in distress, and I was kind of thinking to myself, you know, like if Thailand blows up or something, like the great thing is not only are the properties going cheap, but their currency's probably gotten smashed. So you're coming in with a really strong dollar. Whereas, you know, if US office right now, like you are buying it with dollars, so you kind of don't get that double discount. But sorry. That's right. So there's valuation multiples that are compressed or cap rates that seem high. You know, it's always cap rates are inverse of multiples. Or it's the and it's the currency in what you're using. to pay for those assets, which the dollar is very strong. So there are many markets. I mean, big right now in our portfolio because we're seeing lots of opportunities, Indonesia, more recently the Philippines and Vietnam, so some in Southeast Asia. India right now is actually quite expensive in local market valuations by and large,

so that's not a pound the table opportunity for us right now. We're seeing opportunities in South Africa, despite all the macroeconomic volatility and political uncertainty that's been partly resolved in the last election. In Latin America, we currently have investments in Brazil and Mexico and have actually sold out of a position that did very well recently in Chile. So it's hard for me to answer because everything is so washed out. And I think that's part of the opportunity. I mean, just to touch on it, like the U.S. is so consensus versus E.M., right, or developed is so consensus. Like the U.S. is 4% of the world's population, it's a quarter of the world's GDP, and it's 65% of the world's

market cap, right? Emerging markets are 11% of the world's market cap. And when you look at, and that's sort of just total market cap, passive, active, when you look at like active portfolios, people who track like allocation across asset classes, people are underweight emerging markets, underweight that 11%. Their portfolios are 7% EM. So everybody's underowned. and not looking at and generally not ascribing much value to these markets. And so there's

plenty of mispricings within them. You mentioned Vietnam is one of your favorite markets and I love Vietnam. So I will volunteer to do any on-the-ground due diligence that you need. It's a really fascinating country. A lot of the most recent change has been in the north in Hanoi where there's been new policy around, you know, accelerating infrastructure to support the

inbound foreign direct investment for folks who are basically diversifying their supply chains out of China or China Plus One strategy. So there's been a lot of change in the north following an almost China-like economic model of building out really great infrastructure to then be host to the world's manufacturing. And then also in the south, in Ho Chi Minh City, which has always been in the vibrant kind of diversified economic engine, that city has also benefited from an acceleration of like urban infrastructure, things like metro lines and bridges connecting District 1 with the east side of the river, for example. And those infrastructure changes have been very, very positive. And that's all in the context of a country that's deeply not yet

urbanized. Even for its current wealth level, as measured by GDP per capita, they're under tracking on urbanization and quickly making up for it. And so the migration into the cities is really powerful and a big engine of economic growth there. So it's an interesting market for us kind of top down and it's a certainly interesting market bottom up just in terms of the opportunities you can find there. When I asked you why emerging markets, one of your thing was you talk about private real estate, public real estate, and low leverage levels. And let's just use that transition to the company we want to talk about today. Again, the company is ESR. They're pretty big. They got a big investment from Starwood recently.

Starwood's going to come up a lot in this story. They're pretty big, but their Hong Kong listed, the ticker there is 1821. And why don't I just toss it over to, and again, everyone should remember in foreign investment, foreign company, lots of actual us, please do your own work. But why don't we just toss it over to you? You know, what is ESR and why are they so interested in here right now? Sure, sure. So ESR is an interesting case for us. You know, and what I'll say is that often we find opportunities that are not as pure play as, let's say, a listed lead somewhere, right? But instead are a company where the assets on their balance sheet are substantially hard

assets like real estate, and that's not being valued appropriately because they are confusing, complicated, you know, going through transitions, events, and ESR is all of the above. So ESR is a real estate investment development management platform. Think of it as an alternative asset manager, like a, you know, like a Brookfield. I was thinking it's like they're, because they've got the data, it's kind of like a digital bridge, U.S. digital bridge. I was thinking of it like an Asia digital bridge, but you can tell me if I'm Yeah, I mean, I think it's a good, it's a good comparison in the sense that they focus on

what are called new economy assets, right, which is sort of assets, hard assets that will be the, the engine or the backbone for the fastest growing aspects of the future. economy, right? Things like warehouses for distribution centers for logistics, you know, data centers. So what's interesting about ESR is they have grown through M&A. They're essentially a private equity backed and fueled roll-up. Warburg-Pinkus is the firm that's most involved in their story. And they've kind of aggregated a bunch of real estate development capability, plus real estate management capability and fundraising and fund management capability. So this means that if you are a large sovereign wealth, wealth fund, like you may be a

client of ESR because ESR will propose a vehicle, public or private, a listed read or a private equity vehicle, you know, to invest $100 million into an Asian economy through a thematic focus on, let's say, logistics. and ESR can develop those properties, they can manage those properties, they can charge you a management fee on your capital and potentially a performance bonus if they hit a certain benchmark over time. So it's an interesting company because there's two business models grouped into one. On the one hand, it is an asset light asset manager. It's a KKR and Apollo or a Blackstone, right? That has really been unlike those ones in the United States.

it's much more specifically focused on real estate and new economy in Asia Pacific. On the other hand, it's an asset heavy company because they have to have skin in the game in order to be that asset manager, that alternate asset management platform. They have to have skin in the game in the form of a lot of capital being put into a development pipeline, and they have to have skin in the game in the sense that they have to have to be co-invested alongside their investors, their LPs, so to speak, in the private vehicles that they launch in the public REITs that they manage. So they are the manager of REITs, and they also have stakes in the REITs by owning some of the certificates. So it's a two-part business, asset light,

asset heavy. There's very good reasons fundamentally for those two aspects of the business being bundled together. You can't have one without the other and grow this business the way they have. But it's a valuation challenge for public markets because those who are comfortable valuing hard assets are generally not the same investors in asset life financial management companies and vice versa. So it's an interesting kind of some of the parts valuation disconnect, where if you actually analyze all the parts more fairly, you know, the intrinsic values were far more than today. And it's in the context of, you know, that's very interesting.

You could just own it as a typical value investor. But there's also this kind of event right now, which creates a very interesting catalyst for the stock, too, which is that a consortium of investors have come to offer to buy the company to take it private, and we're still awaiting details of that deal, and it might be favorable and it might be disappointing. But either way, at today's price, you know, at 11.5 Hong Kong dollar share right now, which is above. our cost basis, we were, our cost basis, eight, 10 a share, but still, you know, very conservatively cheap based on an equity value of, I would say, about 19 a share using conservative assumptions in a, in our base case. So I want to come back to the event, because when you, when I first read about this in your letter and stuff, it was kind of just value. And then you're like, oh, also they just got a non-binding, not in binding bid, like

multiple really sophisticated parties are trying to take this out. And I don't believe they disclosed a price yet. So there's a really, really interesting event angle here. But let me just go back to the core business. You know, everything you said sounded great, right? Like I said the digital bridge, but when you say, hey, they have the asset manager, but they also own stakes in publicly listed companies. Like that does sound a lot like Brookfield with Brookfield property and like all BBU, all these things. If I heard, hey, if I was a domestic listener and I heard, hey, this is an alt. They have management stakes. They've got stakes in different listed companies. They're raising assets. I heard that, I'd be like, oh, yeah, like KPR is up about

5X over the past four years. All these guys have done really well. If I pulled up, and I understand ESR was emerging market, but I pull up ESR stock price and it's like, hey, they peaked at 30-ish in 2021 and they're down to 10 right here when they're at least considering to take private bid, you know, the take private is not going to be 30, but 30 to 10, maybe a take private, maybe the stock's a little boosted by the potential of take private bid. So I just ask you, like, I think people think the listing has kind of been a disaster and the stock hasn't really performed all over the life. Like, what happened here?

Has the listing been a disaster? Why has the stock not worked kind of? Right. So you go to this in 2019, 1680 a share, right? I would say on the one hand, it's a disaster. On the other hand, it hasn't been. It's actually quite savvy. they went public at 1680 when their share price was almost at the very top they bought a competitor called aRA asset management similar business and bought it with basically shares right mostly shares and then for the cash consideration they actually issued new shares in order to raise that cash to share and and that was at 27 Hong Kong dollar per share now if you were aRA bought at 27 it's incredibly painful now at 11 and change but I would say for the

original kind of savvy investors, the original private equity and founder investors and Ontario pension, the ones that were early, early into the creation of ESR going public at 16.8 and then using your currency to make an enormous transformative acquisition at 27, that's all very well and good. What's happened and why this has been such a kind of disappointment is a perfect storm of factors. On the one hand, they decided to go, public on Hong Kong, right? And Hong Kong is one of the, I would say, darkest, in one of the darkest hours, it's one of the least liked markets today, right? And that's been a combination of not just concerns over Hong Kong's place in the world with pro-democracy protests,

if you recall that, and then COVID, but also geopolitical tensions with China globally today and macroeconomic concerns of China today. So Hong Kong is an incredibly unloved exchange. And hindsight is 2020, but ESR, if they had just gone public on the Singapore Exchange, probably would have had a very different reception among public investors. That's one factor. You know, public markets hate complexity, and this is a complex company. It's complex because it's the roll-up of so many different businesses. And so for folks to do the kind of work that we do to kind of underwrite part-by-part,

the sum of the parts, it's exhausting. and it's quite difficult to have the underlying view of the underlying assets when so much of the asset value is held in JV and associates, you know, and the balance sheet is quite complicated. Let me pause you on that point, right? Because that when I was, and again, I, you know, I do a days worth of prep for these podcasts, but when I was looking at it, and they even said, I was reading their annual call, they said, we're laser focused on a substantial sellout of assets from our balance sheet,

to ESR managed funds, right? And they've got managed funds where they own big stakes in them. They're selling assets from themselves to the managed funds. If I said, hey, John, or if I was a random person, I was like, hey, Hong Kong listed company, super complex balance sheet. They have a bunch of listed selves where they own stakes in them. There is selling assets back and forth between the companies. The first thing I would be was like, hey, can I get a short, can I get a forensic accountants

on the line to go and check these out? So how did you get kind of comfortable with the red flags of, you know, if I gave you 10 companies that had that characteristic and we're trading on an emerging market exchange, I would guess the over, under for, so really shady stuff going on would be 1.5 or 2.5. So how did you get comfortable with this one? Yeah, I mean, I wouldn't characterize this like that. I know it sort of like seems similar at first draft. I'm not accusing. I'm just saying if I took ESR away and gave you, you know, publicly traded company owns holdcoes back and forth. assets, owns it, and gets made of fees, that would be something that you'd kind of diligence, right? Absolutely. I mean, but I think what you would find is that the alternative asset management business

is a really good one. Because in a nutshell, what you do is you develop assets, right? Or if you're in a different asset class like Oak Tree, you might raise capital and find distressed opportunities, right? But in the case of real estate, you're developing real estate. And then you're selling that real estate into V. vehicles. Let's go with REITs, for example, right? You're doing a, you're dropping an asset that you've developed into a REIT, and there's some fair market valuation. And if you were the minority

investor in the REIT, you would absolutely want to scrutinize the valuation at which that asset has been bought into the REIT, right? But if you're the, but let's say that that is not skewed one direction or another. What you've really done is created this virtuous cycle at the ESR level, or at the asset management company level, because you've developed assets with your balance sheet, but then you've offloaded those assets off of your balance sheet, and in the process, you've freed up capital that you can then recycle into other projects,

but what you've retained is a management fee, right? You're now the manager of a larger reed in this case, right, or a private equity vehicle where you have a fee on assets under management. So the engine is very powerful on the asset head, heavy recycling and then growing the asset light management business. Why do investors put up with this? Why does capital do this?

Part of it is because if you are a large institutional investor and you want to deploy your capital into an asset class like logistics in Japan, then it is actually quite difficult. not as easy as creating a synthetic security. Like, you have to actually have brick and water real estate built that you can then buy, right? And so I would argue like the entire reed industry, even in the United States, is like this as well. You know, reeds, we're focused on reeds. They're not all reads, but reads in the U.S. are a good example or anywhere a good example because you can't retain your cash flow to develop. You have to pay out, right? So there's

by definition, a difference between those who can retain capital to develop and then a reet, which has to pay out all cash flow for most of it, right? Funds from operation. So for a reet to grow, there needs to be a pipeline of development. And if you can be both the pipeline and the manager of the reet, then you can have a very powerful model. Like an example of this is probably prologis in the U.S. Right? So prologis has the development capability. but then they also have a Mexico REIT. They have a Japan fund. And they're able to drop those assets into that REIT. And those who, you know, investors on both sides of that have to watch the kind of misalignment of interests and watch the valuations that assets are kind of dropped from one to another. But I see why there's demand for it on the capital side. And this kind of complexity is really part of why I think this is such a, like discounted value, right, or discounted price. And so if you were Starwood, Barry Sternlinked, right, or SSW, the partners are working

with, if you were the consortium investors looking at this situation today, what you're looking at is a bunch of hard assets as well as management fee streams that in combination are worth, you know, substantially more than today's share price, like that's an interesting business model, and that's an interesting opportunity. let's go let's go to start with so starwood invests i think they buy 10% of the company earlier this year and that's in large part correct me if i'm wrong but in large part there are margin loads that the founder has at uh esr so i just want to go back through how starwood gets involved because that will take us to the event here but also like again if i said hey john like

company complicated accounting founder with margin loan issues you'd be like oh that that's So, Raj and Lone is a huge red flag. I agree. I mean, this is one of the founders. So if you look at ESR today, it's really the combination of a China business plus a Japan business, plus a Korea business, and various founders that all either knew each other or worked parallel to each other back in the day at either prologists or A&B in the region. And so you had these kind of individual entrepreneurs who had experienced developing real estate back in the, you know, terms of. of the century and now they strike out on their own and they have capital from partners like Warburg or others and they build businesses in China and Japan and Korea and then later these

businesses merge and so you have founders that either retain you know strong involvement and or economics and in the case of two of those founders these um the the original the redwood so the ESR, the R in this tail, you know, they had a margin loan on their investment holding and basically had to be taken out by, in this case, Starwood took advantage of it and it was a 10.7% stake. So while that is a certainly a red flag in the case of all companies, like in this case specifically, it's it's only a very you know small amount by an investor that is like one of the legacy founders and it creates a very interesting opportunity for Starwood to resolve the only kind of share overhang that exists others like you know Warburg are still very much skin in the game

and and and I bet I have no idea but I bet the people over at you know at Warburg are pretty not pleased with the idea that there was this margin loan going on. I don't even know if they knew about it. But in any case, somehow they create an entry for one of their competitors, Starwood, to come in and gain a towhold.

So that's perfect. And that takes us to the, so Starwood makes their investment, I'm just making sure I'm following my timeline correctly. Starwood makes their investment in March. They buy, let's round it to 11%. And I believe, so a few weeks later, it comes out in Starwood. And Sterlick, as you said, he says, hey, well, ESR has important investments in logistics and data center.

A few weeks later, it comes up. Starwood is looking to take ESR over completely. And then just last week, I mean, we'd already had the podcast schedule. And just last week, Bloomberg breaks a story that says, hey, the group who's thinking about taking ESR private is expanding. So Starwood, it's SSW. and maybe 6th Street, I think, is hopping in there. So talk to me about the event here, right?

The potential take private, all of that. Well, I mean, just firstly, it's a consortium that is that is putting the initial interest offer together, right? And so it's- And they haven't to suppose the share price level yet, right? So we know that there's-off share price, right? And then buying a stake ahead of time to me is sort of standard playbook for someone wanting to take something private.

Like, if you're going to take something private in general, there's a take-out premium, right, or a control premium. you have to make the tender interesting to minority to shareholders right and if you're going to create a premium you might as well buy as much as a bit as you can so you give your own self that premium when you go to buy out the rest so so so i so i think that's pretty standard playbook the timeline is interesting because even though this was announced that there is interest from a consortium they the company has not disclosed anything around valuation so we've all been speculating now for quite some time around, you know, what is this offer going

to look like? And then you alluded to it, right? There was news recently that the consortium is looking to expand to basically bring on additional firepower through, I think they mentioned a few sovereign wealth funds like, you know, Qatar Investment Authority, for example, to bring in additional firepower. But we still don't have any notion of price. And the article did disclose that there still is a valuation gap between, you know, the company ESR management and the approach from the consortium. So in this period, we're kind of left waiting.

The share price, which originally rallied to about 13, had drifted in downwards, 10 something, we're now back at 11 something. So it's really direction list. And when you read the kind of analysis that sell side research or if you talk to other investors, really all we have to go on from, in one sense is what people might be willing to take, right, who are important shareholders in this. So it's important to mention that there's a takeout code here. And the takeout code is that at least... This is a Hong Kong specific take-up code. Yeah, this is a Hong Kong take-out code.

So 75% of investors who are disinterested shareholders, right? So those are ones who aren't part of the buyout group, like Starwood, who took their stake, or they 75% must approve an offer. And no more than 10% of the disinterested shareholders can object to the offer. So that means if you have one or two investors who together comprise 10% of this offer, and they say, no, it's off the table. So I would say there's some teeth to this takeover code. it's one of the British colonial takeover codes in our fund we've benefited from a similar situation in Jersey for a company corporate in Jersey. The Brits really figured out a minority friendly takeover code that benefits us value investors around the world. And so in this case,

you're looking at who owns shares, what was their cost basis, what might they be willing to do? And I'd highlight that there are some investors like take ARA, right? the company that they bought at 27 a share, so their cost basis in ESR is 27 a share. Those investors right now comprise, you know, a significant number. They would easily trip that level right there, right? It's over 10%. Capital Group, a large public market investor, has 6% of shares, not enough by itself, but that's a substantial chunk.

There's one additional factor here, which is that the original report on the offer mentions that in a price unknown, but the buying group may allow for existing investors to retain their stake in the take private vehicle. So that's interesting. If you're a private equity, comfortable investor, capable investor, you might be able to roll this public equity into a private equity stake. So I highlight capital group because assuming this is, you know, their mutual funds, their publicly, you know, public equity vehicles, they wouldn't be able to go private and retain a private stake. Whereas I mean, when you mentioned ARA, like my first thought was, oh, they're not going to block because you just go buy them out.

You're like, hey, roll your equity. You'll get more of a percent of the company will take out the top publicly traded costs. Just roll your equity and vote for the deal. But as you said, you can't go take out a. capital group or someone. So that takes up. In terms of how, where do you think, like, again, this is not the U.S. with a 13D that says, hey, I'm looking to take this private for $14 per share, $16 per share, $18 per whatever. All we've got is the Bloomberg and I think Reuters had a report too. Where do you think, like, how do you think this plays out? Where do you

think an offer shakes out? What do you think, obviously you could have, you know, standard private equity, take private offers where the first offer is 15, and then the second offer is 18 when shareholders object. But like, how do you think this kind of plays out? Where would a fair price to take it out that lets them get their IRA or kind of leave shareholders happy days? I mean, really, it's anybody's best guess, including mine. And I would say the bulk of our analysis is instead underwriting it fundamentally so that we can say to ourselves, even if this falls through, we're okay. Because not just okay, we want to hold this stock and own it for its upside. In other words, you know, we're not a merger arb shop where we can kind of gameplay

this and diversified across 30 other merger arms going on simultaneously. Instead, we're saying ourselves that we could own this for five years. This is something that could, you know, easily deliver a 70% upside and or much higher, but those returns might be accelerated in the short term. I mean, let's talk about that. On the earnings call, the company, the company was aware of their stock price too, right? I'm just looking at quote from the earnings call. The chairman ends it by saying, hey, the board of management are focused on ways to enhance shareholder value. Getting started what in here was just the start of resetting our narrative. We're frustrated by the share performance. They're frustrated. Do you see value? Can you just build up to some of the

parts? What do you think the fair valuation here is? Yeah, I can. I'll build up to some of the parts and I'll say that management has a bunch of levers to unlock value, to see their share price correct. That doesn't involve the takeout. Right. And that's a when we bought, we bought before the takeout and we bought based on just the deep discount to fundamentals and all the levers that management has. So, I mean, look, I'll take you through it really quickly. This is in rough numbers, market cap is six and a half billion U.S. dollars. You add about $6 billion of net debt, minority interests, the enterprise value of 12.5 billion. What you would want to do is look at their gross asset value, which is really comprised of

a few categories of things. They have investment properties on their balance sheet. This is essentially real estate. It's 38 million square feet. It's about 70% in China, 20% in Japan. The rest the remainder, about 10% in Asia Pacific. So that investment property of hard assets, of actual real estate, we underwrite conservatively at $2.5 billion. Then they have another category, which they call private vehicles. But really, this is co-invests alongside like GIC, for example, where they'll have less than full equity ownership and it's therefore categorized different on the balance sheet, but it's similar assets. It's like real assets, real estate. And we value that at 2.1 billion. So you have the 2.5 on investment properties, another 2.1 on those co-invested and similar assets.

They're the manager to a bunch of reits. One of them is the ESR Logos reet in Hong Kong through ARA acquisition. They have things like Fortune Reet. So they are the manager of those reits, but they have stakes of varying degrees in each of those reits. And at current market prices, those stakes combined are $730 million. They also have a bunch of strategic investments in the region, which really mean that they are invested in the equity of other asset management plans.

platforms, like they're the roll-up of an asset of an alternative asset management, you know, business industry, and there are a few of these that are still on their balance sheet as as partially owned. And those are worth another 930 million. Most of them are publicly traded like Cromwell and or Kenedex. So again, that's a market value. They have a development business and the development business we estimate based on DCF is another $1.3 billion. That's like a 6x evidae. So if you add up all these parts, you know, the 2.5, the 2.1, the 730 million enlisted reads, the 930 in strategic investments, the 1.3 billion in development franchise, you end up with a gross asset value in hard assets of 8.8 billion. And from that,

you have the second half of the business, right? The asset light, asset management business. What is a fund management business worth? It's actually a really interesting debate. You know, we, we say that it's worth a blended multiple on Evadavid 13x, but really that's a high multiple for recurring management fees and a very low multiple for performance allocations. And I'd say the comp set for that are all the U.S. players that people on this product would probably know very well. I would highlight that where this company as an asset manager differs from the Brookfields

and the KKHRs and the Paulus and the Blackstones of the world is that unlike all those players in the U.S., they have not bought an insurance company in order to be able to plow the float from insurance into their alternative assets. That is one big difference because in the U.S., you know, I think a lot of people are raising flags about what's the systemic risk to asset management companies becoming, you know, life insurance companies, sort of an interesting debate. And then they're also different in that. They're much more focused.

They're focused, kind of laser focused on real estate, on new economy, on Asia-Pacific. So there's not like a lot of, this is not a private credit manager, right? And if private credits in a bubble, that would be relevant as well when assessing this side of the business. So on the fund management, we ascribe on that blended multiple for 13x, an additional $7.7 billion. So if you add those two parts up, the 8.8, 7.7, you get to a total gross asset value. That's essentially 16.5, 16.4 billion U.S. dollars. You net out the net debt and the minority interests. This is a net asset value of about $10 billion, and that compares to a market cap of $6.5 billion.

So that's the sum of the parts kind of building up the gross asset value, netting out the liabilities, getting to a net asset value as it compares to a market cap, and there's clearly upside. And that's where we see this, you know, trading around $19 a share. I was out of 19. Yeah. Okay, cool. But just real quick, the development assets in there. And obviously, look, when you're buying $10 billion of value for $6.5 billion, the nice thing is you can be a little off of one or the other and you've still got a lot of value. But you threw out development assets at $1.5 billion. I was just wondering, how are you thinking about it?

Because that is them going out and serving, how are you thinking about the valuation of those development assets? Well, there's actually development assets on two parts of the balance sheet, is investment properties, which has investments under development. Hey, I was, oh, sorry, no, go ahead, please. Just on that one, I mean, we're fairly conservative. The majority of that balance is assets under development in China, but important to note that it's fairly recent, right? So this is after the adjustment of the Chinese property market. And I would highlight that China, though, it's going through a massive real estate downturn.

It's still like a market where you want to de-average it, right? look at the different parts and there's still aspects of the Chinese real estate market that are quite healthy that are not over levered residential developers. And then on the developing business, I think this is a broader point that when you have a development business, there is a certain franchise value because there's a certain ability to, on a run rate basis, kind of continue to build out real estate and kind of capture a development yield spread. And it's a combination of having the access to capital, the execution ability to kind of build on budget and on time. So, and anyway, that's one part of the total.

I would argue that the place to really focus on is the two parts, the fund management business, right? Because if you ascribe a remotely higher multiple on that side, it can really swing the valuation greatly, right, because it's such a high component. it's the single largest component is that asset light fund management business. And so the sensitivity around valuation multiples matter a lot there. And I would argue that we're being conservative because on a forward basis, like this is a real estate as an investment class that is kind of under allocated globally.

And investors are very much interested in continuing to put money towards these hard assets. They're also relevant to the future, they're kind of future positioned because of what they are in terms of their functional use. And it's also, you know, in an era of kind of higher interest rates, inflation protection in real estate is very significant, right? People are looking for real assets. So I would argue there's like growth on that side. Maybe we're undervaluing the largest bucket of all, which is that fund management

business. And then on the gross asset value, the largest bucket to that, then kind of pressure test is the investment properties probably combined with the similar stuff that's private vehicles, the co-invested investment properties. And for us, we go into as much detail like granularity as we're allowed to or able to with public, you know, publicly available information. We value overall the completed properties at $104 per foot in China at 70 a foot. So it's sort of China at 7. 70, Japan at 200. And that's very inexpensive relative to replacement costs, relative to recent transactions.

On development properties, we're putting $46 for these are in development properties. That compares, it's about 10% lower than what the company is actually recorded as their cost so far per foot. So they've plowed, you know, more like $50 plus and yet we're giving some discount and saying that's worth 46. So I'd say we're quite conservative on a replacement cost basis for the two parts of the investment of the sum of the parts, the investment properties, as well as the co-invest on the private vehicles that comprise like the bulk of that part of the sum of the parts.

Whether you're a large firm with training and developmental needs or a young analyst looking to ramp up your skill set independently, Fundamental Edge can be your go-to resource. Their Analyst Academy curriculum is a flexible pre-recorded program supported by live sessions, coaching, and continuous alumni engagement. Independent learners interested in the Analyst Academy can visit Fundamentedge.com slash YafP for a 10% discount code. The next cohort starts in August, but the pre-recorded curriculum can be accessed immediately upon a request. Funds considering Analyst Academy Pro should visit Fundamentedge.com slash corporate training to request more info. Please see the links in the show notes. No, look, the only place I was going to say on the fund of management fees and the performance of management fees, you know, you said it might have been conservative on the multiple from growth and everything. And that's probably right. But the other thing is, you know, again, to bring it back to Brookfield or to bring it back to some of the U.S. rates, you know, if you've got assets on your balance sheet and you have controlled vehicles, one of the great things is you have really good or MLPs drop down yields because you have really good line of sight and to be able to.

being able to grow those management fees just from dropping your controlled asset bases into some of your controlled companies. Now, you know, obviously there's, you can do it in a way where it's really bad for the minority shareholders at control companies. You can do it in a way that's fair. You can do it in some combination. And I have certainly seen all of them, but I would just say a lot of people, Brookfield, you think about Brookfield, a lot of people, one of the things they love about Brookfield

is they've got great continued visibility into growth. in management and hopefully incentive fees from continuing to raise equity at their control subsidiaries. And that's one of the reasons people love to put big multiples on those performances. I don't know if you want to add. Yeah, two quick reactions to that. One, I mean, it ties back to our earlier conversation about all these related party transactions, like how do you have any faith that's done a fair value? And the real answer is that the money is in the long term. If you can have a decent reputation for growing the investable universe and then dropping those into your vehicles,

then that is the positive flywheel that is going to make Brookfield so much money or make their franchise worth so much, right? And so you don't want to be like, what is the expression, like, penny wise, pound foolish. You don't want to like try to nickel and dime folks on anyone transaction and destroy your reputation. No, you want to keep open the, the, ability to originate and then take that origination and park it somewhere where you're the manager of it. And in their case, I mentioned look at the most recent news other than this consortium news, is that ESR has gotten approval to create a China reed, an internal domestic

China read. Now, you can invest as, forget where you're from, but right now they're listed China reeds in Singapore, right? They're listed reads in Singapore that are thematically focused on China, most of the assets are in China, but that's for overseas or offshore capital. Within China, the big story is you have all this onshore domestic capital that's trapped, right, that doesn't have a good, that isn't freely convertible to therefore invest abroad, and has limited options domestically. In fact, a lot of the news in China, macro news, has been the need by the central bank, apparently, to intervene to try to drive up the yields of long-term bond issuance because banks are plowing money into whatever yield they can find

in driving down those yields. In other words, there's a real lack of investment opportunities within China. So if you can create a China reed that targets that is listed in Shanghai that raises capital from domestic capital, right, then you can command an interesting multiple. And they've guided this rate is going to have a dividend yield of 4.5%. I would argue that that's validating the China real estate appraisals recently, which I think are pretty, you know, rich. That piece reminds me of the yield co craze in the U.S. in the early 2000s. It was like, hey, there's no, there's no dividend, there's no yield anywhere, and people were creating yield codes and people were just flocking into them because they wanted the dividend one to remember

earth. No, I was just laughing because you mentioned the pennywise pound foolish where it's better in the long run if you do fair by both sides when you're dropping assets so that you can continue do it. And I'm just laughing because while I do agree with you, I've seen so many times where people are pennywise, pound foolish, where they take advantage of the minority code, but yet somehow they still, people will just give them money for the next deal and be like, oh, well, yeah, they've screwed us 15 times, but they will do it the 16 time. And I was just laughing because it happens all the time in real estate. It's crazy. So you have a lot of, but going back to the fund management business, I mean, you do have a lot of opportunity for them to grow. And that ties

into another thing, which is, you know, ESR has grown in an era of low interest rates of like much cheaper money. And then part of the perfect storm is the fact that money now cost something, right? That interest rates have increased. And so what I think we'll see in the case of ESR is a reduction in their debt because they will kind of sell off assets. They've earmarked about $2.1 billion in divestment, which compares to roughly liability of $6 billion. So they're going to reduce their liabilities by a third, and they're going to do so through, for example, dropping assets into the China reed that they just created. So this conversation is relevant because by having that pipeline of destinations for assets

into vehicles that you manage and then get management fees on. four, you do two things at the same time, right? You're increasing your management fee business while at the same time you're recycling capital to reduce your debt to kind of strengthen your balance sheet, free up capital for other purposes at the same time. Well, John, this has been great. We've been going for a bit over an hour at this point. So I think I need to wrap it up here, but this has been fantastic.

If you want to learn a little bit more about you, reach out to you, talk about international real estate or any of this, how can they reach out and fund you? because you're not on the Twitter and there's no Twitter to tag. Right. That's right.

We run a low profile. Atla capital is our name, ATLA. You know, we are, you can best find us on LinkedIn. And it's been a real pleasure being on this podcast.

Thank you for hosting. Did I say ALTA instead of ATLA at the front? We did in the beginning. That's okay. That's a great scheme. I just Lexi did it. Oh no. Okay.

Well, we'll include a proper link in the show notes and everything. But this has been great, John from at, like Apple, thank you so much for coming on and looking forward to having you on again. Likewise. Talk to you later. Thank you. A quick disclaimer.

Nothing on this podcast should be considered an investment advice. Guests or the hosts may have positions in any of the stocks mentioned during this podcast. Please do your own work and consult a financial advisor. Thanks.