On Nov 12, Sabana Shariah Compliant Industrial REIT issued a scheme document as part of its merger with ESR-REIT. In it was the advisory from Deloitte & Touche Corporate Finance, Sabana REIT’s independent financial adviser (IFA). It says: “Based on our analysis and after having considered carefully the information available to us, we are of the opinion that the financial terms of the merger are fair and reasonable. Accordingly, we advise the Sabana Independent Directors to recommend that the Sabana Unitholders vote in favour of the Scheme Resolution.”
The merger is via a trust scheme of arrangement. As part of the scheme, Sabana REIT unitholders get to vote on two resolutions — to amend its trust deed, and the merger. For the resolution to change the trust deed to carry, at least 75% in value of the total number of Sabana REIT units held by those present must vote in favour of the resolutions.
For the merger resolution, more than 50% of Sabana REIT unitholders present or voting by proxy, and at least 75% of those present by value, must approve the merger resolution. ESR Cayman and Tong Jinquan, Sabana REIT’s major unitholders, cannot vote.
Two hedge/activist fund managers, Quarz Capital and Black Crane, which together hold 11% of Sabana REIT, are planning to vote against the merger. Quarz Capital has privately said it would be satisfied with a cash component such as a special dividend for it to approve the merger.
ESR-REIT’s EGM is a lot more straightforward. Its unitholders will also vote on two resolutions — the merger, and permission to issue 989.9 million new ESR-REIT units to Sabana REIT’s unitholders. Here the resolutions require more than 50% of the total votes cast. All the resolutions are inter-conditional. Any one resolution that does not carry scuppers the entire merger.
Big is beautiful
Undoubtedly, with the listing of CapitaLand Integrated Commercial Trust (CICT), and Ascendas REIT’s latest equity fund raising and acquisitions, size is important. These two REITs — with assets under management of $22.4 billion for CICT, and more than $13 billion for Ascendas REIT — could dwarf smaller REITs, and account for outsized weightages on various indices.
No surprise then that Adrian Chui, CEO of ESR-REIT’s manager, emphasises the importance of size. “When we embarked on this merger, we are congruent of the fact that size does matter, for upgrading properties, redeveloping, following the evolving trends of industrialists and new technology, and for funding,” he says.
One ambition for Chui is to have ESR-REIT included in the FTSE EPRA NAREIT Developed Index, which requires a REIT to report 75% of its earnings before interest, tax, depreciation and amortisation from developed markets for two consecutive years; and to have a free float market capitalisation of around US$1 billion ($1.35 billion).
“Size and inclusion in indexes matter to funding cost such as debt and cost of equity. REITs don’t retain any cash, so access to pools of capital is very important. If you’re larger, you get access to a wider pool, and lower cost. Despite the pandemic, there are REITs that are raising funds,” Chui points out. Frasers Centrepoint Trust raised $1.3 billion in equity, and Ascendas REIT has just proposed a $1.2 billion equity fund-raising to acquire properties in San Francisco and Australia, and a data centre portfolio in Europe.
“Having a larger REIT gives us both the financial and operational flexibility to plan in a Covid world,” Chui continues. A larger REIT is able to upgrade properties through an AEI (asset enhancement initiative), or even redevelop properties with unutilised plot ratio without reducing distributions noticeably. “If we have a larger portfolio, we have more operational flexibility, because if we close down one asset, it may not dilute quarterly earnings too much. We would have to shift tenants around and a larger portfolio gives us the opportunity to do that.”
ESR-REIT has some one million sq ft of unutilised gross floor area (GFA), while Sabana REIT has 1.2 million sq ft of unutilised GFA. Sabana REIT’s gearing is a relatively low 33.7%, and its properties have been used as collateral for its loans, with 94% of its loans secured. Hence it has relatively little debt headroom.
On the funding front, if the merger goes through, the enlarged REIT will be able to access debt on an unsecured basis, with unencumbered assets. “The larger debt headroom will allow us to draw down lines,” Chui says. And the enlarged REIT would be able to access debt at a lower cost of around 2.5% or so, compared to Sabana REIT’s average cost of debt of 3.5%. “This merger helps to unencumber Sabana REIT’s secured assets,” Chui adds.
The merger is expected to be DPU and NAV per unit accretive to ESR-REIT unitholders on a historical pro forma basis.
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Requisition for EGM with unusual resolutions
The problem is, for Sabana REIT unitholders, although the merger would accrete 12.9% to its historical DPU, it is done at a significant discount to NAV. Donald Han, CEO of Sabana REIT’s manager, points out that this is not a sale of properties, but a merger. Unitholders will still own the properties. Nonetheless, Quarz Capital and Black Crane have gone to significant lengths, through open letters, to oppose the merger.
The latest is a requisition of an EGM for five resolutions, announced on Nov 10. According to a Sabana REIT unitholder, the resolutions are strange. “Do you need an EGM to pay out withheld distributions and to ascertain if independent directors are independent?” he wonders. The unitholder is referring to resolutions such as asking the board of Sabana REIT to check if independent directors are independent.
One of the more bizarre resolutions is to check if staff members recruited from other REIT managers are loyal to Sabana REIT. And, of course, another resolution asks the board to pay out withheld distributions.
The two hedge funds have also asked the manager’s board at Sabana REIT to suspend all actions relating to the proposed merger with a view to termination of the proposed merger, and to recommend that Sabana REIT’s manager bears all fees in connection with the proposed merger.
Business as usual
Since Quarz Capital and Black Crane hold 11% of Sabana REIT’s units, the likelihood of the merger being voted down exists. If so, the two REITs would have to go their separate ways. In this scenario, Sabana REIT would face more challenges than ESR-REIT.
“We are a small industrial REIT. We will survive but the problem is, in the current environment where Covid is still among us, with the world going through a third wave, and our borders are starting to reopen, it is challenging. Being small is not sexy. Most of our loans are on a secured basis, and we can only raise $25 million in debt,” Han says.
Sabana REIT’s ability to undertake AEI, or to redevelop and utilise its underutilised GFA, depends on its ability to access funding. “We have plans. We are halfway through our refreshed strategy and we would like to do more AEI,” he adds.
Chui is sanguine about the future should Sabana REIT’s unitholders vote against the merger. “We have our three-year business plans,” Chui says. If the merger goes through, the pace of AEIs and redevelopment could pick up. But if the merger is scuppered, things would move slower. Besides, sponsor ESR Cayman owns and manages assets in developed markets which may be of interest to ESR-REIT.
“If this merger doesn’t go through, we have other options. We still have our sponsor ESR Cayman’s pipeline of assets in Australia and Japan. Australia is a country we would like to look at. ESR Cayman is established there, with property management, marketing and leasing operations, and the jurisdiction is transparent,” Chui says.
In Singapore, metrics in the local industrial property sector have stabilised. “We see that q-o-q, operations have improved,” Chui says, referring to ESR-REIT’s quarterly business updates. Its DPU of 0.798 cents in 3Q2020 included the release of $3.5 million distributable income from 1Q2020, which was previously retained in view of Covid uncertainties. Excluding the release of 50% of the 1Q2020 retained distribution, DPU would have been 0.7 cent, up 5.7% q-o-q.
New leases that commenced during 3Q2020 led to higher q-o-q gross revenue and net property income (NPI). Some 244,000 sq ft of new leases were signed, and 585,00 sq ft of space was renewed. All singletenanted leases due for renewal in FY2020 have been renewed. There are currently less than 5.3% of expiring leases for multi-tenanted properties due for renewal in 4Q2020, of which 4.4% of these expiring leases are in advanced negotiations where tenants have given indications of renewal. “We see demand for high specs space from pharmaceuticals, and precision engineering sectors. Logistics continues to be in demand. Our warehouses are full. The next part is whether we can push up rentals,” Chui says.
As for 4Q2020, he reckons it could be as good as 3Q2020. Chui is also pleased that with a gearing of 41.6%, other REITs have overtaken ESR-REIT’s gearing levels. “We are no longer the highest geared REIT,” he says happily.
