How disagreement about price for Sabana Reit turned its merger with ESR-Reit into a spectacle

IN LESS than two weeks, on Dec 4, unitholders of Sabana Shari'ah Compliant Industrial Real Estate Investment Trust (Sabana Reit) and ESR-Reit will vote at their respective EGMs on a transaction over which a great deal of ink has been spilt.

As that moment of truth approaches, the proponents and opponents of the deal have redoubled their efforts to get their way.

Quarz Capital Management and Black Crane Capital, which claim to have influence over 11 per cent of Sabana Reit's units, requisitioned an EGM just over a week ago to delve into - among other things - the appointment of an independent director and the hiring of certain personnel by the manager of Sabana Reit.

Then, even before Sabana Reit's manager responded, Quarz and Black Crane announced plans to requisition yet another EGM to create an internal manager for the Reit in the event the merger with ESR-Reit falls through.

The manager of Sabana Reit has fired back with righteous scepticism, stating that it is "unable to determine the workability and benefits of the internalisation proposal".

It has also demanded that Quarz and Black Crane explain statements they had previously made about Sabana Reit's 2021 standalone distribution per unit (DPU) potentially rising 20 per cent.

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"While Quarz and Black Crane are not bound by strict rules of engagement set by regulators like parties to the merger are, their statements aim to influence unitholders," Sabana Reit's manager said. "They owe it to unitholders to act responsibly and justify their statements."

Disagreement over price

Beyond all the sound and fury, however, this conflict is actually little more than a disagreement about the price for Sabana Reit.

Under the merger deal, holders of every 100 units of Sabana Reit will receive 94 units of ESR-Reit. Based on ESR-Reit's closing price last Friday of S$0.385, unitholders of Sabana Reit would be getting S$0.362 for each unit they own.

This is 3.4 per cent above Sabana Reit's closing price on Friday of S$0.35. But it is 29.3 per cent below Sabana Reit's net asset value (NAV), as at June 30, of S$0.512 per share.

By contrast, ESR-Reit's closing price on Friday of S$0.385 is only 6.1 per cent below its NAV, as at June 30, of S$0.41 per share.

Quarz and Black Crane have said they will vote against the merger because the valuation accorded to Sabana Reit in the transaction is too low.

Quarz itself proposed a merger of ESR-Reit and Sabana Reit in November last year, to address the overlapping investment mandates of the two Reits and the fact that their managers are controlled by the same corporate group.

Quarz had suggested at the time that every 100 units of Sabana Reit be exchanged for 92 units of ESR Reit plus S$6.70 of cash.

On those terms, and the level at which ESR-Reit is now trading, each unit of Sabana Reit would be valued at more than S$0.421, which is 20.3 per cent above its current market price and 19.2 per cent below its NAV per share.

So, why did the manager of Sabana Reit agree to such seemingly low-ball merger terms? Why did it not canvass the support of key unitholders, such as Quarz, before agreeing to the deal? Could the whole matter have been handled with less acrimony?

Failure to engage

The manager of Sabana Reit has publicly stated that the merger with ESR-Reit was "negotiated at length", the implication being that it had obtained the best terms it could.

If the terms seem less than compelling from the point of view of unitholders of Sabana Reit despite the lengthy negotiation, it might be because Sabana Reit is not all that attractive to ESR-Reit.

The key benefit of the merger is that investors will end up owning units in a larger and more diversified Reit that is better able to raise funds and grow. As ESR-Reit dwarfs Sabana Reit, the former's unitholders arguably have less to gain.

ESR-Reit has 57 properties with total gross floor area (GFA) of 15.1 million sq ft and total assets of S$3.2 billion. Sabana Reit has just 18 properties with a GFA or 4.1 million sq ft, and total assets of S$0.9 billion. The combined Reit will be more than four times as large as Sabana Reit, but only about 30 per cent larger than ESR-Reit.

Even so, there was a fillip of excitement when the merger was announced on July 16. Within a week of the announcement, ESR-Reit had rallied 7.7 per cent while Sabana Reit had risen 9.7 per cent.

Shortly after that, however, Quarz began criticising the deal and announced the intention to oppose it. Both ESR-Reit and Sabana Reit subsequently fell back.

The way some bankers tell it, the manager of Sabana Reit may have been constrained by a non-disclosure agreement from engaging its unitholders as the merger was being hammered out.

My view is that the manager of Sabana Reit and its advisers ought to have known better than to unveil a merger without having ensured that key unitholders were onside.

Unhappiness over the valuation of Sabana Reit soon escalated into something more serious.

Faced with determined dissident investors, and with no wiggle room on the terms of the merger, the manager of Sabana Reit has tried desperately to counter criticism of the deal, to the point of downplaying the Reit's standalone potential.

We are now in a bizarre situation of a Reit manager pouring scorn on the bullish prognosis of its own unitholders, and pushing for a merger that will put everyone out of work.

This has alienated unitholders of Sabana Reit, and enabled Quarz and Black Crane to credibly raise questions about the independence and competence of the Reit manager's board and senior personnel.

What's next?

This week, there are likely to be more sharp exchanges between the manager of Sabana Reit and the dissident investors. Both sides are planning to hold events to make their case to unitholders.

If the merger is eventually passed, ESR-Reit could rally briefly and pull Sabana Reit higher in lockstep with the 0.94 exchange ratio. It is less clear what will happen if the merger falls through.

Both Sabana Reit and ESR-Reit have underperformed significantly this year. It is possible they might not fall much further if the merger fails.

Sabana Reit is down 23.9 per cent this year, and ESR-Reit 27.4 per cent. By comparison, the iEdge S-Reit Index is down 9.2 per cent.

ESR-Reit may well move on to another target.

As for Sabana Reit, much depends on whether Quarz and Black Crane actually have a viable plan to dislodge the manager of Sabana Reit and set up an alternative internal manager.

If this proves to be mere bluster, then the big question could be whether the existing manager of Sabana Reit has enough credibility left to refocus on its job of managing its asset portfolio for the long-term benefit of its unitholders.