KK is the chief number cruncher at Risk N Returns where he talks to himself about Investing and Personal Finance. He likes a good investment idea as much as a great cup of bubble tea.
2019 has been a year marked by mergers and acquisitions (M&A) in the S-REIT space. Rarely a month goes by without a REIT announcing some form of M&A.
The latest in the long line of M&A this year is Frasers Logistics and Industrial Trust’s (FLT) proposed merger with Frasers Commercial Trust (FCOT) via a Scheme of Arrangement. Should the acquisition get the required approval, FLT will also simultaneously move to acquire the remaining 50% interest in Farnborough Business Park from its Sponsor, Frasers Property Ltd (FPL).
Let’s take a closer look.
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As mentioned, there are 2 parts to the merger:
- FLT’s merger with FCOT
- FLT’s acquisition of the remaining 50% interest in Farnborough Business Park owned by its Sponsor, Frasers Property Ltd.
As part of the merger, FCOT unitholders will receive 1.233 new FLT units per FCOT unit as well as a cash consideration of S$0.151 in cash per FCOT unit.
This means that if you own 1,000 FCOT units, you will receive 1,233 units and S$151 in exchange for your units.
You can see that the transaction is done at close to market value with no premium given to FCOT unitholders.
Also, as part of the merger, the enlarged FLT will also commit to acquiring the remaining 50% interest in Farnborough Business Park from Frasers Property.
Currently, FCOT already holds the other 50% of Farnborough Business Park. As such, post-acquisition, FLT will own 100% of Farnborough Business Park.
The acquisition will be fully funded by debt.
Summary of Operational Changes to FLT
NOTE: FCOT currently pays a base management fee (BMF) of 0.5% p.a. of real estate value and performance fee (PF) of 3.5% of real estate asset income less BMF. This is in contrast with FLT’s fee structure of BMF of 0.4% p.a. of real estate value and PF of 5% of Distributable income less BMF.
FLT adopts a fee structure that is slightly weighted more towards performance fees than FCOT.
The only difference is that FLT takes 92% of its fees in units versus 100% for FCOT for FY2019.
That said, FLT has increasingly taken more of its fees in units over the years to mitigate the decline in DPU due to the weakening AUD.
As such, I expect FLT to converge with FCOT’s 100% fees-in-units structure going forward.
And as such, the difference between the 2 structures is miniscule at best and I do not think there will be much difference in amount of management fees charged for FCOT unitholders going forward.
The merger is expected to close in March – April 2020, with an EGM seeking FLT and FCOT unitholders’ approval expected to be conducted in February – March 2020.
Pro-Forma Impact on REIT Metrics
Firstly, to understand if this merger is beneficial to investors, we have to examine the changes in REIT metrics.
Before I begin, I’ll like to state my key assumptions, which has led to some recomputation of figures:
- The amount available for distribution for FLT is translated at S$1 : A$0.9632, the hedged exchange rate for FY2019 used by FLT.
For a more accurate forward DPU computation, I’ve used the ending exchange rate of S$1: A$0.9307 to translate the amount available for distribution instead.
- I’ve used the ending number of FLT units to compute forward DPU, instead of weighted average number of FLT units as used in the announcement, for a more accurate forward yield.
FLT has had a ton of acquisitions and divestments during FY2019. As result, it may not be very useful to use the full year figures to estimate DPU of the current entity and combined entity going forward.
However, without much information to normalise FLT’s figures, I’ll have to make do with the figures disclosed as part of the merger announcement.
|Metrics||FLT (Pre-Merger)||FLT (Post-merger)||FLT (Post-Acquisition)|
|WA Lease Expiry (WALE)||6.3 years||5.8 years||5.8 years3|
|WA Cost of Debt||2.2%||2.6%2||2.6%2|
|Net Asset Value (NAV) (‘000)||$2,154,0002||$3,538,000||$3,540,000|
|Forward Distributable Income||$157,500,104||$236,733,285||$241,564,576|
|Units Outstanding (‘000)||2,259,273||3,393,631||3,394,251|
|NAV per unit||$0.95||$1.04||$1.04|
1Adjusted for completion of German portfolio acquisition as if it were completed on 30 Sep 19
2Implied based on assumptions used in the announcement
3Rough estimation as not disclosed
For most operational and capital management metrics, the merger has nothing much for FLT investors to shout about. In some cases, these metrics deteriorate.
Where the merger shines is in the valuation metrics, with some NAV and DPU accretion as a result of using premium-valued FLT units to exchange for fairly valued FCOT units.
(Let’s repeat the same exercise for FCOT)
FCOT has had a relatively uneventful year in the M&A space with no acquisitions or divestments to speak of.
As such, it is probably ok to use the full year results directly for comparison.
|Metrics||FCOT (Pre-Merger)||FLT (Post-merger)||FLT (Post-Acquisition)|
|WA Lease Expiry (WALE)||4.9 years||5.8 years||5.8 years3|
|WA Cost of Debt||3.0%||2.6%1||2.6%1|
|Net Asset Value (NAV) (‘000)||$1,481,493||$4,793,2822||$4,795,9922|
|Forward Distributable Income||$86,906,000||$320,726,2552||$327,271,6882|
|Units Outstanding (‘000)||909,236||3,393,631||3,394,251|
|NAV per unit||$1.63||$1.412||$1.412|
1Implied based on assumptions used in the announcement
2Figures adjusted by a multiple of 1.233 and assumes reinvestment of cash consideration at $1.24 to improve comparability.
3Rough estimation as not disclosed
FCOT’s investors can be happy with the improvement in most operational metrics.
But what really hurts is that NAV per unit experiences a decline as part of the deal. This shortfall arises even after accounting for the $0.151 of cash per FCOT unit.
There is mild DPU accretion as a result of the Farnborough Business Park acquisition. This is probably why the acquisition is bundled with the merger to make the merger more palatable to FCOT investors.
It is interesting to note that the FCOT announcement omitted disclosing about the NAV impact. (Only show the good stuff I guess.)
Pros and Cons for Investors
Based on our earlier findings, let’s examine the pros and cons of this acquisition for respective investors.
|Greater geographical and portfolio diversification||Dilution in quality as FCOT does not have the same quality in assets as FLT|
|Potential “synergies”, cost reductions and development opportunities arising from greater size||Little improvement in operational and capital management metrics post-merger|
|Potential FCOT improvement in operational performance now that its properties are now at 95% committed occupancy versus 80+% in the past|
|NAV and DPU accretive M&A|
|Greater geographical and portfolio diversification||Significant dilution in NAV|
|Potential “synergies”, cost reductions and development opportunities arising from greater size|
|Improvement in overall quality of the REIT|
Potential Strategies for Investors
Given the merger’s pros and cons, I’m sure investors would like to know how they should proceed with this acquisition. Here are some potential strategies off the top of my head for your consideration if you belong to the following groups of investors:
Existing FLT Investors
As an existing FLT investor myself, I’m indifferent to this acquisition as there is little change in the REIT’s operational and capital management metrics.
I’m happy with the potential upside from having a larger portfolio under management, as well as the potential synergies that may arise from the acquisition. On the flipside, I’m a little annoyed by the dilution of quality of the portfolio.
As such, I think most FLT investors will choose to stay put in their investment.
Existing FCOT Investors
For existing FCOT Investors, the dilution in NAV may be sufficient to warrant selling your units.
If you are still interested in owning the enlarged REIT, you might be better off selling your units and rotating into FLT. This can help you avoid odd lots as well.
New investors Looking to Own FLT
New investors interested in owning FLT should look for arbitrage opportunities going forward as the share price of FLT and FCOT should theoretically trade in lock step going forward in accordance with the following formula:
FCOT Price = 1.233 x FLT Price + $0.151
If any large deviation (my personal threshold is >3%) between FLT’s and FCOT’s share price arises, simply buy the comparatively cheaper counter.
Alternatively, given the NAV dilution that FCOT investors will experience as a result of the merger, it might be easier to simply buy FLT at your desired price.
Overall, the merger of FCOT and FLT seems to be a “Merger of Unequals”, with FLT investors benefiting more from a valuation standpoint.
From a pure metrics point of view, both sets of investors have areas where they can be happy and disappointed about.
Personally, I feel that the merger’s main benefits will only be derived from the potential for cost savings and diversification from having a larger portfolio, something that is unquantifiable at this time.
And as an existing FLT investor, I’ll probably hold on to my units going into the merger. FCOT investors will have some things to think about going forward …
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KK is the chief number cruncher at Risk N Returns (https://risknreturns.com/) where he talks to himself about Investing and Personal Finance. He likes a good investment idea as much as a great cup of bubble tea.