A closer look at the ESR-Sabana deal
Engagement with unitholders is necessary for success.
THE world's largest investors are doling out more and more capital. But these funds are gravitating towards fewer managers as investors seek size and scale.
In light of this trend, real estate investment trusts (Reits) have eyed mergers and acquisitions (M&A) in an attempt to upsize themselves and capture a bigger bite of the market.
Hong Kong-listed ESR Cayman in August announced the acquisition of Ara Asset Management to create the world's third-largest listed real estate asset manager. The proposed deal received shareholders' approval in November, and is expected to be completed by the first quarter of 2022.
This paves the way for ESR Cayman's Singapore-listed real estate investment trust (S-Reit) ESR-Reit to merge with Ara Logos Logistics Trust.
The combined entity will be among the 10 largest S-Reits based on its theoretical free-float market capitalisation.
ESR-Reit has been involved in some high-profile M&A activity. In 2018, it merged with Viva Industrial Trust in what was the first merger between 2 industrial Reits in the history of the Singapore Exchange (SGX).
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Last year, ESR-Reit also dominated headlines - for the wrong reasons, unfortunately - as its proposed merger with Sabana Industrial Reit (Sabana Reit) was scuttled by disgruntled unitholders.
The failed merger is a "cautionary tale" on the importance of considering the composition of unitholders and engaging with minority unitholders, said Robson Lee, a partner in Gibson Dunn's Singapore office and a member of the firm's M&A and capital markets practice groups.
Lee addresses the issues and challenges behind M&A deals and sheds light on why some deals were more successful than others.
Q: In general, what are the different means for Reit M&As?
A: An acquisition of all the units of a Reit or business trust or all the stapled securities of a stapled trust listed on SGX may be effected in various ways, such as a takeover offer, a trust scheme of arrangement (trust scheme) and a reverse take-over (RTO).
Whether a take-over offer, a trust scheme or an RTO should be adopted ultimately depends on the commercial objective of the acquirer.
If the acquirer wishes to acquire all of the units or stapled securities of a target entity, a trust scheme may be preferable. Almost all mergers involving Reits or business trusts in Singapore have been implemented via a trust scheme.
If, however, the acquirer wishes to acquire only some of the units or stapled securities of a target entity, a partial offer would be preferable. An RTO is generally not adopted as the acquirer will have to provide certain assets prior to the take-over.
The composition of unitholders or stapled security-holders of the target entity would also be a relevant consideration, such as whether there are any minority unitholders or stapled security-holders who could potentially reject the take-over offer or vote against the scheme at the trust scheme meeting.
If so, it would be prudent for the Reit manager or the trustee-manager to engage these minority unitholders or stapled security-holders and require them to sign irrevocable undertakings to accept the offer or vote in favour of all resolutions relating to the scheme prior to the announcement of the take-over offer or the trust scheme.
If there is any resistance, the Reit manager or the trustee-manager should also work together with the potential acquirer to sweeten the deal.
Q: So, trust schemes are most commonly employed for M&A deals in Singapore. Could you tell us more about how this works?
A: A trust scheme will typically require several approvals:
a) Approval by the unitholders or stapled security-holders of the target entity to amend the trust deed constituting the target entity - to include provisions that will facilitate the implementation of the trust scheme;
b) Approval by a majority, in number, of unitholders or stapled security-holders present and voting either in person or by proxy. This approving group must also represent at least three-fourths in value of the units or stapled securities voting at the scheme meeting; and
c) The grant of the order of the High Court of the Republic of Singapore sanctioning the trust scheme.
Examples of trust schemes include the merger of CapitaLand Mall Trust (CMT) and CapitaLand Commercial Trust (CCT), and the merger of OUE Commercial Reit (OUE C-Reit) and OUE Hospitality Trust (OUE HT).
In 2020, CMT acquired all of the units of CCT at a consideration per unit of S$0.259 in cash plus 0.72 of a CMT unit.
At CCT's trust scheme meeting, the CMT-CCT merger was approved by 90.3 per cent of the individuals or institutions present and voting either in person or by proxy. These unitholders collectively held 98.2 per cent in value of the total number of units voted.
The High Court sanctioned the CMT-CCT trust scheme and CCT was subsequently delisted. Following CCT's delisting, the enlarged trust was renamed CapitaLand Integrated Commercial Trust and had a market capitalisation of S$11.4 billion and a total portfolio property value of approximately S$22.4 billion.
Also in 2020, OUE C-Reit acquired all of the stapled securities in OUE HT at a consideration per stapled security of S$0.04075 in cash and 1.3583 units in OUE C-Reit.
At OUE HT's trust scheme meeting, the number of individuals or institutions present who voted in favour represented 89.5 per cent of those present and voting either in person or by proxy. They collectively held 96.2 per cent in value of the total number of stapled securities held by the OUE HT stapled securityholders who voted.
The High Court sanctioned the OUE C-Reit-OUE HT trust scheme and OUE HT was subsequently delisted. This was the first merger in Singapore between an SGX-listed business trust and an SGX-listed Reit. The enlarged trust had a market capitalisation of S$2.9 billion and a total portfolio property value of approximately S$6.9 billion.
Q: It's easy to see why trust schemes are the most popular route. But do they always work?
A: An example of minority unitholders derailing the implementation of a trust scheme could be seen in the failed merger between ESR-Reit and Sabana Industrial Reit.
In 2020, ESR-Reit tried to acquire all the units in Sabana Reit for a consideration of 0.94 of an ESR-Reit unit for every Sabana Reit unit.
But the ESR-Sabana trust scheme was defeated at the very first stage of the unitholder approval process.
At the extraordinary general meeting (EGM) convened by Sabana Reit to amend the trust deed, only 66.7 per cent of the units voted were in favour of the amendment. As the amendment resolution required approval from 75 per cent of unitholders, the next meeting - the trust scheme meeting - could not proceed.
Q: Why didn't the ESR-Reit offer work?
A: The failure of the trust scheme did not come as a surprise.
Prior to the Sabana Reit EGM, Black Crane Investment Management and Quarz Capital Management, which collectively held approximately 10 per cent of the issued units in Sabana Reit at the time, were vocal in their objections to the merger and embarked on a bruising campaign against the merger.
Black Crane and Quarz Capital issued a letter to the manager of Sabana Reit on Aug 7, 2020, stating they intended to vote against the merger of ESR-Reit and Sabana Reit.
Among other reasons, Black Crane and Quarz Capital said the consideration for Sabana Reit was a substantial discount to its book value.
Their letter said: "In the 18-year history of the Singapore Reit market with multiple takeovers/mergers, there has never been a single takeover/merger of a Reit target at such a substantial discount to book value."
They added that the merger was a "bold attempt by ESR to potentially solve a conflict of interest issue at the expense of Sabana unitholders".
The conflict of interest, they said, came from ESR Cayman's position as the ultimate controlling shareholder of the managers of both ESR-Reit and Sabana Reit. ESR Cayman, together with the parties acting in concert with it, were also "top unitholders of both Reits with overlapping investment mandates".
Black Crane and Quarz Capital issued a letter to the Monetary Authority of Singapore and SGX in August and a letter to the trustee of Sabana Reit in September highlighting, among others, the potential conflicts of interest.
They also requisitioned an EGM under the Code on Collective Investment Schemes relating to the appointment of Ng Shin Ein as an independent director despite her having had "substantial business relationships with ESR Cayman and its affiliates" and the employment of three ex-ESR employees to senior management roles at the Sabana Reit manager.
Black Crane and Quarz Capital also requisitioned another EGM relating to the proposed removal of the Sabana Reit manager and the appointment of an "internal Reit manager owned by and for all unitholders".
In addition, they hosted a Webinar in November relating to their vote against the merger.
In a letter issued to Sabana Reit's manager on Dec 15, Black Crane and Quarz Capital stated, among others things, that the Sabana Reit manager "is fully responsible for the failure of the disastrous and value destructive proposed merger between Sabana and ESR Reits".
Q: Didn't the managers of ESR-Reit and Sabana Reit try to explain their positions?
A: Both the ESR-Reit manager and the Sabana Reit manager attempted to put out the fire created by Black Crane and Quarz Capital through a series of announcements.
In summary:
a) They acknowledged there was a discount to the net asset value (NAV) of Sabana Reit, but said the merger of ESR-Reit and Sabana Reit would create an enlarged Reit that would "offer the best opportunity for re-rating and for reducing the NAV discount in the long term as part of a larger, more liquid and scalable Reit".
b) They said there were "strict internal controls" at both ESR-Reit and Sabana Reit. ESR Cayman's stake in the Sabana Reit manager is held through an independent third party trustee licensed in Singapore, and there are no overlaps in the management teams of both the ESR-Reit manager and the Sabana Reit manager and also no sharing of information.
c) They stated that Black Crane's and Quarz Capital's claims were unsubstantiated and they "owe it to unitholders to act responsibly and justify their statements".
But the managers' efforts were not successful against Black Crane's and Quarz Capital's onslaughts on the merger.
Q: In your opinion, what could the Reit managers have done better?
A: If the Sabana Reit manager had engaged with Black Crane and Quarz Capital prior to the announcement of the trust scheme, perhaps this debacle would not have occurred.
Even if the Sabana Reit manager was not able to engage with Black Crane and Quarz Capital prior to the announcement of the trust scheme, perhaps due to confidentiality reasons, it should have done so the moment the first signs of resistance surfaced. Instead of going on the defensive, the Sabana Reit manager could have engaged with Black Crane and Quarz Capital while simultaneously working with the ESR-Reit manager to sweeten the deal.
It is crucial to note that Quarz Capital had, on Nov 14, 2019, proposed that ESR-Reit merge with Sabana Reit "in 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" so as to "solve the critical issue of overlapping investment mandates between the two trusts".
This suggests the minority unitholders' principal objection lay in the offer price and if there were any sweeteners to the deal, such as revising the offer price, the minority unitholders' might have agreed to the merger.
Introducing deal sweeteners is not uncommon. In the merger of CMT and CCT, the respective Reit managers worked together and sweetened the deal by ensuring a higher accretion to their respective distributions per unit and the manager of CMT also waived the acquisition fees due from CMT of S$111.2 million.
If these actions had been taken, the merger could perhaps have succeeded. More importantly, the Sabana Reit manager would not be caught in the situation it is in after the failed merger: dealing with the reputational fallout arising from the failed merger and the adversarial stance of Black Crane and Quarz Capital, as well as the increased public scrutiny of its management of Sabana Reit.
Whether the failed merger is a pyrrhic victory for the unitholders of Sabana Reit remains to be seen. It is nevertheless a cautionary tale of the importance of considering the composition of the unitholders or stapled security-holders and engaging any minority unitholders or stapled security-holders prior to announcing any takeover offer or trust scheme.
Where necessary, deal sweeteners should be introduced.
- This article is brought to you by Robson Lee, a partner of Gibson Dunn
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