ESR-REIT - CGS-CIMB 2018-05-18: History In The Making

ESR-REIT - CGS-CIMB 2018-05-18: History In The Making ESR-REIT SGX: J91U

ESR-REIT - History In The Making

  • ESR-REIT has proposed a merger with Viva Industrial Trust (VIT) by way of a trust scheme arrangement. If it goes through, this would be the first M&A in S-REIT history.
  • On balance, we like the merger as it is DPU-accretive for ESR-REIT’s unitholders. With a larger AUM, ESR-REIT could also potentially re-rate and enjoy lower borrowing costs.
  • We maintain our ADD call with an unchanged DDM-based Target Price (S$0.60).

History in the making

  • The proposed merger with Viva Industrial Trust (VIT) marks a milestone as it would be the first M&A in S-REIT history. The scheme consideration payable to VIT stapled security-holders is S$0.96 per stapled security on an ex-distribution basis (implying an equity value of c.S$937m for VIT). 
  • The consideration will be satisfied via 10% cash and 90% through the issuance of new ESR-REIT’s units, implying an exchange ratio of 1.778x.
  • Post-merger, ESR-REIT would potentially be the fourth largest industrial S-REIT with S$3bn AUM and potential market cap of c.S$1.7bn. ESR-REIT manager will be the manager of the combined entity. Accordingly, sponsor ESR would acquire VREIT manager and property manager for a total of S$62m cash. In addition, key management of VIT manager will be joining ESR-REIT manager.
  • Acknowledging that the consolidation of managers is also a critical bottleneck for REIT mergers, we view the above manager arrangements favourably (especially from an acquiree perspective). Such arrangements could help to pave the way for future REIT M&As. 
  • Post-consolidation, ESR will hold 67.3% in the manager; Mr Tong Jinquan (holds c.50% in VIT) will hold 25% and Mitsui will hold 7.7%.
  • Viva Industrial Trust (VIT) is a Singapore-focused business park and industrial REIT. It has nine properties with an AUM (assets under management) of c.S$1.3bn. We consider UE BizHub EAST and Viva Business Park to be the jewels in the group’s crown (c.67% of AUM).

Benefits of the merger

  • From ESR-REIT’s perspective, a larger AUM could re-rate the REIT. We observe that bigger-cap REITs tend to trade at a premium against their smaller-cap peers.
  • Secondly, the merger will result in the conversion of all of Viva Industrial Trust’s secured debt into unsecured debt. There could be further borrowing costs savings with a larger AUM.
  • Thirdly, ESR-REIT would gain immediate access to high-tech, R&D and high value-added tenant sectors through higher business park exposure. Post-merger, business parks would account for 30% of ESR-REIT’s AUM.
  • Fourthly, the manager estimates a 5.6% accretion to FY17 pro forma DPU.

Potential pitfalls of the target REIT

  • We note that Viva Industrial Trust (VIT)’s earnings could peak in FY18F as income support for UE BizHub East expires in Nov 2018. This is partially mitigated by higher contributions from Viva Business Park (VBP) due to the maximisation of “white” space. 
  • While ESR-REIT is acquiring VIT at an implied 1.26x P/BV, the counter-argument is that value could be unlocked if underlying land lease at VBP is extended.
  • We view potential multi-tenanted building (MTB) conversion risks as c.40% of VIT’s AUM is on single-tenanted/master leases.

Maintain ADD

  • The M&A is expected to be completed by 3Q18. During this process, an EGM is scheduled to be held in Sep. 
  • Unitholders’ approvals are required for the
    1. merger,
    2. issuance of new units (for the merger) and a
    3. whitewash waiver.
    This is because post-merger, Mr Tong Jinquan’s interest in ESR-REIT will increase to more than 30%. Mr Tong and ESR are required to abstain from voting in these approvals. 
  • Pending the completion of the merger, we keep our estimates and DDM-based Target Price.
  • We like the merger given the
    1. DPU-accretion,
    2. potential re-rating effect from a larger AUM, and
    3. potential lower borrowing costs.
  • In essence, ESR-REIT would be the largest non-GLC (government-linked company) industrial S-REIT.
  • Downside risks include higher rate hikes, unfavourable acquisitions and challenging industrials market.

YEO Zhi Bin CGS-CIMB | LOCK Mun Yee CGS-CIMB | https://research.itradecimb.com/ 2018-05-18
SGX Stock Analyst Report ADD Maintain ADD 0.600 Same 0.600