BLUEPRINT: Keeping it regional

It has been less than a year since e-Shang Redwood was formed out of a merger between two regional logistics operators, Shanghai-based e-Shang and Singapore-based Redwood Group. Yet while the entity might be relatively new, its co-founders are industry veterans, carving out an enviable position for ESR in the Asia logistics marketplace.

Sitting in a hotel meeting room in Shanghai, where ESR operates its biggest office with 120 people, Charles de Portes, president, and Jeffrey Shen, the firm’s co-chief executive, talk about ESR and its giant rivals with candor and self-assuredness – perhaps due to their decades of experience and entrepreneurial backgrounds.

Shen, who spent over five years at Prologis, was known as the right-hand-man of Ming Mei, chief executive of Global Logistic Properties, during his brief stint with the firm before he left to create e-Shang in 2011. Stuart Gibson and de Portes, co-founders of Redwood, were among the first senior executives of Prologis to move to Asia in the late 1990s and helped to launch both Prologis and AMB’s platforms in Japan.

Armed with local expertise and a strong roster of corporate shareholders, including Warburg Pincus, Sam Zell’s Equity International and the Dutch pension administrator APG Asset Management, ESR aspires to become the leading logistics operator in China, Japan and Korea by development pipeline in the next 12 months.

Faster growth is ESR’s mantra and it is aiming to wrestle market share from its peers, particularly sector powerhouse GLP. To do so, the co-founders have a strategy that leverages the firm’s comparative advantage. “We have something that none of the other groups have: we are not trying to conquer the whole world. We are going to stick to our core competency and that is building a concentrated and focused Asia platform to provide pan-Asia services to our clients,” says de Portes.

“Our goal is not to have the number one AUM, because if you play that goal, your strategy is just to be big. For example, a lot of GLP’s original strategy was oriented towards size, and on a race to get there – including a stretch to secondary and tertiary markets in China. What we built at Redwood and e-Shang was focused on Tier 1 cities, and very selectively, Tier 2 high-demand locations. We have remained disciplined and focused only on the top two cities, even in South Korea and Japan. Yet through such focus, we have more than six million square meters of pipeline across China, Japan and Korea, which in combination is arguably larger than any of our competitors in Asia.”

But while Asian dominance is a longer-term goal, one of the biggest short-term milestones for ESR is to get listed. The firm plans an initial public offering some time next year with a view to enhancing its funding capacity and grow the platform.

Jeffrey Perlman, managing director and head of South-East Asia for Warburg Pincus, says ESR is “already of a size and scale that is ready for the capital markets.”

Rumors of a potential listing have been doing the rounds since e-Shang and Redwood merged in January. Both de Portes and Shen say that was not optimal timing, however, and the markets have now become more robust.

Nevertheless, a hurdle in the process might arise in the event of the potential privatization of GLP, according to some industry observers. According to a late October Bloomberg report, the Singapore-listed firm attracted takeover interest from a consortium led by China Investment Corporation, the Chinese sovereign wealth fund. GLP, for its part, denied the claims, even though they sent its share price soaring by about 15 percent at one stage.
GLP’s fate aside, Shen quips that ESR’s competitors do not want it to IPO because they want a chance of taking over the platform. He lays out the aggressive road map planned for one of its biggest markets, China, after the listing. “In three years’ time after the IPO, we want to be the largest in the retail logistics sector and also the largest in cold storage in China. More and more e-commerce players are moving quickly to the food and cold storage industry.”

When a listing does come about, it is anticipated to provide another channel for capital raising. Indeed, around 50-60 percent of the firm’s capital is expected to come from ESR’s existing funds management business following the listing. ESR currently has about $3 billion in equity under management across its three target markets in Asia, with investments from the Canada Pension Plan Investment Board, APG, Malaysia’s Employees Provident Fund, Dutch pension fund PGGM and the Chinese insurer Ping An Insurance among others.

This year, the firm has raised around $850 million of new capital for Asia, mostly for Japan and some for China, and that number is expected to reach over $1 billion before year-end,
de Portes says.

That capital comes in addition to the funds already collected for Redwood’s legacy vehicles in both China and Japan, which were brought into the merged entity. These include: Redwood China Logistics Fund, a value-add vehicle containing $430 million of equity from PGGM; Redwood Japan Logistics Fund II, a Japan-focused fund currently in fundraising mode – that vehicle has attracted more than $800 million including side-car commitments so far; and just months before the merger was announced, e-Shang formed a logistics club venture with APG and CPPIB, alongside local operator Kendall Square Logistics for Korean investments. That vehicle was capitalized with $500 million from the partnership. Called KSLP, the club represents e-Shang’s Seoul-based platform and it is led by another two executives who used to work at some of logistics’ biggest firms: Thomas Nam and Jihun Kang were formerly senior figures at Prologis and AMB, respectively.

Going forward, the firm will continue its strategy of setting up development funds for each market individually. In the second half of 2017, it will also launch core logistics funds, given many of its assets, especially in China, are now completed and stabilized. The firm did not disclose any target fundraising amount for these, however.

What ESR is certain of not doing is launching a pan-Asia logistics fund, a strategy other logistics firms have considered. “Each market in Asia has its own risk and reward dynamics. And it is very rare that you will find the same investor who wants to invest in China, Japan and Korea logistics at the same time. I have been raising logistics funds in Asia for 16 years and we haven’t seen this,” says de Portes.

Redwood’s funds management business was an important driving factor behind e-Shang’s decision to merge.

In 2010 and 2011, Shen, who was the head of Tier 1 markets in China for GLP, felt that the firm was not moving fast enough on e-commerce projects, placing greater onus on its global ambitions. He left the company to co-found e-Shang together with Warburg Pincus and Sun Dongping, a Chinese entrepreneur.

Warburg Pincus’s Perlman explains the motivations behind the Redwood tie-up: “When we brought in APG, who initially committed $650 million, it was really the first transformation of e-Shang into a funds management platform. We felt that once large institutional investors underwrote the company then they were very likely to go with us across multiple geographies, because they want to deploy a meaningful amount of capital. It played along the lines we envisioned and APG ultimately went into Korea with us.

“Japan and China are the two key anchors if one wants to become the largest pure-play Asia logistics platform. That was the primary logic – Redwood was incredibly strong in Japan and had strong capital relationships at the LP level.”

For Redwood, the opportunity to firm-up its presence in China, a market it had entered in 2009-10, was equally appealing.

“I will be honest: e-Shang’s team was broader and further ahead than the Redwood team in China pre-merger. They were bigger, more experienced and moving very fast with e-commerce. Ours was a boutique team that was focused on the [third-party logistics businesses] in Tier 1 cities and although focused on quality, we were doing [about] half the annual pipeline compared to e-Shang,” says de Portes.

“Nobody among our – nor their – shareholder group nor senior management wanted to play for second, third or fourth position in China. On a combined basis, realistically we felt we could well rival for number one in terms of growth and average annual starts, but with a greater focus on prime locations.”

This set off discussions in the third quarter of 2014 between the two firms’ founding partners, who have known each other since their days at Prologis. And it is this pedigree, they say, that has remained a key advantage for the newly-carved ESR.

“As many of our senior management worked at very senior levels for our current competitors and we created a lot of their original local strategy and training, we generally have a good feeling as to how they might underwrite and prioritize projects. Nonetheless, we respect our competition and it is important on the best projects that we move very fast,” de Portes says.
Priyaranjan Kumar, regional executive director for capital markets in Asia Pacific at Cushman & Wakefield, has worked with Redwood before. PERE learned that the capital advisory firm advised on a $100 million investment made by the State Oil Fund of Azerbaijan into RJLF II several months ago.

Kumar says both de Portes and Gibson have always been glued to their business and deeply involved in every part of the value creation process. He recalls a site visit to one of Redwood’s Japan developments in Yokohama, when Gibson took a day off and personally walked them through the site. On another occasion, bidders in a land auction were required to put down $500,000 as initial deposit a few days in advance. For this, Redwood’s founders were willing to put down their personal capital, despite not knowing if they would win the auction or succeed in corralling sufficient investment capital.

“This entrepreneurial DNA of ESR, together with a well-capitalized and diversified LP base, has succeeded in creating a viable alternative to the other big logistics firms,” Kumar says. “The street will love its story, because ESR is nowhere even close to its maturation phase; it has a long road ahead.”

Battle plan
Asked about the competition from Goodman, Prologis and GLP, de Portes says: “If they were 100 percent focused on one market they would be fiercer local competitors. For example, my answer about Goodman would be much different if Greg Goodman and his team were sitting in Shanghai, not in Australia, Europe or the US; or if Ming Mei was 100 percent focused in China. But their priorities are different and spread globally.

“They have less pressure to do a lot more in China, as opposed to taking a pause and rebalancing their investment efforts in other countries. That works well for us, too. We keep all our best people here all the time and our investment committee is here. That gives us a further advantage in terms of speed of decision making.”

Even so, comparisons with other industry peers are inevitable, as ESR competes against names that have dominated the sector for years.

As of October, GLP had 170 million square feet of completed area for leasable logistics in China – over seven times that of the second place firm, Goodman, which has 21 million square feet, according to GLP data. ESR, meanwhile, continues to inch closer to Goodman, with 20 million square feet of completed logistics space.

To be sure, ESR’s approach in China also stands out from some of its peers with regards to its focus on Tier 1 and selective Tier 2 markets instead of venturing further inwards. This strategy, ESR’s shareholders say, is a key difference working to their advantage.

“Many of the other players are building speculatively in remote Tier 2 and Tier 3 locations with the hope of attracting tenants. Arguably no one except ESR is thinking about de-risking the development pipeline through active pre-leasing. ESR is solving an actual need by building in locations where there is strong tenant demand,” says Sachin Doshi, managing director and head of private real estate investments for Asia-Pacific at APG Asset Management.

According to Shen, around 30 percent of ESR’s pipeline is currently pre-leased in China.

“There is a huge difference between first and second tier cities. In places like Chengdu, there is around 20 percent vacancy but in Shanghai and Beijing it is difficult to even find 100,000 square meters of available space,” he says. “If you look at the retail business portfolio, almost 60 percent of the total revenue – either through online or offline sales – is coming from first tier cities. That is why our pipeline is focused on these areas.”
Shen has built strong relationships with major tenants over the years in China. This also falls in line with one of the group’s key strategies – to build crossover synergies with tenants and become a regional provider of logistics space.

He explains: “Look at the total investment we make in one logistics park. If, for instance, we put in one dollar, our tenant would put 70 to 80 cents. ESR would buy the land and build the facility, while the tenants will put in place other working systems. In comparison, our peers only invest 40 cents. We are much closer with our tenants’ business.”

In Japan, ESR had the largest gross floor area in terms of new developments since 2014, amounting to approximately 22.6 million square feet. Daiwa House is at the second spot with 21.53 million square feet, according to one Japanese logistics specialist.

In Korea, meanwhile, ESR believes it has a first-mover advantage because none of its three international competitors has a scalable presence. According to de Portes, this means ESR can take some “serious positions that may become difficult barriers to entry for others to pass.”
From a performance perspective, ESR’s executives believe approximately 14-15 percent IRRs can still be achieved in markets like China. In Perlman’s view, the industrial and logistics sector, including development projects, is one of the best in real estate to generate sufficient yield in the current zero interest rate environment.

“Right now, there is a 500-750 basis point premium from an IRR perspective for logistics development projects in comparison to acquiring single assets,” he says.

“From a cap rate perspective in a market like China, you will be building at 8-9 percent yield and you would sell for somewhere around 6 percent. That analysis is intact for each of the three markets: China, Japan and Korea. We are still able to identify projects that can deliver that magical 200-300 basis point spread, which ultimately delivers mid-teens returns.”

At the same time, the overall financial performance of a company in growth mode like ESR is also crucial to its shareholders. APG’s Doshi says its investment is generating returns well north of 20 percent per annum at the ESR management company level.

ESR’s shareholder base comprises firms with varying risk and return appetites; Warburg Pincus is the majority shareholder, while APG has a 15 percent stake and Equity International holds around 12 percent.

As such, you have typical private equity investors like Warburg and EI, which hold investments within a limited timeframe. APG, on the other hand, is an institutional investor that typically commits for a long-term stable hold. When questioned about this dynamic, de Portes says it has never led to any conflict about the ultimate objectives and investment approach of ESR.

“EI bought into a business that was primarily funds management. When Warburg came in with e-Shang, it was circa half funds management and half asset-based. All the shareholders realize the importance of the funds management business and that the LPs are long-term. So even if one wanted to find one’s own liquidity over the next few years, one would do so in such a way that the LPs all feel comfortable that they will be well-protected by continuity of the local and funds management teams,” he says.

Perlman agrees that having an alignment of interest with the management is the key. “Whenever we build these businesses – some from scratch like e-Shang – it is all ultimately about the management team. What we are trying to ultimately create is a durable long-term business that can effectively survive and thrive after we ultimately exit the business. That is why many of our platforms have gone public,” he says.

“As much as we love this business, we cannot hold on forever, and we have to return capital to our investors. That is our mandate. At the same time, we are a long-term investor; we have been in this investment for over five years now and we still have plenty of runway to continue to go out and execute the business.”

From APG’s perspective, Doshi says that one of the reasons the pension opted for a two-step investment in e-Shang was in considering the possibility the management company could go public.

“We always knew doing an IPO was part of management’s and Warburg Pincus’s plans. For us, the key is that the company keeps growing profitably, and it scales up in the areas we see growth without taking disproportionate risk. The next focus should be on creating core vehicles to monetize developed properties, recycle capital and continue to grow the development book.”

To ensure ESR continues its pace of growth, however, its internal processes also need to be institutionalized, he says. “If a company is growing as fast as ESR you need to take a step back and check if the systems and processes are getting institutionalized at the same pace.”
Institutionalization of the company is a journey and the founders are cognizant of where the company needs to grow. The combination of e-Shang and Redwood was a firm step in that direction to bolster its funds management capabilities.

According to Kumar, for an entity that has been through an M&A, the most important thing is to be aware of what clients are thinking and to provide them with a consistent customer program across different markets. He says ESR will need to ensure its front and back-ends are well synchronized so it can present itself as a single integrated northern Asia player and earn repeat business from its clients.

All the shareholders and clients of ESR that PERE spoke with believe this is eminently doable. More importantly, they believe in the challenge they pose to the sector’s better established big three firms and in the long-term growth potential of the logistics sector as an investment class in Asia. It is these beliefs which form the basis on which this new firm is aggressively charting its journey forward.