Is CapitaLand Mall Trust and Capitaland Commercial Trust's proposed merger good for unitholders?

CapitaLand Mall Trust (CMT) and CapitaLand Commercial Trust (CCT) are set to combine to form the largest REIT in Singapore. The proposed merger is the latest in a string of mergers over the last few years.

Mergers may benefit REITs through greater diversification, higher liquidity, cost savings due to economies of scale and access to cheaper equity.

With that said, here are some things that investors should note about the proposed deal between the two CapitaLand REITs.

DETAILS OF THE MERGER

CMT is offering to buy each CCT unit for 0.72 new units of itself and $0.259 in cash. The enlarged REIT will be renamed Capitaland Integrated Commercial Trust (CICT).

The combined REIT will own both CMT and CCT's existing portfolios, making it the largest REIT in Singapore and the third-largest in Asia Pacific. Its portfolio will include 24 properties valued at $22.9 billion.

WHAT DOES IT MEAN FOR CURRENT CMT UNITHOLDERS? 

The best way to analyse such a deal is to look at it from the angle of both parties separately. 

For CMT unitholders, the merger will result in them owning a smaller stake in an enlarged REIT. Here are the key points that investors should note:

Based on pro forma calculations, the merger is distribution per unit-accretive. 

Based on similar assumptions, the deal is NAV-accretive. The net asset value (NAV) per unit of the enlarged REIT is expected to be $2.11, higher compared to $2.07 before the merger.

As debt will be used, it will cause CMT's aggregate leverage to increase from 32.9 per cent to 38.3 per cent.

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The question here is whether current CMT owners will be better off owning units in the merged entity. I think so. The deal will be both DPU and NAV-accretive. While the merged entity will have a higher gearing, I think the trade-off is still advantageous.

On top of that, the enlarged REIT will also benefit from economies of scale. As I briefly mentioned earlier, bigger REITs benefit from diversification, cost savings and the ability to take on bigger projects.

THE DOWNSIDE FOR CMT

Although I think the deal is beneficial to unitholders of CMT, I doubt it is the most efficient use of capital.

CMT is paying 0.72 new units of itself, plus $0.259 in cash, for each CCT unit. That works out to around $2.131 for each CCT unit. Even though that seems fair when you consider CCT's current unit price of $2.13, the purchase price is much higher than CCT's actual book value per unit of $1.82.

Needless to say, CMT unitholders would benefit more if CMT is able to buy properties at or below their book value. Ultimately, because of the current market premium attached to CCT units, CMT will end up having to pay a 17 per cent premium to CCT's book value.

Although the impact of paying above book value is countered by the fact that CMT will be issuing new units of itself at close to 25 per cent above book value, I can't hep but wonder if CMT could gain more by issuing new units to buy other properties at or below book values.

WHAT DOES IT MEAN FOR CCT UNITHOLDERS? 

At the other end of the deal, CCT unitholders are getting a stake in the merged entity and some cash for each unit they own.

Here are the key things to note if you are a CCT unitholder:

Based on pro forma calculations, the merger is DPU-accretive for CCT, if we assume that the cash consideration is reinvested at a return of 3 per cent per annum.

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From a book value perspective, the deal will be dilutive for CCT unitholders. Before the merger, each CCT unit had a book value of $1.82.

After the deal, CCT unitholders will own 0.72 new units in the enlarged REIT and $0.259 in cash. The enlarged REIT (based on pro forma calculations) will have a NAV per unit of $2.11. Ultimately, each CCT unit will end with a book value of $1.78, a slight decrease from $1.82 before the deal.

OTHER CONSIDERATIONS FOR CCT UNITHOLDERS

For CCT unitholders, the question is whether they will be better off owning (1) units of the existing CCT, or (2) cash plus 0.72 units of the enlarged REIT.

I think there is no right answer here. Ownership of the enlarged REIT has its benefits but CCT unitholders also end up obtaining the new units at quite a large premium to book value.

Although the deal will result in DPU-accretion for current CCT unitholders, the enlarged REIT also has a higher gearing than CCT and consequently, has less financial power to make future acquisitions.

Investors need to decide whether the yield-accretion is worth paying up for (due to the new units being issued at 25 per cent premium to book value), or whether they rather maintain the status quo of owning a decent REIT with a lower gearing and better book value per unit.

THE GOOD INVESTORS' CONCLUSION 

There are certainly reasons for both sets of unitholders to support the proposed merger between these two CapitaLand REITs. The deal will benefit CMT unitholders in terms of both DPU and NAV-accretion, while CCT unitholders will also gain in terms of DPU growth.

In addition, the enlarged REIT could theoretically benefit from economies of scale, portfolio diversification, and greater liquidity.

That said, I have my doubts on whether it is the best use of capital by CMT due to the purchase price's 17 per cent premium to CCT's book value. CCT unitholders also have a lot to digest, and they will need to assess if they are comfortable that the deal will be dilutive to them from a book value perspective.

This article was first published in The Good Investors. All content is displayed for general information purposes only and does not constitute professional financial advice.