SINGAPORE (Jan 22): CapitaLand Mall Trust (CMT) and CapitaLand Commercial Trust (CCT) have jointly proposed the merger of their two REITs to create a diversified commercial REIT, CapitaLand Integrated Commercial Trust (CICT), through a trust scheme of arrangement. CMT will pay $2.1238 for each CCT unit comprising 0.72 new CMT units and $0.259 cash.

The total consideration of $8,192.8 million comprises 2,777.5 million new CMT units at an issue price of $2.59 each or $7,193.7 million (88% of total price), and cash consideration of $999.1 million (12% of total price).

The merged entity will double in size in terms of AUM to $22.9 billion and its market cap will be $16.8 billion, making it Asia-Pac’s third largest REIT, and obviously the largest S-REIT by quite a large margin. Both CMT and CCT are in important indices such as MSCI, Straits Times Index and FTSE EPRA NAREIT Index. CICT would just be larger component in indices based on market cap.

The proposed merger is subject to unitholders' approval during EGMs to be convened by CMT and CCT by May 2020. The merger is expected to complete by Jun 2020 if all approvals are received.

Advantages of the merged entity

Upon completion of the Merger, the Merged Entity will have the ability to undertake up to $4.6 billion worth of overseas acquisitions in developed countries (assuming up to 20% overseas exposure), while remaining predominantly Singapore focused. Development headroom would rise to $6 billion based on current REIT regulations, from the current $3 billion each for CMT and CCT. Debt headroom – assuming gearing of 45% - rises to $2.9 billion.

There will be reduced asset concentration risk as net property income (NPI) contribution from the top 5 assets of the Merged Entity will be reduced to 43%, compared to CMT’s existing 51% and CCT’s existing 83%. This increased diversification reduces earnings vulnerability and increases its flexibility to unlock value and reconstitute its portfolio with a lower impact on NPI. The Merged entity will be almost evenly divided between retail, office and integrated developments (which is mainly Raffles City).

The Merged Entity will enjoy significantly enhanced ability and flexibility to undertake larger redevelopments and asset enhancement initiatives (AEIs) to deliver organic growth for unitholders according to presentations made by Tony Tan, the CEO of CMT’s manager, and Kevin Chee, the CEO of CCT’s manager.

During a briefing on Jan 22, when asked about the CEO of CICT’s manager, no clear answer was given. “At this moment the focus is to cross the finishing line. Both teams are working alongside for this deal. We see a lot of complementarity effects,” Tan says.

When asked about whether CapitaLand Retail China Trust would also be merged, Tan says: "the whole reason why we want to do this merger is because we want to be the clear leader in Singapore and no 3 in Asia-Pac. CRCT would represent 1% of our exposure." He adds that CICT's focus is mainly Singapore and up to 20% of assets could be in developed markets. Emerging markets are unlikely to be CICT's focus.

What happens to fees?  

Interestingly, CCT has one of the lowest fee structures and the lowest fees as a portion of assets, revenue, NPI and distributable income among S-REITs. Its fee structure is also a lot more efficient than CMT’s. CCT’s base fee comprises just 0.10% of the value of deposited property and the performance fee is 5.25% of the net investment income (which is similar to distributable income). CMT’s base fee is 0.25% of the value of the deposited property and performance fee is 4.25% of the NPI.

Tan says for existing assets of CCT, its current fee structure applies and for existing assets for CMT its current fee structure applies. New assets in the merged entity will be based on CMT’s fee structure.

CMT’s A2 rating in jeopardy

CMT may lose its A2 rating because CCT carries a rating that is a couple of notches lower. CMT has the highest rating of A2 by Moody’s Investors Service among the S-REITs, and is among the highest rated in the global REIT arena. All of its properties are unencumbered, and its financial ratios are within parameters set by the ratings agencies for companies with A2 ratings.

In the past Tan had articulated that CMT’s A2 rating is important. “As far as possible we would like to defend our A2 rating. But we have to measure that against business opportunities, and other considerations. Business opportunities would override our desire to defend our rating. However, if we deliver on execution, our balance sheet will improve. If we face risk of downgrade, we will work over time to regain it,” Tan says.

Cash component funded by debt

CMT may take on debt for the $944.1 million cash portion of transaction. “The cash component would be funded through additional debt. From a structuring point of view [this transaction] will be no different from an acquisition. We will have different components of equity and debt,” Tan says.

“The proposed transaction is more beneficial to CCT due to DPU accretion of 6.5%. Also, CMT's gearing increase from 32.9% to 38.3% due to debt incurred to finance the cash component of the acquisition consideration,” says UOB Kay Hian in an update.