With Sabana Reit merger in question, will ESR move on to next target?

AN observer to the tussle between ESR-Reit and activist unitholders at Sabana Reit has described the proposed merger between the two Reits as being "in the intensive care unit".

Getting the deal done would require the agreement of nearly all the minority unitholders of Sabana Reit, said Justin Tang, head of Asian research at United First Partners.

Fund managers Quarz Capital and Black Crane Capital, which have said they will not support the merger, collectively control 10 per cent of Sabana Reit.

Sabana Reit's sponsor ESR, meanwhile, holds 20.88 per cent. And Chinese tycoon Tong Jinquan holds 3.3 per cent. Both parties have said they will abstain from voting on the scheme of arrangement for the merger.

For the deal to go through, more than half of the individual unitholders present and voting at the scheme meeting must be in favour of the deal. On top of that, these unitholders must represent at least 75 per cent of the units voted.(See Amendment Note)

Given that typically only half of an issuer's unitholders or shareholders will turn up at such a meeting, Mr Tang said: "This means almost all other minorities have to say yes."

What are the factors that unitholders need to consider?

Playing it cool

Acquiring Sabana Reit would give ESR-Reit greater heft - an increasingly important attribute among real estate investment trusts. The combined Reit would have a better chance of making it into the EPRA NAREIT index, which would put it on the watch lists of more institutional investors.

But ESR-Reit appears to have no intention of bending over backwards to make the merger happen. ESR-Reit has already said that it will not - and in fact cannot - revise the offer price for Sabana Reit.

Meanwhile, the sponsor of ESR-Reit has gone back to accumulating units in another industrial Reit: Aims Apac Reit (AA Reit). On Aug 5, ESR Cayman bought 400,000 units in AA Reit for S$485,440. This took its stake from 12.95 per cent to 13 per cent.

ESR-Reit's sponsor has been quietly building its holdings in AA Reit. At the start of November last year, it had held just 5.24 per cent of AA Reit.

ESR-Reit's purchases of AA Reit bring to mind steady purchases of Sabana Reit before the proposed deal was announced.

Besides having other options available to it, ESR-Reit may also believe that its offer is a good one. Sabana Reit has historically traded at a discount to its net asset value. At its closing price of S$0.37 on Wednesday, it was still a 27 per cent discount to its net asset value of S$0.51 per unit as at end-June 2020.

More than just the price

Quarz and Black Crane also believe Sabana Reit shareholders have other options besides what they see as a merger that undervalues Sabana's assets.

Although they recognise the merits of a marriage - economies of scale, increased synergies, potential re-rating of the enlarged entity - they say Sabana Reit would be able to obtain some of the purported benefits of the merger via organic means.

For instance, Black Crane said it had written to Sabana Reit's board in June 2019 with suggestions on how the Reit can reduce the discount of its unit price to net asset value.

It had, for instance, suggested removing the Shariah compliance of the Reit so that it can refinance debt more cheaply. But Black Crane said none of its suggestions has been taken seriously or executed.

Quarz and Black Crane point out that ESR-Reit has now proposed that the Shariah compliance be dropped once the merger is completed.

"It raises concerns on whether the fiduciary duty of Sabana's board and management to act and protect all unitholders' interest has been potentially compromised," said Quarz and Black Crane in a letter.

Of course, the Shariah compliance factor may not be as significant a factor as size in determining Sabana Reit's borrowing costs or valuation. Smaller-sized Reits have long traded at a discount.

But Quarz and Black Crane have used this issue as one of several examples suggesting that Sabana Reit's manager has not done its best to explore the available options to boost the Reit's valuation.

In a call with The Business Times, Peter Kennan, chief investment officer at Black Crane, said: "Sabana Reit's management has steered themselves into a corner with not many options, and the independent financial adviser (IFA) would likely say, 'Given that you are in a corner, the best option is this', but the IFA wouldn't ask them why they got into that corner in the first place."

He said the manager has not been thinking "entrepreneurially", but has been following "more of a compliance mindset".

"There are other options to create value for Sabana unitholders which the manager has not fully explored," he said, adding that the Reit's choices quickly became limited when ESR bought control of the manager in 2019 and accumulated a 20 per cent position in the Reit over time.

Alternatives

Quarz and Black Crane have suggested Sabana Reit could run an auction for its assets or hold a beauty parade for potential offerors. The problem with these suggestions isn't, however, that they aren't good, but that they also require support from the Reit's manager and sponsor. Short of internalising the Reit manager, this will be a persistent difficulty.

Quarz and Black Crane will be counting on the support of other minority unitholders to push its suggestions through. But that will require other unitholders to agree that they are getting a raw deal. On that point, views differ.

Independent investment site Probutterfly.com said ESR-Reit seems to be taking advantage of the suppressed stock price of Sabana Reit to launch a takeover.

But Mr Tang from United First Partners said the risk for minorities should the deal fail is that Sabana could continue to underperform.

"Will history repeat? This is not the first time that a potential merger with Sabana Reit has failed. In November 2017, Sabana Reit had announced that talks of a possible sale to ESR-Reit had also fallen through.

"The question minorities have to ask themselves is what happens if the deal fails? Can they stand on their own feet and will they be able to accomplish what the minority activists say is possible?"

Amendment Note: The article has been amended to clarify the votes required to pass the deal.