Investors who are paying attention to the developments in the REITs sector would have heard about the proposed merger between ESR-REIT (ESR) and Viva Industrial Trust (VIVA). Though the merger is still under negotiation and nothing is cast in stone, we want to examine the potential results should the merger take place.
In this article, we will be highlighting three main points that investors should take note of in this potential merger, and DBS’s proposed strategy for investors to profit from it.
- Creation of Singapore’s fourth largest industrial REIT
The proposed merger will see ESR purchasing all the issued and paid-up stapled securities of VIVA using the newly issued shares of the combined REIT. With this merger, the two REITs will merge to form Singapore’s fourth largest industrial REIT, comparable to the larger cap industrial REITs like Ascendas REIT and Mapletree Industrial Trust. As the Trust grows, there are potential operational cost savings to be made with higher negotiating powers on maintenance contracts.
Further, the size of the REIT matters to investors as seen by the premium attributed to large-cap industrial REITs which typically trade at an average of 1.35 times of its price-to-net-asset-value, 0.3 times higher than that of a mid-cap industrial REIT. This is likely due to the “liquidity” premium priced in by investors, along with a lower cost of capital assumed for larger REITs.
As the REIT expands in size, it can likely re-finance the existing VIVA debt at a more attractive rate with increased liquidity and asset base. VIVA’s cost of debt is currently 0.46 percent higher than ESR’s. DBS estimates that a 0.5 percent decrease in interest rate will result in a 2 percent increase in the combined net property income of the two REITs.
- Potential for further growth
Mid-cap industrial REITs have been finding it difficult to grow in the recent years. With the proposed merger, the REIT will be backed by E-shang Redwood, a respectable sponsor who will help the company gain improved access to debt and capital markets. This is important for the REIT’s future acquisition plans and sourcing abilities as they can continue to grow inorganically.
- Other mid-cap industrial REITs might benefit too
Given the announced plans for mergers, investors are also eyeing other mid-cap REITs that might potentially be next acquisition targets. Pricing in such speculations, DBS opines that other mid-cap industrial REITs will also see a lift in their share price. However, it is important to note that accurately identifying any potential deal in the future will be hard.
Strategy To Adopt
Given that VIVA is already trading at a premium to net-asset-value at 1.24 times despite a lower expected portfolio yield of 5.7 percent versus ESR’s 6 percent, DBS expects little appreciation to its share price.
On the other hand, ESR is currently trading at a lower price-to-net-asset-value of 0.96 times which is far from the potential 1.35 times that could be attained when both REITs merge (taking the average price of large-cap industrial REITs). Hence, there is more potential for capital gains by investing in ESR, with DBS estimating a potential 15 to 20 percent increase.
Another benefit that ESR can gain in this merger is increased exposure to higher valued business park assets, rising significantly from 2 percent to 30 percent. DBS expects that the minimum price for ESR will equate to its current net asset value of $0.59 per unit as of 31st December 2017, and hence see a slight increase of $0.01 from its current price.
DBS has recommended investors to Buy ESR-REIT with a target price of $0.63. Currently, ESR-REIT is trading at $0.555.