ARA Logos unitholders must weigh pure-play logistics status against being part of a larger entity

THE manager of ESR-Reit appears determined that the industrial real estate investment trust (Reit) bulk up via a merger.

Less than a year after ESR-Reit's proposed merger with Sabana Reit failed to secure the 75 per cent approval needed from unitholders of the latter, the managers of ESR-Reit and ARA Logos Logistics Trust proposed a S$1.4 billion merger last week to form ESR-Logos Reit.

When the proposed deal with Sabana was announced, ESR-Reit was aiming to grow its total assets from S$3.2 billion to S$4.1 billion under the enlarged group. This time around, the merger with Ara Logos would grow its total assets to S$5.4 billion. New-economy assets such as logistics and high-specs industrial properties will account for about two-thirds of the gross rental income of ESR-Logos.

Instead of an all-share deal - as was proposed in the ESR-Reit and Sabana merger plan - ESR-Reit will acquire all of ARA Logos's units for a mix of 10 per cent cash and 90 per cent new units.

ARA Logos unitholders will receive a scheme consideration of S$0.95 per ARA Logos unit - comprising S$0.095 in cash and 1.6765 new ESR-Reit units, to be issued at S$0.51 apiece.

Assessing the benefits

Reit managers have been claiming that scale offers benefits such as access to wider pools of capital, lower costs of funds, greater operational flexibility, and enhanced diversification.

ESR-Reit's unitholders are probably convinced of the importance of having scale. Nearly 99 per cent of valid votes cast by ESR-Reit's unitholders supported the proposed merger with Sabana.

But the pro forma financial effects on ESR-Reit of the proposed merger with ARA Logos show the deal as accretive to distribution per unit but dilutive to net asset value (NAV) per unit, which may cause some concern to ESR-Reit unitholders.

In any case, the hurdles to get a deal done are lower for ESR-Reit. The deal requires approval from more than 50 per cent of votes cast by ESR-Reit unitholders.

For ARA Logos, unitholder approval first requires an approval of 75 per cent for a resolution to amend the trust deed. Then a scheme meeting will take place at which unitholders in favour must number more than 50 per cent of the total number of unitholders voting at the meeting. These unitholders must also represent at least 75 per cent in value of the total votes cast.

Ivanhoe Cambridge Asia Inc, which owns around 8.7 per cent of ARA Logos units, has signed an irrevocable undertaking to vote in favour of the merger.

Do the numbers work for ARA Logos unitholders? The scheme consideration represents a premium of 1.6 per cent to the last traded price of ARA Logos of S$0.935 on Oct 14, 2021, prior to the announcement of the proposed merger.

With its focus on logistics assets in Singapore and Australia, ARA Logos last traded on Oct 14 at 1.4 times its NAV as at Jun 30, 2021.

This trading multiple exceeds the 1.17 times' end-Jun NAV that ESR-Reit last traded at on Oct 14, 2021.

In short, ARA Logos unitholders are asked to exchange units in an entity that was priced at a richer multiple for units in one that traded at a lower multiple.

While ARA Logos unitholders get some cash as part of the scheme consideration, they will get new ESR-Reit units at a price that is 10 per cent higher than ESR-Reit's closing price of S$0.465 on Oct 14. Also, the new ESR-Reit units are priced at a premium of 35 per cent to the pro forma NAV per unit of the merged entity of S$0.377, after taking into account the latest valuations.

The question, then, is whether ESR-Reit can re-rate post-merger and fetch a price-to-book that is much better than 1.17 times.

If ESR-Logos trades at 1.32 times' S$0.377, then ARA Logos's unitholders are getting cash of S$0.095 and units worth S$0.838 for every one unit held. This would bring the total consideration to S$0.933, which is roughly the last traded price of ARA Logos prior to announcement of the proposed merger.

To put that valuation in context, the four largest industrial Reits - Ascendas Reit, Mapletree Logistics Trust, Mapletree Industrial Trust and Frasers Logistics and Commercial Trust - traded at between 1.3 times and 1.6 times their latest reported book values on Oct 20, 2021.

Independence versus being part of a group

ARA Logos is managed by Logos Group, which is majority owned by ARA Asset Management. The manager of ESR-Reit is majority-owned by ESR Cayman, which had entered into an agreement to buy all of ARA Asset Management.

Shareholders of ESR Cayman will vote on whether to approve the deal to buy ARA Asset Management on Nov 3, 2021. Should this deal proceed, ESR Cayman will become the new majority owner of the manager of ARA Logos.

ESR-Reit's manager points out there is an initial US$2 billion of visible and executable Asia-Pacific new economy pipeline assets available from a merged ESR Cayman and ARA Asset Management to supercharge ESR-Logos Reit's growth as a dominant future-ready Reit.

Unitholders of ARA Logos can derive whatever benefits come from having ESR Cayman as a sponsor regardless of whether ESR-Reit and Ara Logos merge.

But there is merit to removing the overlap in mandates of ESR-Reit and ARA Logos, as conflicts of interest will be reduced when it comes to the asset pipeline.

Still, ARA Logos unitholders need to carefully weigh giving up their independence and their positioning as a pure-play logistics trust in order to be part of a larger group holding a mix of logistics, high-specs industrial, general industrial and business park properties.

As an independent entity, scaling up via acquisitions may take time for ARA Logos. But it could still forge a path forward by riding on the support of investors for pure-play logistics trusts.

The results of mergers are questionable. Unitholders of CapitaLand Commercial Trust (CCT) received mainly units and some cash when CCT successfully merged with CapitaLand Mall Trust to form CapitaLand Integrated Commercial Trust (CICT).

Based on CICT's closing price as at Oct 20, 2021, unitholders of CCT are down by 16 per cent compared to where CCT last traded on Jan 21, 2020, prior to announcement of the merger. Over that same period, unit prices of commercial trusts Mapletree Commercial Trust and Keppel Reit declined by 12 per cent and 15 per cent, respectively.

Working on a merger takes both time and money. After the proposed merger with ESR-Reit fell through some of Sabana's unitholders had requested some accountability for the expenses spent on the merger.

Whether or not this latest merger gets the go-ahead will depend on whether the unitholders of ARA Logos have faith that a larger, more diversified ESR-Logos can trade at a juicy premium to its book value.