Price Meltdown For Eagle Hospitality Trust- The Curse Of Queen Mary

Eagle Hospitality Trust ("EHT") IPO debuted at a price of US$0.78 per unit back in May 2019 with lackluster response from retail investors which resulted in one of the worst ever under subscription record for the year. It eventually closed off at a disastrous pricing of US$0.73 per unit for the day which was a 6.9% decline. The nightmare does not end for shareholders of EHT as it continues to plunge in value into the USD$0.64 to USD$0.70 range over the next few months. Unfortunately, the bloodbath rages on with a price meltdown when the issue of lease default on one of its major property asset held in the form of the iconic Queen Mary cruise ship surfaced. This is shocking as the sponsor (Urban Commons) has just listed the trust on SGX. Queen Mary at Long Beach California was valued at US$159.4Mil and makes up 12.55% of the total valuation of the 18 hotel properties (US$1.27 Billion) which are being launched into the Trust. 

Valuation of the 18 hotel properties in Eagle Hospitality Trust

The Curse of Queen Mary

The Queen Mary is a hot tourism spot at Long Beach California which draws more than 1.5 million tourists annually to the site. The City of Long Beach had served a letter on the sponsor Urban Commons for potential default of lease due to essential repair works concerning structural integrity which were not carried out and may lead to the collapse of the ship and cause safety issues for its staff and tourists visiting or staying on board. Urban Commons is required to provide a response to the demand letter by the City of Long Beach. There is thus a perceived risk that Urban Commons may be found to be in default of the lease. If so, EHT will lose all rental income from the Master Lessee. 

An interesting point to note is that Queen Mary was voted one of the Top 10 most haunted places in America by Time magazine given its long and colorful history. The current meltdown in EHT market price makes me wonder whether the ghosts of Queen Mary are haunting it and causing the spate of bad luck?

Is Eagle Hospitality Trust currently oversold?

It is strange that after the suspension of trading halt was lifted and despite extensive clarification by EHT that its sponsor did not default on the lease, many investors simply panic (or maybe a lot of them lost hope) and keep unloading their stocks. As at 25 October 2019 (Friday), the price of EHT was at an astounding all time low of S$0.545 per unit which is a 31% plunge in price from IPO. This is an impressive dividend yield of 11.5% if there is no default and business goes on as usual for Queen Mary. 

In the event of default, distribution is expected to be reduced by around 20%. 

In terms of valuation of EHT, it will drop by 12.55% as per the aforesaid adopted valuation of key assets.

Compare the expected decline in yield or valuation relative to the current 31% decrease in price, there seems to be a  more than 10% margin of safety for current investors who took up position.

Risk of further selldown of EHT- Red flag indicators

The point here to note is that the above math is based on stripping out the financial contribution of Queen Mary to EHT. I can actually think of at least 3 scenarios that can worsen the entire situation and self implode EHT notwithstanding the Queen Mary problem. The key point to note here is that Urban Commons had claimed that all along, structural issues had been resolved. But it remains a fact that if so, why would the authorities of City of Long Beach issue out such a letter to Urban Commons and demanded a reply by 31 Oct 2019?

Other red flag questions investors need to ask here are:

(i) Is Urban Commons facing cashflow issue here such that only selective bare minimum key repair works can be performed?

(ii) The issue of default conditions are at dispute here. Urban Commons definition and the City of Long Beach definition are different. Why would the City of Long Beach send out the letter if Urban Commons had been diligently carrying all out repairs deemed necessary?

(iii) What are the values of the senior management and working culture at Urban Commons, the sponsor of EHT? The current incident whereby they served the letter by the City of Long Beach actually does say something about them. At the bare minimum, the communication standard is poor that lead to the breakdown in understanding on both sides.

(iv) Will there be a potential law suit in future by the City of Long Beach against Urban Commons?

(v) Is Queen Mary the only property affected? If the sponsor turns out to be under financial distress due to any of the above, EHT will be negatively affected not just by Queen Mary but in fact all the rental income from its lessee are at risk (please see below screenshot on Master Lease Agreements). Hence it is a fallacy to simply assume that segregating out the Queen Mary will derive the net value of the remaining hotels. All the Master Lessees are actually literally on the same boat.

Parting Thoughts

No one has a crystal ball to know exactly whether the current situation will deteriorate further or it is just simply an over-reaction by the market. Investment is based on one's assessment of the probability of good news or bad news to determine valuation. Risks are inherent in all businesses.

For myself, I have started picking up some stakes in EHT as I find the entry price very attractive to compensate for the potential downside risks. I would never imagine myself to be holding on to hospitality related businesses as I find them too cyclical in nature and bad for my heart. It is a taboo for me. For EHT, the current price meltdown as well as the attractive fixed rental income component of 66% relative to 34% variable component made me change my mind.