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Big celebrations ahead for marriage between ESR-REIT and Sabana REIT

Samantha Chiew
Samantha Chiew • 6 min read
Big celebrations ahead for marriage between ESR-REIT and Sabana REIT
In a world where "bigger is better", analysts are bullish on the merger of ESR-REIT and Sabana REIT.
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SINGAPORE (July 17): ESR REIT and Sabana REIT yesterday announced that a proposed merger, by way of a trust scheme arrangement, where ESR-REIT will acquire all of Sabana REIT’s units in exchange for new ESR REIT units.

See: ESR-REIT and Sabana REIT to merge, bringing total assets to $4.1 bil

With that, DBS Group Research lead analyst Dale Lai is keeping his “buy” call on ESR-REIT with a target price of 43 cents, while upgrading his recommendation on Sabana REIT to “buy” with a 40 cents target price.

The announcement of this merger comes after activist fund Quarz Capital Management said in November last year that ESR Cayman's cross-ownership of the managers of both REITs puts Sabana at a disadvantage when the two trusts' investment mandates overlap. Hence, to resolve this issue, Quarz called for both the REITs to merge.

See: Hedge fund manager writes open letter to ESR

This merger however, is not the first for ESR REIT. In 2018, ESR-REIT merged with Viva Industrial Trust in a share and cash offer. VIT unitholders were paid 96 cents per unit of which 90% was with ESR-REIT units, and 10% in cash.

See: Warburg Pincus-backed REIT to buy rival in Singapore's first REIT merger

And now with its second merger, the enlarged REIT, if approved by shareholders, is expected to create a sizeable S-REIT of about $4.0 billion in assets under management (AUM) and with a market cap of $1.8 billion, making it the fifth largest industrial S-REIT. This will allow the enlarged REIT to better compete for capital and benefit from a broader institutional base over time.

Together, both the REITs will have 75 properties in Singapore. With most of Sabana REIT’s properties near ESR-REIT’s assets, the manager of the enlarged REIT is can then extract synergies and economies of scale.

“The combined unutilised GFA will add up to about 2.2 million sq ft and offers future organic growth opportunities,” says Lai.

“This will, in our view, translate to a lower cost of capital and with the enlarged S-REIT trading at a premium to NAV, catch up with the larger cap industrial S-REITs. With the enlarged REIT at the doorstep of a potential inclusion into the EPRA NARREIT Index by 1H21, investors should keep a close watch on this stock,” Lai adds.

The analyst believes that this merger is a value accretive deal that has the flexibility and potential to unlock hidden value in the future. Based on FY21 estimates, the deal is 3.4% accretive to ESR-REIT’s DPU and 18.7% to Sabana REIT’s DPU.

As it is, unitholders of the enlarged REIT will be able to enjoy a more stable and diversified earnings base with an increased focus in the higher specifications & logistics properties which should be resilient in a post Covid-19 world.

“We like that the enlarged REIT has the financial flexibility to potentially execute on about 2.2 million of unutilised GFA (+11%) that may be tapped on in the future given its higher development and debt headroom,” adds Lai.

Although the implied offer price of 37.7 cents is around 26% discount to the net asset value, the analyst acknowledges this to be an attractive trade-off, especially for Sabana REIT unitholders, given the opportunity to ride on the longer-term growth prospects of a larger developer-backed REIT.

Furthermore, the exchange ratio of 0.94 times is higher than Sabana REIT’s five-year average of 0.87 times.

“While an implied pricing of around $165 per sq ft on a EV/GFA basis appears to tilt this in favour of the buyer, we see this as fair deal as more capex would need to be invested over time to raise the overall portfolio attributes to better compete in the future,” says Lai.

Overall, the analyst sees this proposed merger as positive for both REITs’ unitholders.

“From a capital market’s perspective, the enlarged REIT will bring about benefits as its stronger size and liquidity will attract more institutional investors, which may be tougher if both REITs trade on their own. In a world where ‘big is better’, we believe this to be a driver to its re-rating in the medium term,” says Lai.

Apart from DBS, other analysts are also sharing a similar positive sentiment on the merger of the two REITs.

CLSA Securities said that the merger is “a good deal” and has kept its “buy” rating on ESR-REIT with a 47 cents target price. It likes the merger for its portfolio diversification and the ability to undertake larger asset enhancement initiatives with minimal disruption to DPU.

Soochow CSSD Capital Markets (SCCM) also has retained its “buy” recommendation with a revised target price of 47 cents.

Although ESR-REIT’s 1H20 results were below estimates due to weaker operations, rebates and retention cause by Covid-19, SCCM analyst Zhao Yiyuan still likes the REIT for its undemanding valuation and mid to long term growth potential.

“The proposed merger with SSREIT increases near term resilience with larger warehouse/logistics segments & unlocks mid-term catalysts through operational synergies, potential index inclusion, and increase in total untapped GFA,” says Zhao

On the other hand, Morningstar Equity Research rates ESR-REIT as “stable” with a higher fair value estimate of 42 cents.

It views this merger positively as it increases the trust’s exposure (in terms of portfolio valuation) to high-specs and logistics properties to 26% and 25%, respectively, from 16% and 23%, enhancing the diversification of its portfolio; it enhances the diversification of the tenant base where the contribution of the top 10 tenants is expected to account for 25% of gross rental income compared with 31% premerger; and it is distribution per-unit accretive to unitholders.

Daiwa however is less bullish on this merger as it maintains its “hold” call on ESR-REIT with a 42 cents target price. Analyst David Lum explain that this is due to the REIT’s results being broadly in line with forecasts, and what he regards a “some lingering uncertainty” around the recurrent post-merger DPU.

Lum however does see medium-term opportunities for the enlarged REIT post-merger in the overseas markets where its sponsor has a presence.

As at 1.05pm, units in ESR-REIT are trading 3.9% higher at 40 cents, while units in Sabana REIT have increased by 5.6% to 38 cents.

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