Arbitraging Strategy on the OUE Commercial and Hospitality Trust Merger

by: Tam Ging Wien

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This is an unusually short post for ProButterfly, but we thought that many investors and traders might be interested in looking at an arbitrage strategy.

Just 2 days ago, we posted our thoughts on the OUE Commercial REIT (OUE C-REIT) and OUE Hospitality Trust (OUE H-Trust) proposed merger.

For the uninitiated, OUE Commercial REIT (OUE C-REIT) and OUE Hospitality Trust (OUE H-Trust) are proposing to merge in a cash and stock deal where OUE C- REIT will acquire OUE H-Trust by paying OUE H-Trust unitholders, $0.04075 in cash plus 1.3583 new OUE C-REIT units. Per 1,000 units of OUE H-Trust, unitholders shall receive $40.75 and 1,358 new OUE C-REIT units.

Source: OUE Commercial REIT and OUE Hospitality Trust Joint Announcement

As a result, almost 2.5bil new OUE C-REIT units will be created as part of this deal. OUE H-Trust will be delisted after the merger. Parent company OUE Group will continue to retain a 48.3% in the enlarged REIT.

The enlarged entity will be among the largest diversified S-REITs with total assets valued at close to S$6.8bil.

Source: OUE Commercial REIT and OUE Hospitality Trust Joint Announcement

Playing an Arbitrage

For those who are trying to play an arbitrage game to buy OUE H-Trust to gain from the conversion to OUE C-REIT, here are some figures for you to review based on Wednesday (17-Apr-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:

  • OUE HT $0.72 X 10,000 = $7,200.00
  • Cash back $0.04075 X 10,000 = $407.50

This means that an investor would pay $7,200.00-$407.50 = $6,792.50 for 13,583 units in OUE C-REIT. In other words, an investor who manages to purchase OUE H-Trust at the price of $0.72 is effectively paying $0.500 per OUE C-REIT unit upon conversion.

As the current price of OUE C-REIT on the open market is now $0.51, an investor using an arbitrage strategy stands to gain 1.00c per OUE C-REIT. In the example of 10,000 units of OUE H-Trust (which converts to 13,583 units in OUE C-REIT), the investor could reap $135.83 at the cost of $6,792.50 or 2.00%. Of course, if an investor is able to obtain the units in OUE H-Trust lower than 72c, their arbitrage profit would be higher.

For this deal to go through, the management would need to seek shareholder approval which required the convene of an Extraordinary General Meeting (EGM). Assuming the resolutions are approved, it will take few more months to complete the deal. All in all we estimate this could be between 4 to 6 months.

Given that it could be as long as 4 to 6 months wait, we think that a 2.00% is not worth our funds being locked up for so long and risk uncertainty and price fluctuations which could eliminate the profits.

For more sophisticated investors, if the arbitrage opportunity widens, perhaps you might want to consider a strategy.

Personally for us, we are neither investors in OUE C-REIT, OUE H-Trust or would attempt the arbitrage as these prices.

Is it safe?

There is no such thing as a risk free arbitrage.

There is a small possibility that 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.

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 are should calculate the cost of their transaction fees before proceeding as exceedingly high fees could potentially nullify any profits from the arbitrage.

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 sufficient shareholder approval), a highly leveraged investor may potentially end up in losses exceeding the initial capital.

When deciding to take such an arbitrage opportunity, there is also cost associated with the opportunity - in other words, Opportunity Cost. 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. Given that our calculations above (excluding transaction cost) comes up to a 2.00% yield in 4 to 6 months, on an annualised basis, this would give a profit of 4.00% to 6.00%. If an investor had instead deployed this capital into other investments (REITs included!) yielding at least 6.00% or more, the investor would have been better off. Hence, this opportunity must be seen from the lens of an investor who have excess cash but unable to deploy it for other better opportunities.

Concluding Remarks

Arbitrages opportunities in the market is not a new phenomenon. It occurs all the time as the market is imperfect. 

A similar arbitrage opportunity appeared during the ESR-REIT and Viva Industrial Trust merger.

However, the spread of the arbitrage is usually small, necessitating a large transactional volume or high leverage transaction to make a meaningful profit. This requires precision calculations to guarantee a profit.

Our personal view is that at the current price of 72c for OUE H-Trust, the 2.00% yield over the next 4 to 6 months in insufficient to entice us to take this arbitrage opportunities as we have better yielding investments to deploy our capital.

However, if the market suddenly shows a favorable arbitrage spread, we may consider.  

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We are hosting our next new and refreshed The Essentials of REIT Investing seminar on the 11th March 2020 (Wed) from 7pm to 10pm at the Maybank Kim Eng Event Hall (Level 3), 50 North Canal Road, Singapore 059304

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