Thoughts on the Ascott REIT and Ascendas-HT Merger

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.

The merger creates an enlarged portfolio of 88 properties with more than 16,000 units in 39 cities and 15 countries across Asia-Pacific, Europe and the US.

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.

Should the proposal complete, A-HTrust will be delisted following the merger.

The proposed deal is expected to be DPU accretive on a historical pro forma basis for both Ascott Reit unitholders and A-HTrust stapled unitholders. The pro forma DPU for Ascott Reit would have increased to 7.34 Singapore cents, up 2.5 per cent from 7.16 Singapore cents, and the DPU for A-HTrust would have increased to 6.14 Singapore cents, up 1.8 per cent from 6.03 Singapore cents.

Let’s discuss whats going through our minds.

How Can DPU be Accretive to Both Unitholders?

When 2 bodies are merged, the merges entity will always be somewhere in between of the 2. Just like pouring an equal amount of 80° water and 30° water, the resulting combined body of water will be somewhere in between 30° and 80°. Therefore, from the perspective of on body, the temperature has risen and from the other perspective, the temperature would have dropped.

Similarly, how can a merged entity be DPU accretive both ways? One should have a net DPU increase while the other should have a net DPU decrease. In the most optimal way possible, both entities would at least maintain their DPUs.

We worked out based on our understanding of the deal, what is the net result from the perspective of the Ascott unitholder and the A-HTrust stapled security holder.


Source: REITScreener ResearchProButterfly Research

We observe that the NAV would be boosted by 38.7% while the number of units would be boosted by 41.5%. The DPU on the other hand is expected to increase 2.5% according to the pro forma results. It would be clear therefore that this deal is DPU but slightly NAV per Unit dilutive to existing Ascott unitholders. The gearing is expected to remain someone stable.


Source: REITScreener ResearchProButterfly Research

On the other hand, when viewed through the lens of the A-HTrust stapled unitholders, the units have increase faster than the NAV accretion while the DPU would have fallen after accounting for the 0.7942 exchange rate. This will result in the deal being dilutive for the A-HTrust stapled unitholders as they would experience a fall in both the DPU and the NAV per Unit. Gearing on the other hand would seem to increase slightly from 33.2% to 36.2% based on our estimates.

We think that the partial cash deal of 5.43c per unit will compensate for the decline in the DPU and should also provide enough time for the entity to grow organically to more than make up for the decline.

Overall, we think that the deal has been structured fairly balanced for both Ascott unitholders and A-HTrust stapled unitholders.

However, it still doesn’t explain our very first thought, how can both entities after merging could possibly result in a DPU accretive deal? After the digging around, we finally found our answer. The trick was in the structuring of the deal and the assumptions behind the calculations. We list out the key assumptions as extracted from the announcement from the A-HTrust stapled unitholders perspective:

  • The combined entity Ascott REIT-BT would adjust to a 100% payout instead of the current 90% practices by the A-HTrust (including S$5.1mil that was retained which is assumed to be distributed)
  • Assuming the Cash Consideration is reinvested in the combined entity Ascott REIT-BT at the issue price of S$1.30 per Ascott Reit-BT Stapled Unit

Ah! So, this is where the slight of hand is, the deal is setup to extract a higher payout ratio from the A-HTrust side by raising the payout ratio from 90% to 100%.

But raising the payout ratio alone isn’t enough to create the DPU accretion, so they make another assumption that A-HTrust stapled securityholders will reinvest the cash portion received to gain a higher DPU. Is this assumption fair would the majority of the shareholders take the funds and buy into the enlarged entity or will most just take the money? I suspect the later is more likely, and this may not necessarily be a valid assumption for most. It also assumes that the reinvestment I made at a price of $1.30, therefore reinvesting it at a lower price may actually favour the investors. Take note also this assumption has not taken into account brokerage fees that an investor needs to incur to reinvest this component.

Our concluding thoughts on this matter is that the differential figures and are actually not very significant and if the combined entity simply continues growing organically the gap will close very quickly. Hence, we see this as a negligible effect and would consider the deal structured in a very balance manner for both Ascott and A-HTrust unitholders.

Note: Here is a note to those sharp eagle-eye’s readers, for those you noticed that our calculations resulted in a NAV per Unit of $1.21 instead of the $1.22 value in the announcement. This is because we have specially accounted for the S$22.5mil transaction cost that would be need to be incurred as a result of this deal. Therefore in reality, there is a slight dilutive slippage in the NAV per Unit due to merger cost.

Was the Acquisition Opportunistically Timed?

The acquisition was a part cash and part equity funded with a ratio of 5-to-95 with the equity cost at S$1.30 per Ascott unit.

Comparing that Ascott’s units over the last 5 years traded between in a narrow range from a low of $1.02 to a high of $1.31. The high of $1.31 was achieved in mid-June just prior to the announcement at a P/B Ratio 1.05.

A-HTrust also hadn’t progress much in the last 5 years either – trading in a narrow range of 60c to 98c prior to the announcement at a P/B Ratio of 0.9640. The stock traded up to $1.04 immediately following the announcement pushing the P/B Ratio up to 1.0230.

Coincidentally, the timing was also such that this was the first trust merger within the enlarged CapitaLand merger.

Based on the 2 factors above, we think that this is likely an opportunistic move to quickly capitalize on the high Ascott valuation relative to the lower valuation of A-HTrust recently during this REIT rally season. This move is both good for Ascott unitholders who gain DPU accretion and benefits of an enlarged trust while A-HTrust unitholders benefit by realizing increased valuation of their holdings.

Big is Beautiful – Scale Matters

When it comes to REITs, we are on the view that scale really does matter. Larger REITs come with the advantage of:

  • Consolidating operations to achieve economies of scale which lowers the overall expenses of the REIT
  • Larger debt profile and are therefore able to negotiate better interest rates with lenders resulting in lower interest cost
  • Larger REITs are better able to utilize debt funding more effectively compared to smaller REITs potentially lowering dilutive effects on unitholders
  • Larger marketcap REITs with branded sponsors backing are generally larger free market float and more liquid allowing more institutional support

This is no different for this merger and we think that the enlarged Ascott REIT-BT will certainly bring about the benefits listed above.

Specially for this deal between Ascott and A-HTrust, here are some highlights from the presentation slides on the benefits of this deal which are self-explanatory. We list them here for would be readers to be aware of.


Source: Ascott REIT Presentation Slides


Source: Ascott REIT Presentation Slides


Source: Ascott REIT Presentation Slides

We think that the rest of the Singapore S-REIT market is also poised for further consolidation especially in the industrial space.

Large Sponsor-Unitholder Alignment of Interest


Source: Ascott REIT Presentation Slides

As a result of the deal, the sponsor CapitaLand is expected to hold a 40.2% interest in the enlarged Ascott REIT-BT entity. We think that this shows a very high alignment of interest between unitholders and the sponsor.

Conclusion

After reviewing this merger, we think that CapitaLand has structured a fairly well-balanced deal for unitholders on both sides of the equation. Existing Ascott REIT unitholders would benefit from a larger trust with DPU accretion while A-HTrust unitholders stand to realize increased value from their current holdings.

We believe that big is certainly beautiful in the REIT and Trust sectors giving the enlarged entity a much greater following, institutional interest, negotiation leverage and economies of scale. We think that other mergers will likely follow within the S-REIT space. The industrial sector is particularly worth watching.

It is also comforting to know that there is significant alignment of interest between unitholders of the enlarged entity with CapitaLand the sponsor.

In conclusion, we like the deal we think that existing unitholders have much to gain from it looking at CapitaLand’s longer-term strategic direction for trust in the coming years.

 

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