OUE Commercial Real Estate Investment Trust (SGX: TS0U) and OUE Hospitality Trust (SGX: SK7) are proposing a merger to form a S$6.8 billion diversified real estate investment trust (REIT). In short, OUE Commercial REIT will pay OUE Hospitality Trust a cash-plus-units deal that will total S$1.49 billion based on OUE Commercial REIT’s unit price of S$0.57.
In an earlier article here, I used some valuation metrics to assess if the proposed merger was beneficial to existing owners of OUE Hospitality Trust. Based on my simple assessment, OUE Hospitality Trust unitholders could make an immediate profit of 1.3 Singapore cents per stapled security owned based on the current market prices of both REITs (bearing in mind market conditions may change).
That said, there are always two opposing parties in every deal. In this article, I will attempt to assess whether the merger will benefit existing OUE Commercial REIT minority unitholders.
Details of the merger
Under the proposed scheme, OUE Commercial REIT will fully acquire OUE Hospitality Trust for a total price of S$1.49 billion. The deal consideration consists of S$0.040705 in cash plus 1.3583 new OUE Commercial REIT units for each OUE Hospitality stapled security.
In total, OUE Commercial REIT will fork out S$74.6 million in cash and pay the balance by the issuance of 2.5 billion new units at a price of S$0.57 per unit.
Is it a good deal for OUE Commercial REIT unitholders?
From OUE Commercial REIT’s perspective, the key aspects of the deal to consider are whether the price paid for OUE Hospitality Trust is fair, and if the assets it will be obtaining add value to existing unitholders.
With that said, let’s take a look at some of the important numbers.
Source: Author’s compilation of data from proposed merger announcement. *Book value of enlarged REIT is based on author’s computation (calculated by adding the book values of the two REITs together, deducting cash paid out, and dividing by the enlarged number of units)
There are a few things to note from the table above. First, the purchase consideration varies widely depending on whether we use the market price of OUE Commercial REIT units or the book value per unit of the enlarged REIT.
Using the book value per unit of the enlarged OUE Commercial REIT of S$0.62, we can see that OUE Commercial REIT is paying quite a large premium over OUE Hospitality Trust’s market price and book value. The implied price of S$1.63 billion, based on my calculation after taking into consideration the enlarged unit base, is 21.6% over the existing market capitalisation of OUE Hospitality Trust.
This’s because the deal involves the issuance of new units of OUE Commercial REIT at a price below the book value of the enlarged REIT.
Based on this alone, the deal looks unfavourable for existing OUE Commercial REIT unitholders.
Distribution per unit impact
Another point to consider is whether the acquisition will have a positive impact on distribution per unit. According to pro-forma calculations, the acquisition would have increased OUE Commercial REIT’s DPU by 2.1% in 2018 if the deal was made on 1 January 2018. The chart below shows the DPU impact on a historical pro-forma basis (figure in Singapore cents):Source: OUE Commercial REIT Acquisition Presentation
Gearing of the enlarged REIT
Another aspect to consider is how the enlarged REIT will be financially positioned after the merger. A key consideration to determine the financial muscle of the enlarged REIT is the gearing level after the merger. The table below highlights some numbers pertaining to this point.
Source: Author’s compilation of data from OUE Commercial REIT and OUE Hospitality Trust 2018 Earnings Report and Presentation slides of the merger announcement. *Computation from the combination of assets and deducting cash expenses for the merger
The enlarged REIT will have a gearing of 40.3%, which is higher than both trusts before the merger.
The Foolish bottom line
Mergers and acquisitions are usually extremely difficult to assess. The issuance of new units as part of the deal further complicates the process. Hopefully, by breaking down the key aspects of the deal here, investors can get a better idea of whether the merger is favourable for both parties.
In my view, because the new units of OUE Commercial REIT are being issued at a price well below the book value of the enlarged REIT, the deal looks unfavourable from the point of view of OUE Commercial REIT’s unitholders. Not only is OUE Commercial REIT paying a premium for OUE Hospitality Trust, but the new units issued will also end up lowering the enlarged REIT’s book value per unit. In addition, the enlarged REIT will have a higher gearing ratio than OUE Commercial REIT has currently. And although the deal is supposed to be DPU-accretive, the DPU accretion seems very minimal, in my view.
That being said, I recognise that there are other aspects of the deal to consider, such as potential economies of scale, the higher trading liquidity of its shares, and greater portfolio diversification. Investors need to decide if these potential benefits of the enlarged REIT do indeed warrant the premium paid to purchase OUE Hospitality Trust.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn't own shares in any companies mentioned.