(Apr 15): On April 9, almost seven million units of OUE Commercial Real Estate Investment Trust changed hands as investors headed for the exit. Just five months after the completion of a dilutive transaction, OUE Commercial REIT announced a second dilutive transaction. On April 8, the managers of OUE Commercial REIT and OUE Hospitality Trust announced a merger between the two under a scheme of arrangement that will need unitholders’ approvals (see Indicative timeline). The sponsor, OUE, and its affiliates cannot vote.
See: OUE C-REIT and OUE H-Trust in merger to create diversified S-REIT with $6.8b in assets
According to the joint announcement, the total cost of the proposed merger to OUE C-REIT is estimated at $1,515.3 million, comprising $1,491.3 million to acquire OUEHT units; an acquisition fee of around $8.3 million, or 0.375% (half the usual of 0.75%) of the asset value of OUEHT, payable in OUE C-REIT units to OUE C-REIT’s manager; and other expenses of about $15.7 million, payable in cash.
Of the $1,491.3 million, $74.6 million will be in cash and the remainder will be in OUE C-REIT units in the ratio of 1.3583 OUE C-REIT units for every one OUEHT unit. OUE C-REIT had 2,861.6 million units in issue as at Dec 31, 2018, and may need to issue in excess of 2.5 billion new units, depending on the volume-weighted average price at the time the extraordinary general meeting circular is published in May or June.
The $74.6 million, or 0.04075 cent to be paid for every OUEHT unit, will be financed by debt, causing the pro forma debt of the merged OUE C-REIT to rise from 39.3% to 40.3% (see Table 1).
At the latest price of 52 cents on April 5, before the merger was announced, OUE C-REIT would be paying 74.69 cents a unit for OUEHT, which is trading near its net asset value a unit of 75 cents. No wonder RHB Securities is advising its clients who own OUEHT units to accept the offer: “The effective offer price is at par with OUEHT’s latest NAV (FY2018) and in line with the hospitality REITs’ average 1x price to book value. Accept the offer.”
For OUE C-REIT, merger is mildly accretive to DPU, dilutive to NAV
The transaction is mildly accretive to OUE C-REIT’s distributions per unit, but quite dilutive to its NAV (see Tables 2 and 3). This is because OUE C-REIT has been trading below its NAV of 71 cents since its rights issue to part-fund the acquisition of the office portion of OUE Downtown last November. The rights issue in itself was dilutive, as the OUE Downtown acquisition was not DPU- or NAV-accretive.
For the acquisition of OUEHT, OUE C-REIT’s NAV per unit will fall to 62 cents from 71 cents, assuming units are issued at last year’s rights issue theoretical ex-rights price (TERP) of 57 cents. The dilution would probably be larger if units are issued at the latest one-month volume-weighted average price of 51 cents (see chart below).
Pro forma DPU is only mildly accretive, by 2.1%, with DPU rising from 3.41 cents in FY2018 to 3.48 cents, assuming full-year contribution from OUE Downtown Office and assuming OUEHT’s management fee structure is replaced with the fee structure in the OUE C-REIT Trust Deed. OUE C-REIT’s performance fee is based on DPU growth, while OUEHT’s performance fee is a percentage of net property income (NPI).
Rationale for size
During a media briefing on April 8, OUE C-REIT’s financial adviser and Tan Shu Lin, CEO of the REIT’s manager, highlighted the merits of the deal.
The merged REIT will be large, with an asset size of $6.8 billion. As a diversified REIT, it will be the third largest after Suntec REIT and Mapletree North Asia Commercial Trust. If all goes according to plan, the merged REIT’s properties will comprise three asset classes — commercial, hospitality and a smattering of retail. Pro forma revenue increases 74% to $306 million and NPI gains 81% to $251 million.
A diversified REIT has an advantage, according to CEO Tan. “The enlarged REIT will be able to look at integrated developments, and we are seeing the rise of such developments in the market and we can evaluate these as a whole. This will put us in a very good position to drive growth in the future,” she says.
The merged OUE C-REIT could, for instance, acquire OUE Downtown Gallery, a mall; and Oakwood Premier OUE Singapore, a serviced apartment development with a hotel licence. Last year, OUE C-REIT acquired the office component of OUE Downtown.
A diversified REIT could be more stable and less affected by market cycles. “The diversification of the new REIT will mitigate earnings risk from office cycles and hospitality downturns. The new mandate also allows the group to acquire integrated developments that otherwise would have been harder to acquire,” says CLSA in a note on the merger.
Of course, a larger REIT has greater financial flexibility. For acquisitions, it could raise equity through a placement or equity fundraising, both of which are less dilutive than a rights issue. “The larger entity is expected to become the eighth-largest REIT by assets under management. This could improve funding sources,” CLSA adds.
The holy grail for developers and REITs is to make it into the FTSE EPRA NAREIT Developed Markets Index. Hongkong Land, CapitaLand, Ascendas REIT, CapitaLand Mall Trust and CapitaLand Commercial Trust are the largest local members of this index. To qualify, a developer or REIT is required to report 75% of its earnings before interest, tax, depreciation and amortisation from developed markets for two consecutive years and have a free float market cap of US$1.26 billion ($1.7 billion). While the merged OUE C-REIT qualifies on the Ebitda front, its probable free float of $1.08 billion is not quite at the threshold level yet.
Although FTSE EPRA NAREIT DM Index components trade at tighter yields than non-members, some analysts caution that OUE C-REIT may not be a beneficiary even if it is included in the index. For instance, institutional investors may prefer a more focused exposure to certain sectors. “We understand that most investors’ preference has been for a pure exposure to a particular sub-property asset class. The only exception that the market has largely accepted has been a mix of office and retail assets, for example, Mapletree Commercial Trust, Mapletree North Asia Commercial Trust, Suntec REIT and Starhill Global REIT,” says DBS Research. At any rate, there may be limited synergy between a hotel REIT and an office REIT, it adds.
Serial acquisitions leave OUE C-REIT weakened
OUE C-REIT has made two major acquisitions since its IPO in 2014, leaving it in a weakened position. In 2015, when its asset size was just $1.6 billion, OUE C-REIT acquired a 67% stake in One Raffles Place (ORP) for $1.1 billion, funded by debt, convertible bonds and a 9-for-20 rights issue at 55.5 cents apiece.
In 2018, OUE C-REIT acquired the office portion of OUE Downtown for $927 million, including rental support. To do so, OUE C-REIT had a dilutive rights issue, raising $567.5 million through an 83-for-100 rights issue priced at 45.6 cents apiece. The TERP was 57 cents, and OUE C-REIT has yet to reach TERP. DPU fell from 4.67 cents in FY2017 to 3.48 cents in FY2018. Now, with a full year of NPI from OUE Downtown and the acquisition of OUEHT, DPU could move just 2.1% higher on a pro forma basis.
The acquisitions of ORP and OUE Downtown have taken OUE C-REIT’s unit price from 80 cents at IPO to just 51 cents on April 9. At one point, after the OUE Downtown transaction, unit price fell to 45.6 cents.
As a result, minority unitholders who received IPO units at 80 cents apiece (or paid $800 for 1,000 units) would have paid another $1,011 for a further 1,280 units. Over the years, if unitholders had held the REIT, they would have received $250.55 in distributions for 2,280 units. Over five years, investors would have paid OUE C-REIT’s sponsor the equivalent of 79.42 cents a unit and received 25.05 cents in return through DPU. Given these returns, some jaded unitholders are questioning the quality of the sponsor.
OUE’s tendency to sell non-accretive assets into its REITs to be funded by dilutive rights issues is another concern. In recent months, OUEHT’s unit price has been under pressure, owing to the expectation that it may acquire Oakwood Premier. In addition to dilution from the upcoming merger, OUE C-REIT’s yields will probably remain under pressure, given that the convertible bonds issued to help fund ORP expire in July this year.
DBS Research has also flagged the impact of imposing yet another dilutive exercise on OUE C-REIT’s unitholders. “OUE C-REIT just undertook a rights issue in late 2018 to acquire OUE Downtown. With the merger between OUE C-REIT and OUEHT, the second major corporate action within six months, and OUECT’s share price yet to fully recover, we believe there may be some push-back from some investors, especially given (1) the relatively long wait until August when the merger is scheduled to be completed, and (2) the overhang from the issuance of more units to fund the acquisition of OUEHT.”
Whether the merger is value-destroying remains to be seen, but confidence in OUE C-REIT’s sponsor has already been shaken, and that is why some unitholders headed for the exit after the announcement on April 8.
This story appears in The Edge Singapore (Issue 877, week of Apr 15) which is on sale now. Subscribe here
