Activist fund calls for merger of Sabana Reit and ESR Reit

Singapore

ESR Cayman's cross ownership of the managers of Sabana Reit and ESR Reit puts Sabana at a disadvantage when the two Reits' investment mandates overlap, and ESR should resolve the issue by merging them, says activist fund Quarz Capital Management.

In a letter on Thursday, Quarz argued that Sabana Reit trades at a sharp discount to its book value of S$0.56 per unit because it is in direct competition with ESR Reit for assets in the Singapore industrial real estate sector, which is "limited in size and transactions".

Quarz wrote in its open letter to the board and management of ESR Cayman and Sabana Reit: "We find ESR's argument that they can manage the two Reits independently unconvincing...

"ESR's substantially larger stake (by value) in ESR Reit can potentially create corporate governance concerns on which Reit should have priority. It is also inequitable to minority investors if the Reits are forced to invest out of Singapore such that ESR can mitigate this issue."

Quarz believes a merger by way of a trust scheme will solve the problem. "We propose a cash and unit transaction where 0.92 units of ESR Reit and S$0.067 of cash will be exchanged for one unit of Sabana Reit," it said.

Such an offer would value each Sabana Reit unit at around S$0.545 or a 2.7 per cent discount to book value. Unit holders in the enlarged ESR Reit would also benefit from a jump in distribution per unit (DPU) post-merger, it said.

Due to Sabana Reit's low aggregate leverage of 30.8 per cent, the combined entity will also have around S$180 million of debt headroom to make DPU-accretive acquisitions, Quarz noted.

Other catalysts that will help Sabana Reit grow its DPU are the completion of ongoing asset-enhancement initiatives at the New Tech Park at 151 Lorong Chuan in the first half of next year; Quarz expects this to yield an additional S$3.3 million of net property income per year.

Meanwhile, if Sabana Reit brings its portfolio occupancy rate up to the national level of 89 per cent from 80.6 per cent as at Sept 30, it could generate around S$3.4 million of additional net property income, Quarz added.

Partial payment of management fees in units could also raise distributable income by S$3 million, it further noted.

ESR Cayman did not immediately respond to a request for comment.

Sabana Reit units rose 2.22 per cent to S$0.46; ESR Reit units rose 1.92 per cent to S$0.53 on Thursday.

Market watchers have been bracing for ESR to drive more consolidation in the fragmented industrial Reit sector ever since ESR Reit absorbed Viva Industrial Trust last year, in the first-ever merger in the history of Singapore Reits.

Last week, ESR raised its stake in AIMS APAC Reit.

In May, ESR took control of Sabana Reit from Vibrant Group in a S$62.2 million deal, which involved ESR paying S$0.48 per unit for Vibrant's stake in Sabana Reit.

That is lower than what Quarz hopes ESR will offer for Sabana Reit under a merger scenario, but a "critical difference" is that Vibrant's was an all-cash transaction, in which the sale of its Sabana units was bundled with its controlling stake in the Reit manager that was valued at a rich 26.1 times the Reit manager's net profit in 2018, Quarz said.

Quarz did not disclose the size of its stake in Sabana Reit, but said that together with its affiliates, it is one of the top five unit holders of the Reit.