EREIT/ALOG merger EGM on 21 Mar 2022
? Aside from the usual merger benefits, the proposed EREIT-ALOG merger is crucial to avoid conflicts of interest that could derail the growth of both REITs.
? We see more merits from the REITS merging than on a standalone basis.
? Reiterate Add on ALOG, EREIT. Both REITs are trading at 6-7% DPU yields.
ESR REIT-ALOG merger EGM set on 21 Mar 2022
The EGM for the EREIT-ALOG merger has been set on 21 Mar 2022. Based on the revised
offer, EREIT is offering S$0.97 per ALOG unit (10% cash and 90% units), which values
ALOG at 1.45x P/NAV (based on an issue price of S$0.49). Based on EREIT’s current
price of S$0.42, EREIT is still valuing ALOG at S$0.84, or 1.26x P/NAV, above ALOG’s 5-
year historical, 1-year historical and current P/NAVs of 1.12x, 1.26x or 1.2x respectively.
For the merger to go through, EREIT requires >50% of the total number of votes cast from
shareholders, while ALOG requires >50% of total number of votes cast and ?75% in value
of ALOG units. If the merger is approved, the scheme will be effective by end-Apr 2022.
What’s important aside from the usual benefits of a merger?
Addressing conflicts of interest. The issue of conflict of interest arose after the proposed ARA acquisition by ESR Group was completed on 20 Jan 2022. With both EREIT and ALOG now sharing a common sponsor and having overlapping mandates, there will be conflicts of interest if both REITs continue to operate as different entities. For instance, both REITs may have to compete for the same assets from the sponsor/third parties in the future. We understand that both REITs were often the direct competitive bidders for the same assets recently. In addition, the sponsor has to split its operational and finance sources between the two REITs, and both REITs may also need to compete for the same pool of tenants, all of which could impact the growth of both REITs negatively.
What if the merger does not go through?
We believe both REITs, with their relatively small AUM/market cap compared to peers, may not be able to grow as fast as desired due to higher cost of funding. The ability to acquire larger assets is also capped. To avoid conflicts of interest, ESR Group could also decide to divest one of the REIT’s managers, resulting in one of the REITs potentially losing their “halo” effect and premium valuation (which will affect the ability to acquire, and hence grow) as the REIT may have limited access to asset pipeline and funding. To put things into perspective, developer-sponsored industrial SREITs command a premium valuation of 1.1
to 1.5x P/NAV (vs. non-developer sponsored industrial SREITs of 0.9-1x), although we believe the premium commanded by sponsored REITs is also driven by their more diversified geographical exposure, which the merged entity will see post-merger. We expect both REITs to continue to carry out capital recycling if the merger fails to proceed, but individual asset sales may not get similar market valuation premiums.
More merits from the merger than on a standalone basis
We believe a merger brings more benefits (e.g. diversification and ability to grow) in the longer term, in particular when other REITs are also scaling up their portfolio size for diversification and to compete for growth. We think EREIT is valuing ALOG fairly and the merger provides 12.8% and 5.3% DPU and NAV accretion, respectively, to ALOG. Although the deal is DPU accretive but NAV dilutive for EREIT, ALOG’s portfolio could strengthen the portfolio of the merged entity with its pure logistics assets in Singapore and freehold land exposure in Australia. In addition, logistics assets in both countries have been seeing strong demand and an increase in valuation would offset EREIT’s initial NAV dilution from the merger in the longer term. The increased flexibility in portfolio rebalancing (to increase its exposure to new economy properties), AEIs and lower cost of funding (from potential rerating and lower cost of debt) would also help to accelerate growth potential of the merged entity. The sponsor has a New Economy pipeline of >US$59bn for the merged entity to explore. Re-rating catalysts/downside risks include acceleration in growth post merger/inability to pare down gearing post-merger, which will limit growth opportunities.