Reit managers, sponsors should get in front of evolving investor attitudes on mergers

THE managers of ESR-Reit and Ara Logos Logistics Trust (ALog Trust) reacted strongly this week to suggestions that they had been less than transparent in coming to a decision to merge the two real estate investment trusts (Reits).

In separate reports earlier this month, 2 proxy advisory firms - Institutional Shareholder Services (ISS) and Glass Lewis - had raised questions about the "process aspect" of the merger.

In particular, ISS noted that ALog Trust had not "shopped around" for alternative transactions. "A robust sale process would offer comfort to unitholders that alternatives were evaluated and deemed inferior," ISS said.

During a conference call on Monday (Jan 24), the managers of ALog Trust and ESR-Reit objected and said they had simply done what everyone else had done.

"No questions on processes were raised for the previous Reit mergers we have observed so far," said Karen Lee, chief executive of ALog Trust's manager. "We are not doing anything that deviates from normal market practice," she added.

Yet, normal market practice with respect to the merger of Reits with common sponsors has arguably fallen out of line with the expectations and sense of fair play of many ordinary investors. And as Reit mergers grow more common, "normal market practice" needs to evolve.

Moreover, the managers of ALog Trust and ESR-Reit are mistaken about questions never having been raised about the process aspect of Reit mergers.

Back in 2020, unitholders of Sabana Industrial Reit who were upset about the low valuation of their units in the proposed merger with ESR-Reit campaigned for better terms and raised questions about how the deal might have been hammered out.

In a letter dated Aug 17, 2020, they asked the Monetary Authority of Singapore and Singapore Exchange Regulation (SGX RegCo) for "guidance, clarity and support" in resolving the conflict of interest risks they faced as a consequence of ESR Cayman owning the managers of both Sabana Reit and ESR-Reit.

The dissident unitholders highlighted in their letter that the proposed merger with ESR-Reit valued Sabana Reit well below its net asset value, which they said "(raised) concerns on whether the fiduciary duty of Sabana's board and management to act and protect all Sabana Reit unitholders' interest (had) been potentially compromised".

In a letter to Sabana Reit's trustee, dated Sep 3, 2020, the dissident unitholders expressed doubt that the manager was acting in the best interests of the Reit by pursuing the proposed merger with ESR-Reit. They asked Sabana Reit's trustee to form an opinion as to whether the Reit's manager had failed to abide by the terms of the trust deed.

The dissident unitholders even tried to requisition an extraordinary general meeting to obtain information from the manager's board on how the independence of one of its directors had been determined.

They also raised concerns about the voting process involving custodians and nominee companies at scheme meetings, arguing that the "one-proxy rule" might result in votes of many shareholders not being represented.

These efforts did not persuade the managers of Sabana Reit and ESR-Reit to change course, nor did they elicit any regulatory intervention. The fact is the Reit managers were acting within the letter of the law - and not deviating from normal market practice.

In the end, the dissident unitholders managed to rally sufficient votes to block the merger.

Conflicts of interest

While there has been no significant organised resistance against other Reit mergers over the last couple of years, pockets of discontent are not uncommon.

The fundamental problem with mergers involving Reits that have common sponsors is that the managers are conflicted.

The manager of the target Reit and the manager of the acquiring Reit are not incentivised to negotiate for the best possible price for their respective unitholders as they would be in a bona fide arm's length transaction.

The narrative of ALog Trust's manager makes no pretence of this. "We would like to reiterate that the proposed transaction is not a sale process of ALog Trust or its assets," Lee said, in a statement on Jan 22.

"ALog Trust unitholders are not selling out their units, but instead rolling over into an enlarged platform with a strong sponsor, while crystallising part of their investment returns in cash," she noted.

In effect, the goal of the Reit managers is to set a price that mobilises sufficient unitholders to vote the deal through.

Evolving attitudes, customs

With the experience of successive Reit mergers, the attitudes of investors as well as the customs and conventions of the local market are gradually evolving.

For one thing, investors are no longer completely buying the bigger-is-better, win-win narrative. They have become more aware that Reit mergers sometimes come with exchange ratios that are out of line with prevailing market prices.

ALog Trust suffered a sell-off when its merger with ESR-Reit was first unveiled on Oct 15 last year, as did Mapletree Commercial Trust when its merger with Mapletree North Asia Commercial Trust was announced on Dec 31.

On Jan 10, with the market price of its units sagging ahead of an extraordinary general meeting to seek unitholder approval for the acquisition of 16 properties from its sponsor, Mapletree Logistics Trust (MLT) denied rumours that it was about to merge with Mapletree Industrial Trust (MIT).

Responding to questions from investors, MLT's manager said there was "no compelling reason" for the two Reits to merge.

"We believe that there is sufficient differentiation between MLT and MIT in terms of asset type, geography and tenant profile, and they are both operating at a meaningful scale individually with promising growth prospects in their respective sectors," MLT's manager said.

Meanwhile, a recent court decision has brought clarity to how custodians and nominee companies ought to vote at scheme meetings. "This has led to an outcome that more fully represents shareholders' votes, including shareholders who hold their shares through relevant intermediaries," said SGX RegCo on Jan 12.

Over time, it seems likely that investors will demand more transparency from the managers and sponsors of merging Reits. Rather than benchmarking themselves against what was done in the past, Reit managers and sponsors should try to get ahead of the expectations of investors.

For a start, managers of target Reits should do more than merely state that their merger proposal has the unanimous support of their independent directors; or that there are no alternative offers on the table.

Instead, they should perhaps embrace the concerns raised by ISS and Glass Lewis and actively solicit alternative offers.

While Reit managers and sponsors risk seeing their assets under management decline, the confidence it would engender among Reit investors would likely be supportive of Reit valuations in general.

More than anything else, strong market valuations are perhaps the best assurance that the interests of Reit sponsors and unitholders will be closely aligned.