(July 8): No sooner had CapitaLand and Ascendas Singbridge completed an $11 billion merger on July 1 than the enlarged group announced the merger between CapitaLand’s two hospitality trusts — Ascott Residence Trust (ART) and Ascendas Hospitality Trust (AHT) — on July 3. The combined real estate investment trust will own 88 properties with 16,000 units in 39 cities in 15 countries valued at $7.6 billion.
While the merger itself was widely anticipated, the speed at which it was announced took many by surprise at the hastily called analyst and media briefing on July 3. This is the S-REIT sector’s third merger in a year. Last November, ESR-REIT completed its merger with Viva Industrial Trust, and OUE Commercial REIT is merging with OUE Hospitality Trust.
Developments in the S-REIT sector have kept the local market abuzz. On June 28, Prime US REIT lodged its prospectus. On July 2, the Monetary Authority of Singapore issued a consultation paper asking for feedback from REIT participants on raising the aggregate leverage limit from the current level of 45%.
Also on July 3, Frasers Logistics & Industrial Trust announced plans to acquire interests in nine freehold logistics properties in Germany and three freehold logistics properties in Australia for a total of A$644.7 million ($612.5 million). FLT’s portfolio value would rise to A$3.5 billion after the acquisition from A$2.9 billion as at March 31 (See: Frasers Logistics & Industrial Trust bulks up in Germany).
As the S-REIT sector — now 17 years old — evolves, there is a clear gravitation towards size. It is becoming apparent that larger REITs with known sponsors boast liquidity, institutional interest, access to capital and debt, and lower cost of capital and debt. These in turn make it easier to acquire properties to grow distributions per unit and assets under management, leading to a virtuous circle.
The merger
Beh Siew Kim, CEO of ART’s manager, says the merger is an “NAV-to-NAV transaction”. This means that to obtain the merger ratio, the net asset value of AHT was divided by the NAV of ART. The NAV of AHT as at March 31 (it has a March year-end) was $1.02, and the NAV of ART as at Dec 31 was $1.22. The merger ratio (1.02:1.30) is 0.836 times. The price that ART will pay for each AHT stapled security of $1.0868 is based on this ratio. The payment comprises cash per unit of 5.43 cents and 0.7942 unit of ART issued at $1.30 each. The total cost to ART is $1.23 billion, comprising $61.8 million in cash and 902.8 million in new ART units.
“The exchange ratio represents a fair deal for unitholders of both [REITs]. Unitholders will continue to receive their DPUs [distributions per unit] till completion of transaction,” Beh says. This is likely to be in December (see Chart 3).
The structure of ART will change, and unitholders will be able to vote on this later this year. The merger will be through a scheme of arrangement (see Tables 1 and 2), where independent unitholders can vote on the transaction. Since AHT comprises a REIT and business trust, ART will have to establish a BT and ART will be stapled to the BT to form a stapled security. AHT’s REIT will become a sub-trust of ART, and AHT’s BT will become a sub-trust of ART’s BT.
ART’s investment mandate will remain focused on lodging. The REIT will continue to invest in serviced residences, rental housing and hospitality. It will also comply with REIT regulations and guidelines, including leverage levels and development limits.
Bigger is better
The enlarged ART will position itself as the largest hospitality trust in Asia-Pacific, with total assets rising to $7.6 billion from $5.7 billion (see Chart 1).
Beh describes the enlarged ART as a proxy for Asia-Pacific hospitality trusts. Because of its size, it will be noticed by institutional investors. “We will be the proxy hospitality trust in Asia-Pacific, so anyone who wants to invest in hospitality trusts in Asia will come to us,” she says.
More importantly, Beh is keen for ART to become a component of the FTSE EPRA NAREIT Developed Index. The merger would enable ART to fulfil the criteria for index inclusion. According to DBS Group Research, these are: (i) common stock listed in an eligible country and stock exchange; (ii) classified under the industry classification benchmark (ICB) as real estate; (iii) deriving at least 75% of Ebitda (earnings before interest, taxes, depreciation and amortisation) from relevant real estate activities in developed markets; (iv) a minimum free float of 5%; (v) a minimum market cap that is 0.3% of the index, currently at $1.7 billion; (vi) median daily turnover greater than 0.05% of shares in issue; and (vii) a detailed annual report in English.
The enlarged ART’s free float will increase by about 50%, from $1.6 billion to $2.4 billion, compared with the minimum free float requirement for EPRA NAREIT equivalent of $1.7 billion as at June this year. Ebitda contribution from developed countries is expected to increase to 82% on a pro forma basis (based on FY2018). “This will facilitate the inclusion of ART into the FTSE EPRA -NAREIT Developed Index and result in higher trading liquidity and a larger investor base for Ascott REIT [ART],” Beh says.
Aggregate leverage of 36.9% (see Table 3) of the larger REIT implies more debt headroom. “We can undertake more development opportunities and we have increased debt headroom to fund accretive acquisitions,” Beh says.
DPU-accretive
The ART-AHT transaction is DPU-accretive and NAV-neutral (see Table 3), based on pro forma numbers. There are challenges, though. The Australian market — especially Sydney and Melbourne — is soft. Both cities are facing supply pressures and the Australian dollar is soft, given its reliance on Chinese trade. Based on pro forma figures, Australia will contribute around 18% to combined pro forma gross profit of $325 million.
Beh sees opportunity in AHT’s portfolio. “The AHT portfolio is encumbered (with mortgages) and some management contracts will expire in the next three years. This will give us the opportunity to enhance the assets [in good locations],” she says.
Although the transaction sounds like a done deal, it is not. Both ART’s manager and AHT’s manager will appoint independent financial advisers ahead of the extraordinary general meetings to be held in October.
As with most mergers, the acquiring entity is likely to come under selling pressure. ART’s unit price fell three cents to $1.28 on the merger announcement. At this price, its yield is 5.7%, based on pro forma DPU of 7.34 cents. Some investors may wait out the weaker phase and buy when yields are nearer 6%. UOB Kay Hian has maintained a “buy” rating; Maybank-Kim Eng has retained its “hold” recommendation.
Since listing in 2006, Ascott REIT has generated more than 300% in returns for unitholders. Beh says with the merger, ART will be bigger and stronger and able to deliver further returns to unitholders.
