On Aug 6, ESR-REIT’s manager announced that it does not intend to increase the scheme consideration for Sabana Shariah Compliant Industrial REIT, announced on July 16. Sabana REIT’s unitholders are being offered 0.94x the price of ESR-REIT. Last month, this valued Sabana REIT at 37.7 cents. ESR-REIT closed at 39 cents on Aug 6, valuing Sabana REIT at 36.6 cents.

Quarz Capital Management which owns 5% of Sabana REIT, is not happy with the offer price, partly because it is now at a discount to Sabana REIT’s net asset value of 51 cents as at June 30, which in itself was lower than the NAV at Dec 31, 2019 of 57 cents. This was partly due to a 5% or $54.7 million decline in portfolio valuation. Appraisers and valuers assumed lower rental growth and lower occupancies for master lease properties that converted into multi-tenanted properties.

“Accordingly, the exchange ratio of 0.940x is final, except that the ESR-REIT Manager reserves the right to do so in a competitive situation,” the announcement by ESR-REIT says.

On Aug 7, Quarz Capital along with Hong Kong-based Black Crane Capital which also owns 5% of Sabana REIT, announced they intend to vote against the scheme proposal during the EGM in Oct. Together, Quarz Capital and Black Crane hold 10% of Sabana REIT.

In an open letter to the board and management of Sabana REIT’s manager, Jan Moermann, chief investment office of Quarz Capital Management and Peter Kennan, CIO of Black Crane Capital, outline five reasons for them to vote against the merger: discount to net asset value; DPU accretion; unutilised GFA; Shariah compliance; and timing.

The main reason the merger is not advantageous to Sabana REIT’s unitholders is the pricing, which is at discount to NAV. According to Quarz Capital thediscount is the highest among the mergers or takeovers that have occurred in the S-REIT space. For instance Viva Industrial Trust was acquired by ESR-REIT at a 23% premium to NAV. 

This ties in with the timing of the merger offer. In 2018, when the offer for VIT was made, it was trading at around 91 cents, which at the time was a 26% premium to its then NAV. On the other hand, ESR-REIT was trading at a discount. So the transaction was not NAV accretive for ESR-REIT unitholders but NAV accretive to VIT unitholders.

In the case of Sabana REIT, it was trading at a discount to NAV when the offer was announced. Although the ESR-REIT offer is a premium to Sabana REIT’s market price, it is a hefty discount to the latter’s NAV. Moreover, on a pro forma basis, Sabana REIT’s NAV of 51.2 cents falls to 40.6 cents based on the enlarged REIT’s REIT's pro forma NAV per unit for 1H2020 of 43.2 cents multiplied by the gross exchange ratio of 0.940x.

However, to make up for this, the DPU accretion is the most in any REIT merger. Sabana REIT’s pro forma DPU, assuming that the retained distributable income is retained, is 1.322 cents or a 12.9% accretion based on Sabana REIT’s 1H2020 DPU. Pro forma DPU is 2.643 cents for an accretion of 12.8% assuming the retained distributable income in 1H2020 is fully distributed.

Thirdly, Moermann and Kennan claim that Sabana REIT’s properties have significantly higher potential upside in terms of increased occupancy and undeveloped gross floor area (GFA) than ESR-REIT’s. According to a DBS Research report in Sept 2019, Sabana REIT has more than 2 million of unutilised GFA. ESR-REIT has 1 million sq ft of unutilised GFA from two properties, 7000 Ang Mo Kio Ave 5 and the other is 3 Tuas South Ave 4 in Tuas Biomedical Park.

The fourth reason to reject the offer is Shariah compliance. Removing the Shariah compliance does indeed add to distributable income. For FY 2019, Sabana REIT’s non-Shari’ah income that was donated represents approximately 0.01% of Sabana REIT’s gross revenue, Sabana REIT’s annual report states. In FY2019, Sabana REIT reported gross revenue of $76.3 million, translating into non-Shari’ah income of $76,000.

The fifth reason according to the two significant unitholders is the timing of the announcement. “Given Sabana REIT’s strong balance sheet, there is no imperative for Sabana REIT to undertake a merger at this time,” Moermann and Kennan state.

Moermann and Kennan reckon they could get sufficient support to scupper the merger. One of the conditions of the trust scheme is for the merger to be put to a vote by Sabana REIT’s minority unitholders at an EGM in October. ESR Cayman, which holds around 20.92% including its stake in Sabana REIT’s manager, and Tong Jinquan who owns 4.98% cannot vote. Under the scheme, more than 50% of unitholders present holding at least 75% of the units need to vote in favour of the resolution for it to pass. The duo have created a website to engage unitholders at www.savesabanareit.com

If the transaction is scuppered, where does that leave Sabana REIT? ESR Cayman owns the manager. Under the S-REIT structure, the manager and sponsor, with a limited holding in the REIT are able to control the REIT. Sabana REIT’s future without the merger would appear less exciting as a relatively small REIT. ESR-REIT would probably revert to its original strategy of AEI, and looking for other opportunities based on the state of the market.

The problem with industrial property in Singapore is the shorter land lease compared to commercial and retail, which is why industrial REITs usually trade a higher yields than retail and commercial REITs. Previously most industrial land had 60 year leases which were changed to 30 year leases. The latest JTC land sales had land tenures of just 20 years. In addition to short land lease, JTC stipulates certain conditions on who can be tenants. Among them are anchor tenants having to lease 70% of the property. Every tenant has to be approved by JTC in terms of business operations that can be satisfied. In addition, an upfront land rent is payable to JTC, and a five year moratorium exists on resale of land or property on JTC land.

Interestingly, Sabana REIT has experienced a tussle before. In 2017, following an extremely dilutive rights issue, and the prospect of acquiring three properties whose valuations were boosted by an unrealistic master lease, a number of minority unitholders led by Jerry Low who painstakingly gathered interest among retail and minority unitholders to requisition an EGM to remove the manager. While that did not materialise during the EGM, the sponsor and manager eventually changed.

Low no longer holds any units in Sabana REIT. “This time round, i really believe all parties are trying to do good for Sabana REIT. I hope they can come to a compromise,” he says.