FCOT unit holders advised to vote for FLT merger

Singapore

THE offer by Frasers Logistics & Industrial Trust (FLT) to acquire all units of Frasers Commercial Trust (FCOT) is fair and reasonable, the independent financial advisor to FCOT unit holders said on Friday.

Although the deal is dilutive to FCOT unit holders on a net asset value (NAV) basis and implies a trailing distribution yield of 5.71 per cent - almost flat from FCOT's 5.75 per cent yield before the merger was announced - FCOT unitholders should vote in favour of the merger, advisor Evercore wrote in a scheme document published on Friday.

Evercore noted that the merger of FCOT into the larger Reit will result in FCOT's NAV per unit of S$1.629 falling by 13.26 per cent to a pro forma NAV of S$1.413 per unit in the enlarged Reit.

From a geographical perspective, FCOT unit holders will also see their exposure to Singapore reduced from 55.6 per cent to 21.5 per cent in the enlarged portfolio, with increased exposure to Australia and new exposure to Europe. "This may lead to FCOT unit holders facing increased foreign exchange exposure," Evercore said.

However, these aspects are balanced by the fact that the merger will deliver a 4.2 per cent increase in pro forma distribution per unit (DPU).

Evercore also observed that FCOT has a historical track record of increasing overseas exposure. Last year, FCOT declined to exercise its right of first refusal for a 50 per cent stake in Frasers Tower in Singapore. In 2018, it also divested 55 Market Street and acquired a 50 per cent stake in Farnborough Business Park in the UK.

"FCOT unit holders may continue to face increased foreign exchange exposure even if the merger is not completed," said Evercore. "FLT's distributable income has historically been less dependent on capital distributions from divestment/disposal gain as compared to FCOT."

That said, FCOT's two Singapore assets - Alexandra Technopark and China Square Central - were the biggest drivers behind FCOT's quarter-on-quarter net property income growth in the three months ended Dec 31 last year.

Some S$40 million in asset enhancement works at Alexandra Technopark were only fully completed this January. Occupancy is now at 97.2 per cent, up from 68.6 per cent a year ago. The space vacated by Microsoft has also been fully backfilled with new lease commitments at rents averaging 8 per cent above existing rents, FCOT said in January.

China Square Central, the subject of S$38 million in asset enhancement works, also recommenced business operations in phases from November 2019, so investors are eyeing more uplift.

FLT is paying S$1.54 billion to acquire FCOT, to be funded via cash (9 per cent) and equity (91 per cent).

For each FCOT unit they hold, FCOT unit holders will receive S$0.151 in cash and 1.233 new FLT units at an issue price of S$1.24 apiece. So FCOT unit holders will be paid a total scheme consideration of S$1.68 for each FCOT unit held, which is a 3.1 per cent premium to FCOT's NAV per unit of S$1.629.

That said, the effective terms of the deal could be the same even if a different headline number other than S$1.68 were chosen. This is because the total scheme consideration is simply the issue price (S$1.24) of FLT units multiplied by a gross exchange ratio (1.355). Lower the gross exchange ratio or issue FLT units at a lower price and the scheme consideration falls.

This is why analysts advise investors to concentrate on what the fair value of the entire merged entity could be, and assess if the deal benefits them by looking at the net exchange ratio of 1.233 and cash component of S$0.151.

The net exchange ratio of 1.233 times is higher than the cash-adjusted exchange ratios of 1.208 times and 1.196 times implied by the six-month and 12-month volume-weighted average price (VWAP) of FCOT units and FLT units before the deal was proposed, the circular said.

Separately, Deloitte & Touche Corporate Finance, the independent advisor to FLT unit holders, said that the proposed deal is not prejudicial to the interests of FLT and its minority unitholders.

The issue price of S$1.24 per FLT unit is the VWAP of FLT units on the last trading day before the merger was proposed.

The merger will raise FLT's NAV from S$0.95 to S$ 1.04 per unit, and result in 2.2 per cent DPU accretion.

To be sure, DPU accretion would have been a meagre 0.6 per cent from the acquisition of FCOT alone.

This is why FLT is pairing the merger with the purchase of the other 50 per cent stake in Farnborough Business Park, which Frasers Property Limited (FPL) owns, to achieve 2.2 per cent acquisition in total to make the deal more palatable, analysts said.

On Friday, FCOT also furnished more details about the outlook for Australian industrial property, which makes up 59 per cent of FLT's portfolio.

"Investor demand for industrial space has continued with further yield compression compared to the third quarter of 2019. It is expected that yields will begin to stabilise over the next 12 months as the investment cycle approaches its peak," the circular said.

Most analysts have written positively about the FLT-FCOT merger.

Citi analyst Brandon Lee wrote in December: "Initial investor feedback to the proposed merger... was largely negative or neutral at best, due to a diluted logistics footprint, lack of clear synergies and introduction of UK business park. However, we expect logistics to remain FLT's priority."

He has a "Buy" call on FLT, but reiterated that the cap rate cycle poses a key risk to his view: "With industrial cap rates now lower than pre-financial crisis levels, and foreign capital a significant portion of transactional activity, a key risk for the sector is that the relative attractiveness of industrial yields diminishes."

FLT and FCOT will hold separate extraordinary general meetings on March 11, followed by a trust scheme meeting for FCOT unit holders that day.

The merger needs to be approved by at least 75 per cent in value and 50 per cent in number of FCOT unit holders at the scheme meeting.

FPL, the sponsor of FLT and FCOT, will abstain from voting. FPL will own 21.9 per cent of the enlarged Reit. If the scheme is approved, FCOT units will cease to trade after March 31.