Can property companies survive without Pogos?

By: April Lynn Tan, Philippine Daily Inquirer, Aug 26, 2019

Property companies are among the worst performers in the Philippine Stock Exchange (PSE) this August. The main reason for their poor performance is news that China wants the Philippines to ban online gambling, a request it made after it lauded the Philippine Amusement and Gaming Corp.’s (Pagcor) decision to suspend the issuance of more Philippine offshore gaming operator (Pogo) licenses.

The exit of Pogos from the country will undoubtedly have a negative impact on the property sector. According to Leechiu Property Consultants, Pogos currently occupy around 1.1 million square meters (sq m) of office space.

If Pogos leave, there will be a significant increase in office vacancies, pulling down lease rates and hurting the profits of office landlords.

Last week, I had the privilege of talking with David Leechiu of Leechiu Property Consultants. Although he agrees the exit of Pogos will hurt the property sector, the impact will not be as bad as what is being implied by the current performance of some property stocks.

One of the main reasons why he is not so pessimistic is because Pogos pay advance rent of 12 to 24 months. Because of this, property companies will not be under pressure to cut lease rates assuming Pogos are forced to leave the country.

Moreover, out of the 1.1 million sq m of office space occupied by Pogos, 200,000 square meters are Philippine Economic Zone Authority-accredited, which makes them highly attractive to the offshoring and outsourcing (O&O) sector.

David also said only around 60 percent of Pogos come from China. Consequently, not all 1.1 million square meters of office space will be vacated assuming Pogos from China are evicted.

Finally, because of the strength of the domestic economy, traditional businesses now account for a big share of office leasing transactions.

Based on Leechiu Property Consultants’ estimates, traditional businesses and the O&O sector accounted for a combined 912,000 sq m of office leasing transactions last year. As such, excess supply that will be created by the evicted Pogos should easily be absorbed by the market in a little bit over a year.

Even with the possibility of Pogos exiting, David said he remained bullish in the office leasing segment. This is largely due to the limited supply of office space that will be added in Manila. Based on his estimates, total supply from 2019 to 2023 is 3.35 million sq m, which is equivalent to only 670,000 square meters annually. This is well below the 912,000 sq m that was taken up by traditional businesses and the O&O sector last year.

Among the listed property companies, two stocks were hurt the most by the news of Pogos possibly saying goodbye, namely Filinvest Land (FLI) and Megaworld (MEG). The two stocks’ weak performance is not surprising given that 20 percent of FLI’s and 14 percent of MEG’s office leasing portfolios are exposed to Pogos.

Nevertheless, from a valuation perspective, we believe the magnitude of the two stocks’ sell-off is unwarranted. FLI and MEG are down 22.4 percent and 26.7 percent from their peak prices, respectively. This is despite the fact that both stocks were trading at a discount to their peers, even at their peak prices. Although POGOs account for a sizeable portion of the two companies’ office leasing portfolio, their share to the companies’ total net asset value is only minimal at 5 percent for FLI and 4 percent for MEG.

Note that aside from office leasing, both companies have other businesses such as residential sales, malls and hotels. Both companies also own a huge amount of land bank in attractive locations such as Clark and BGC. As such, we don’t think FLI and MEG deserve to be 22.4 percent and 26.7 percent less valuable even if Pogos will no longer be allowed to operate in the country.