Description

Fibra Macquarie “Fibra MQ” (FIBRA MQ)

Thesis: Following the legalization and then removal of red tape of the tax-advantaged REIT structure in Mexico, we have the opportunity to invest behind a fantastic management team at a 2013 dividend yield of >7% and a 2014 dividend yield of >10% with significant growth from acquisitions thereafter.  We believe this is a 12-24 month double.  This “Fibra” is in prime position to create significant shareholder value through cap rate arbitrage via acquisitions of real estate throughout Mexico. 

Macro Disclaimer: One should consider several macro factors prior to buying a Mexican REIT, including interest rates, structural trends (demographics, industrial cost competitiveness versus other nations, fiscal policy/currency and a host of other factors that will impact supply and demand of industrial real estate properties in Mexico).  I will spend little time on pitching the merits Mexico’s economic outlook in this write-up and more time on the value arbitrage, which I think is the most important lever for value creation over the next 12-18 months.

Description: Fibra MQ is a real estate investment trust that operates, owns and in some cases develops industrial properties in Mexico (with Class A and retail properties likely to be acquired in short order).  93% of their rental income is denominated in USD (predominately multinationals) and their debt matches their income (4.59% cost of debt today).  The Mexican real estate market is highly fragmented and undeveloped with just less than 2% of total commercial real estate owned currently by Fibras.  FIBRA regulatory requirements and accreditation are new, complex and limiting.  As a result, Fibra MQ, Terrafina and more expensive peer, Fibra Uno have a fairly significant first mover advantage with which they can exploit their cost of capital advantage versus peers, because they pay zero taxes and  have significantly greater scale than their peers.  I would suggest reading recent initiation reports by sellside analysts as well as the prospectuses of the three aforementioned companies to understand the effectively brand new Fibra structure.  Essentially, to become a Fibra, you must pay 95% of taxable income in cash distributions, have 70% of assets invested in real estate and each property must be held for at least four years from the completion of development or acquisition. 

Management: Fibra MQ management is composed of ex-Carlyle LatAm and GE Capital executives.  They own 6.5% of the company, and also receive 10% of the value appreciation per share above a 5% real-return threshold.  The CEO, Jaime Lara, is 48 and was co-head of Carlyle LatAm Real Estate, a Director of GE Capital Mexico and a Regional Director (Mexico) of MetLife Real Estate Investments.  Juan Monroy, 38, is Head of Acquisitions.  He was Director of Acquisitions at Acadia Realty Trust and is an NYU Stern and HBS graduate.  Peter Gaul, 53, is the Head of Real Estate Operations.  He was VP and Head of M&A at Verde Realty.  Prior to Verde, he was a Director at GE Capital Mexico.  Eduardo Camarena, 34, is Head of Business Development and Investor Relations.  He is an ex-investment banker from HSBC Mexico and Citigroup.  Mr. Camarena is a CBS graduate who completed the Applied Value Investing program.  We have performed several reference checks on the team and they are giants among midgets in their niche.  This is very important given that our thesis is predicated on management shrewdly allocating capital.

Market Dislocation: This industry is in its infancy.  As a result, analysts are just beginning to sharpen their pencils on the companies within this new asset class.  Liquidity is likely to improve naturally with more research coverage as well as with Naftrac and MSCI inclusion.  Naftrac would be up to a month of buying pressure, but is likely a year away.  However, there is a decent chance that Fibra MQ will be included in the MSCI at the next reweighting (mid-May).  Additionally, Mexico’s pension funds, Afores, have less than 10% of their allowable $12 billion of exposure in Fibras, and that $12 billion is growing by about 20% per year with the overall growth of Afores.

We believe another contributing factor to Fibra MQ’s undemanding valuation results from the fact that they have not yet made an acquisition (listed at the end of 2012).  Fibra MQ trades at a 180bps cap rate discount to Fibra Uno (7.1% versus 5.3% on current asset bases) despite Fibra MQ possessing superior management and arguably better assets.   Analysts do not include acquisitions in their analysis, yet they are inevitable and will significantly alter the fundamentals and valuation of the company.

An examination on the total addressable market illustrates the potential upside created by cap rate arbitrage.  We would also encourage interested investors to study the maturation of other tax advantaged asset classes such as US REITs and MLPs to gain conviction.  In addition to the acquisition upside, you have three strong organic growth drivers that are not reflected fully in analyst estimates: (1) higher rents as we are just beginning to anniversary the crash (standard 5 year contracts) (+2% NOI per annum), (2) higher occupancy driven by structural growth in Mexico (+1% NOI per annum) and (3) inflation – most contracts linked to CPI (+2-3% NOI per annum).  If management successfully executes, this should be an ideal long-term compounder. 

Total Addressable Market: Despite being three of the largest players, MQ, Terrafina and Uno have very low market shares, suggesting that they could grow several times their current size.  In the Mexico retail segment, Uno has a 0.3% share while the other two have zero share (won’t be the case in 1 year).  In the Office segment, Uno has a 4% share while the other two also have zero share (also won’t be the case in 1 year).  In the Industrial segment, the three have a combined 9% share.  The source of this information is JLL, CBRE and Company filings.  It does not take long to find the data (see sell-side reports). 

Now, let’s dive into what the numbers mean for Fibra MQ.  They have an identified acquisition pipeline of >$2bn.  This pipeline is under exclusivity and they expect to acquire effectively all of it over the coming 12-24 months (and probably more).  Fibra Uno has proven the model thus far, and we believe that Fibra MQ can and will follow in their footsteps and more than double their EV via acquisitions within two years.  Based on our assumptions, which we believe to be conservative (we doubt they buy sub-9% on average and most of their debt will be raised at 5%), there is 77% accretion on a distribution/dividend per share basis purely through this cap rate arbitrage.  We are not sure where the cap rate will settle, but if Fibra Uno is any indication, investors will likely become more excited by the potential for additional acquisitions and the cap rate will likely compress.  Thus, a virtuous cycle is created and each acquisition becomes more accretive, provided that their cap rate compresses faster than what they pay for acquisitions.  This admittedly can work in reverse as well, so the risk is making sure you are not caught on wrong side of significant moves in cap rates.  Given the magnitude of the spread currently and the underlying structural drivers of property demand in Mexico, we believe we are in the beginning of an upward reflexive cycle (case studies on US REITs and MLPs confirm our view).

Risks

Global Recession Will Impact NOI: Similar to US REITs, a global recession similar to 2008-2009 will adversely impact Fibra MQ. 

Mitigate #1: The industry faced NOI declines in 2008-2009, but neither MQ nor Uno saw occupancy dip much below 90% and overall rental rates did not fall by more than low single digits (overall).  Most of Fibra MQ's customers are global businesses with over 90% paying rents in USD.  If history is a guide, the strengthening USD will likely offset a significant amount of rental income declines for Fibra MQ.

Mitigate #2: These companies are far less levered than US REITs so the hit to net income will be less severe.  US Office REITs are levered on average 7.3x (UBS) and the US Industrial REIT average is 8.0x (UBS) versus Fibra MQ at 4x.

Mitigate #3: Mexico’s government has room to stimulate the economy if it chooses (deficit at ~2% of GDP and total debt at ~42% of GDP), and a US recession could lead to more off-shoring to Mexico.

Competition: There will likely be more Fibras coming to market over the coming year(s).

Mitigate #1: Size matters.  Fibra MQ, Terrafina and Uno will remain the biggest public FIBRAs, which means lower cost of debt and probably equity as well.  Given that most of the upside here will be created through cap rate arbitrage, an expensive share price can actually accelerate value-accretive acquisitions.

Currency: 93% of Fibra MQ revenues are in USD.  Ironically, a strengthening Mexican economy could lead to translation losses for Fibra MQ. 

Mitigate #1: Occupancy and rents serve as a natural hedge to this as do their costs (MXN).  This will likely claw-back some value over time, but the primary thesis should work significantly if this is the case (a healthy Mexican economy will enable strong organic growth and better financing for acquisitions).

Catalyst