by: Tam Ging Wien
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CapitaLand made a join announcement together with its hospitality trust – Ascott REIT (Ascott) and Ascendas Hospitality Trust (A-HTrust) in a join proposal to combine both trust and establish the largest hospitality trust in the Asia-Pacific. The combined asset value of both trusts is approximately S$7.6bil and will form the eighth largest hospitality trust in the world.
This comes shortly after market rumours that the enlarged CapitaLand would follow through by combining its REITs and trusts entities shortly after the completion CapitaLand and Ascendas-Singbridge merger. Earlier in April 2019, activist fund manager - Quarz Capital Management publicly proposed the merger in order to increase its value and optimize its size.
Based on the details of the announcement, Ascott will acquire all A-HTrust units for S$1.0868 per unit, comprising S$0.0543 in cash and 0.7942 Ascott REIT-BT units issued at a price of S$1.30.
The total consideration for the combination is S$1.24 billion ($915 million), comprising S$61.8 million ($45.6 million) in cash and 902.8 million units of Ascott Reit-BT Stapled Units, according to the statement.
For more details on our thoughts surrounding this deal, do Thoughts on the Ascott REIT and Ascendas-HT Merger where we discuss the following points:
For those who are trying to play an arbitrage game to buy A-HTrust units to gain from the conversion to Ascott REIT-BT, here are some figures for you to review based on Wednesday’s closing prices (17-Jul-2019 closing price).
Please note that readers should adjust the market prices based on individuals purchase prices. Our example uses 10,000 units and ignored the transaction cost:
This means that an investor would pay $10,400.00-$543.00 = $9,857.00 for 10,000 units of A-HTrust. Upon completion of this deal, these units will be converted to 7940 units in Ascott REIT-BT. In other words, an investor who manages to purchase A-HTrust at the price of $1.04 is effectively paying $1.24 per Ascott REIT-BT unit upon conversion.
As the current price of Ascott REIT on the open market is now $1.30, buying the Ascott REIT shares right now will entitle the unitholder to convert on a one-to-one basis the to the enlarged Ascott REIT-BT entity. Therefore, by buying through A-HTrust and applying the arbitrage strategy, an investor stands to gain 6c per Ascott REIT-BT unit. That’s about 4.84% discount to the current price, not too bad at all!
In the example of 10,000 units of A-HTrust (which converts to 7940 units in Ascott REIT-BT), the investor could reap $476.40 in value at the cost of $9,857.00. Naturally, investors who are able to obtain the units in A-HTrust lower than $1.04 or Ascott REIT-BT’s share price appreciates higher than $1.30 after the deal, their arbitrage profit would be higher.
For the investors that had bought units in A-HTrust at the closing price of $0.98 just the day before the announcement – at the completion of the deal, they would have theoretically profited $985.60 or about 10%!
There is no such thing as a risk-free arbitrage, however at the current price of $1.04 per unit of A-HTrust, an arbitrage margin of 4.84% is still pretty decent.
However, investors attempting this strategy will have to take note of various risk, we highlight some non-exhaustive risk here:
Note that, there is always a risk the deal may fall through, or the terms of the deal changes sometime in the future. If such a scenario occurs, then the market prices of both REITs could potentially change resulting is capital losses for the investor. Personally, our view of this risk is unlikely as CapitaLand has initiated the merger and has significant influence and vested interest to see it through.
Some more sophisticated investors may choose to use leverage in order to boost the arbitrage returns with the same amount of capital. While in theory this is possible, leverage always cuts both ways. In the event of an unexpected scenario (e.g. deal failed to secure enough shareholder approval), a highly leveraged investor may potentially end up in losses exceeding the initial capital.
Remember to consider the opportunity cost in attempting this strategy. The funds that will be locked up while waiting for this deal to conclude could have also been put into other REITs which may yield a higher return.
Another factor that was not discussed in the above scenario is the transaction fees. It is quite possible depending on the type of trading account used that the fee incurred is small enough to maximize profit. Would be arbitragers should calculate the cost of their transaction fees as this could cut into the profits.
There was a similar arbitrage opportunity that happened during the OUE Commercial and Hospitality Trust Merger back in April 2019. At that time, the arbitrage difference was only 2.00%. The Ascott-AscendasHT deal works out to be a much more significant difference of 4.84% at the present moment.
We think that this gap is likely to close as time progresses and as more information and news of the confirmation of the deal reaches the market.
At this moment, an arbitrage opportunity exists where investors are able to take advantage of purchasing shares in A-HTrust and gain from the conversion to Ascott REIT-BT shares later when the deal completes.
This however comes with risk as the funds would need to be locked up for at least a 6 month period.
Would be investors who are also interested in investing in the greater Ascott REIT-BT entity could consider this method to acquire Ascott REIT-BT shares at a 4.84% discount to market currently.
Of course, market prices could change in the future, who knows, Ascott REIT’s price could still fall below the cost price of $1.24 in the next 6 months. Investors should proceed using this strategy with full knowledge of the risk involved.
We doubt the current difference of 4.84% will remain for too long and the differential is likely to narrow going forward.
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