by: Tam Ging Wien
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Ascendas REIT (A17U.SI) or A-REIT for short, closed the week at $3.17 on Thursday just before a trading halt kicked in on Friday morning (01-Nov-2019). A-REIT announced that it would propose to acquire a total of 30 business park assets from its parent CapitaLand Ltd (CapLand) for a total of S$1.66bil (US$1.22bil).
The properties comprise of 28 freehold offices located across six business parks in San Diego, California (8 properties), Raleigh, North Carolina (5 properties), and Portland, Oregon (15 properties), in the U.S. for a purchase consideration of S$1,285.3mil (US$937.6mil). The remaining two properties are located in Singapore, namely Nucleos and FM Global Center – for an acquisition price of S$289mil and S$91mil, respectively.
As a result of this deal, CapLand expects to realise an estimated gain of around S$95.4mil from the transaction.
The proposed acquisition will be funded with a 100-for-16 renounceable rights issue with units issued at S$2.63 apiece. The issue price represents a 17% discount to the last traded price of S$3.17 or 15% discount to the theoretical rights issue price (TERP) of S$3.0955. This is expected to raise about S$1.31bil with the remaining amount to be funded by debt. This represents approximately 76% of the purchase consideration funded by equity while the remaining 21% will be funded by debt.
The trading halt was only lifted after trading hours on Friday evening.
Source: Ascendas REIT
Source: Ascendas REIT
The combination of acquisition and the rights issue will result in DPU and NAV per Unit accretive, though only so slightly at just 0.63% and 3.29% respectively. DPU yield is expected to increase from 5.06% to 5.21%, a 3% increase.
We always prefer that our REITs would have a DPU accretive acquisition rather than just Yield accretive. If you are not sure what the difference is, make sure you check out our previous article:
Due to a large part of the deal being funded by equity, the gearing is expected to fall from 36.3% to 34.6%.
Most rights issues are usually DPU dilutive owning to the steeper discounts and higher number of units issued. However, in A-REITs case, they are among the rare S-REIT rights issue that still managed to achieve an accretion despite a 16% increase in units sold at a 17% discount. This is likely due to its very rich valuation of 1.49x book value which lowers its cost of equity. At the issue price of S$2.63, unitholders will still be purchasing the shares at 1.23x book value. After all, it would only make sense to acquire assets using the lower cost of funding – if cost if equity is lower, why not maximize it and reduce gearing?
Source: Ascendas REIT
ProButterfly.com covered four S-REIT acquisitions recently, if you have not had a chance to read them, do head over to the following articles:
Most of the recent S-REIT acquisitions were funded by a combination of private placements and/or preferential offerings and a higher debt component. The discounts offered where significantly less which allowed A-REIT’s peers to raise significantly more without diluting too much. This allowed them to achieve much higher DPU accretion.
But why did A-REIT choose to use a rights issue rather than a combination of private placements and preferential offerings with a larger debt component? While I can appreciate that the other S-REITs where not looking to raise such a large sum of money, but MCT’s private placement and preferential offering at S$902.3mil wasn’t small either compared to A-REIT’s S$1.31bil.
We think that the reason is likely because A-REIT and CapLand really wanted to maximize the use of equity to bring down gearing as well as guarantee that the acquisition will be successful and not be derailed due to fund raising issues.
The rights issue proposed by A-REIT is fully underwritten by DBS Bank and J.P. Morgan in the proportion of 50.0% and 50.0% respectively. This means that should the rights issue not be fully taken up; both the banks would need to take up the remaining rights in equal proportion ensuring that A-REIT will always obtain the target fund raising. Pricing the rights at a steeper discount also increases the chances that most shareholders will bite. MCT on the other hand used a private placement and preferential offering that is not underwritten by any financial institution.
Ensuring a higher proportion of funds using equity would bring gearing down from 36.3% to 34.6%. In addition, instead of giving a high DPU accretion upfront, A-REIT narrowed the accretion factor and instead rely on the long triple-net-leases with an annual 2.5% - 4.0% escalation naturally do its work in the coming years. On the enlarged asset under management (AUM), A-REIT would very easily be able to drawdown on its line of credit to acquire time-sensitive opportunistic assets in the future.
But why? Why offices and business parks in the US? These are not exactly industrial assets and A-REIT is more well known for being an industrial property landlord than a business space landlord. The addition of more business park space would increase its exposure to the sub-sector from 33% to 42%. While we acknowledge that the assets are in a different geography, we would actually prefer A-REIT to acquire longer term WALE specialized industrial and logistics assets with sticky tenants.
Source: Ascendas REIT
Source: Ascendas REIT
Looking at the top-10 tenant base that make up approximately 52% of the rental income of the US properties, we can see that they are well-known names with 2/3 of them having investment grade credit ratings. The tenant base is also fairly diversified across the various industrial sectors.
Source: Ascendas REIT
The tenant base also has a reasonably long WALE of 4.2 years and a well-spread out lease expiry profile. Although the assets were acquired at a fairly low cap rate of 6.0%, we do like the fact that the maajority triple net lease with 2.5% - 4.0% annual escalation ensuring a good and predictable organic growth for the next few years.
Source: Ascendas REIT
We used to hold a much larger portion of A-REIT in the past, but we have been gradually reducing our portfolio exposure to A-REIT as we choose to lock-in profits as its share price rose over 2019. Approximately 75% of our exposure to A-REIT has been sold this year.
With this discounted rights issue, it could be an opportunity for us to increase our exposure to A-REIT at a lower price. We expect that there is a possibility that share price for A-REIT is likely to trade downwards during at the market open on Monday. Using the theoretical ex-right price (TERP) provided by A-REIT’s rights issue announcement document at S$3.0955 per share and using a hypothetical example of 10,000 A-REIT shares, let us illustrate our strategy.
This hypothetical example does not take into account transaction cost in order to simplify the illustration. We also do not assume any knowledge of the original cost of the investor acquiring the initial exposure of 10,000 units.
Let’s assume that our current hypothetical portfolio of 10,000 units in A-REIT has 10,000 units and unit prices of A-REIT fall on Monday to the TERP price of S$3.0955. Below are a list of steps that we could take:
As illustrated in the table above, in the event that we sell our extra units at the same price as what we acquired it at (our example uses TERP of $3.0955 as the guide entry price), we would be able to marginally benefit from the increase exposure. In real life, this benefit would probably be negated somewhat by the transaction cost.
If, however months from now after we obtain our additional shares, but the market price fell a further 10c (or 3.2%) which is quite likely, we would be sitting on losses of about 3.8% not considering the transaction cost. In the worse-case scenario, certain news rattles the broader markets or perhaps specific news hits A-REIT unexpectedly, we could see more than a 10c fall in the share price.
In a good-case scenario, we manage to sell our additional units at the current market price, we would benefit by gaining about 6.3% by lowering our total cost of ownership per unit. We think there is a possibility that the share price for A-REIT could gain ground and rise back to pre-rights prices in the short term (i.e. 3 to 6 months’ time post-rights listing) for this scenario to play out.
Using the strategy above, we could potentially increase our exposure to A-REIT by 32% at the same time reduce out total cost per unit by 6.28% in the good-case scenario. In the bes- case scenario, A-REIT will surpass the current market highs.
Though strategy is somewhat complicated, it is only possible because of a combination of factors that make this acquisition unique and not usually present in other acquisitions:
Most other acquisitions do not provide a sufficient margin of discount for this complicated strategy to be worthwhile or too dilutive that the share price is unlikely to recover to pre-rights market prices.
It is of course not fool-proof, one could still loose money if the share price moves against you. There is also a chance that the share price on Monday does not fall to the TERP level or lower to enter safely.
[2019-11-04 1:25pm Added:
The share price for A-REIT held steady on Monday morning, we will be update the theoretical scenarios above to reflect a theoretical entry of $3.17
We added the scenario above where an investor would hypothetically buy in the open market at the current price of $3.17 and selling it in the future at a 10c loss or 5c gain.]
[2019-11-04 5:30pm Added:
The share price for A-REIT fell to a low of $3.10 touching the TERP in our original assumptions before the start of the trading date. It closed after a brief recovery to $3.12.
We added the scenario above where an investor would hypothetically buy in the open market at the close price of $3.12 and selling it in the future at a 10c loss or 5c gain.]
Certainly, this strategy is not for everyone and required a little bit of trading skills as well as market monitoring. Markets can be unpredictable and in our current day and age, a single tweat could completely move markets for or against you.
For those uncomfortable in executing such a complex trade should simply stay away from it invest for the long term instead.
We could of course simply just buy additional rights from the open market at a price and exercise them. But this strategy is not assured as we do not know how many units we could get from the open market.
Also, the spread of the units on the fairly illiquid rights market is difficult to predict. In prior rights issue, due to the dilutive nature of the rights, there are sellers who sell away their rights to exercise, however in this case due to the accretive nature of the rights issue, we think that more unitholders are likely to keep the rights and exercise them.
There is no guarantee that we can get the number of rights we want at the right price that we want it. Therefore, we developed the strategy that we described above.
As the rights market become available, we could further increase our exposure through the purchase of additional rights later for exercise. So we see this more as augmenting the strategy rather than a completely different strategy.
We generally think that Ascendas REIT’s foray into the US is an interesting one. We like the quality of the assets, tenants and exposure to a new geographic sector. We also like that fact that majority of the leases are triple-net with long leases and built-in rental escalations giving a steady growth in the coming years. The downside is that the assets are acquired as a fairly low cap rate.
After this acquisition, we hope that in the future, A-REIT would to increase exposure to specialised industrials and logistics assets more than business parks – keeping in line what A-REIT is better known for.
Calling for a rights issue instead of the usual private placement and preferential offering route tells us that A-REIT and CapLand really want to ensure that the target equity financing is raised to complete the acquisition. As a result, due to the larger dilution and lower issue price, the DPU accretion is much less than its peers.
For advance investors and traders however, we could turnaround the situation by taking a tactical bet of increasing our exposure to A-REIT at the rights issue price. The strategy is somewhat complicated and certainly not risk free. But in this specific case, it is only possible because of a combination of factors that make this acquisition unique:
Overall, we are still excited to know that S-REITs have managed to make their rights issues immediately DPU and NAV per Unit accretive.
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