ESR-REIT - DBS Research 2018-05-21: Supersize Me ~ ESR-REIT & VIT Merging To Form 4th Largest Industrial REIT In Singapore

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ESR-REIT SGX:J91U VIVA INDUSTRIAL TRUST SGX:T8B

ESR REIT - Supersize Me: ESR-REIT & VIT Merging To Form 4th Largest Industrial REIT In Singapore

• ESR-REIT and Viva Industrial Trust moving forward with merger plans via scheme of arrangement; estimated completion in 3Q18. 
• Milestone transaction to boost NPI by c.104%, with pro forma DPU accretion of +5.6%. 
• Immediate savings from refinancing of Viva Industrial Trust’s debt. 
• Combined entity could see further re-rating on liquidity premium.

What’s New 

ESR-REIT, Viva merger process kicks into high gear.

• ESR-REIT and Viva Industrial announced potential merger – a milestone transaction which could transform the enlarged trust into the fourth largest industrial REIT in Singapore, with approximately S$3bn (+79.8%) in assets. 
• According to the announcement, the merger will be effected by way of a trust scheme of arrangement, which would entail: 
  • Consideration of 96 Scts per unit payable to Viva Industrial Trust holders on ex-distribution basis (or implied equity value of c.S$936.7m for Viva Industrial Trust). This represents a c.7.9% premium to Thursday’s close of 89 Scts, market capitalisation of ~S$866.8m 
  • To be satisfied by cash (10%) and issuance of new ESR-REIT units (90%) at 54 Scts per unit. 
• For every 100 Viva Industrial Trust stapled securities held, security holders can expect to receive S$9.60 in cash and 160 new ESR-REIT units. 
• If successful, Viva Industrial Trust will become a wholly-owned sub-trust of ESR-REIT and the enlarged trust will continue to be managed by the ESR-REIT manager. 

Bigger is better; DPU accretion of +5.6%.

• The proposed merger is set to yield immediate benefits to the enlarged trust, with potential synergies to be unlocked over the longer term. 
• Post merger, the enlarged ESR-REIT’s NPI could double alongside the c.40% boost in GFA to 13.6m sqft. On a pro forma basis, the merger could have boosted FY17 DPU by c.5.6% to 4.068 Scts. 
• Apart from immediate quantitative benefits, the acquisition of Viva Industrial Trust’s complementary S$1.3bn high-quality asset portfolio also has several other positive attributes: 
  • Economies of scale across management, marketing and leasing functions. 
  • Immediate access to Viva Industrial Trust’s attractive Business Parks and High-spec tenant sectors, which consistently command the highest rental rates among industrial properties Exposure to Business Parks/High-spec sectors raised from c.29% (including 7000 Ang Mo Kio Avenue 5) to c.46% of the enlarged trust’s portfolio. 
  • Wider geographical coverage across 56 properties aids portfolio diversification and enhances cross-selling opportunities. 
  • Potential unlocking of value from c.495,000 sqft of untapped GFA. 
• We believe that potential synergies will hinge upon the REIT’s ability to extract operational cost savings through having two portfolios in close proximity, allowing the manager to better manage tenancies and potentially extract savings through better negotiations on maintenance contracts going forward.
• In our view, the immediate savings is to refinance Viva Industrial Trust’s cost of debt, which as of 30 December 2017, was c.0.45% (45 basis points) higher than ESR-REIT’s. 

Credit metrics set to improve.

• The REIT manager plans to convert all Viva Industrial Trust debt into unsecured debt and expects the shift towards a 100% unencumbered post-conversion portfolio to help extend debt tenure to 2.5 years (vs 1.6 years) and reduce pro forma debt costs from 3.8% to 3.7%. 
• We estimate that every 0.5% reduction in interest rate will lead to a 2% improvement in the combined ESR-VIVA REIT’s net property income. 
• Merger poised for completion by 3Q18, subject to the following security/unitholder and court approvals: 

Re-rating of 15-20% on the horizon?

• Post merger, the enlarged trust could see further re-rating on the liquidity premium. 
• In our earlier report “Size really matters!”, we noted that investors have historically accorded large-cap REITs (1.36x P/NAV) with premium valuations compared to mid-cap industrial REITs (1.05x P/NAV). Meanwhile, ESR-REIT trades at the lower end of 0.9x P/NAV.
• Upon potential combination of both REITs, we see ESR-VIVA trading higher towards the higher multiples of the larger-cap industrial REITs. Our numbers have not adjusted for the combination but a “pro-forma” scenario have been provided in our earlier report. 
• We currently have a BUY call with a Target Price of S$0.63. 

Derek TAN DBS Vickers | Carmen Tay DBS Vickers | https://www.dbsvickers.com/ 2018-05-21

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