Dr Wealth CICT Merger Review

This is HUGE news.

How HUGE, you ask?

3rd Largest APAC REIT huge.

Jokes aside, CapitaLand Mall Trust (CMT) and CapitaLand Commercial Trust (CCT) are looking to merge via scheme of arrangement, renaming themselves as CapitaLand Integrated Commercial Trust (CICT) in the process.

This merger will create the 3rd largest REIT in the Asia Pacific and propel CICT to overtake Ascendas REIT as the largest REIT in Singapore by market cap. 

I think this move comes as a huge surprise to investors and analysts, myself included. REIT Merger speculation for CapitaLand’s REITs had largely been focused on CMT and CapitaLand Retail China Trust (CRCT) given their common mandate over retail assets. 

Anyway, as usual, let’s take a closer look at this transformative merger.

M&A Overview

Compared to the Frasers Logistics & Industrial Trust (FLT) and Frasers Commercial Trust (FCOT) merger, the CICT merger is cleaner and more clear cut.

Scheme Consideration

The merger is structured with CMT playing the role of the acquirer and CCT playing the role of acquiree. As such, CCT unitholders can expect to receive 0.72 units of CMT and $0.259 per unit of CCT they own. This implies a value of $2.1238 per CCT unit.

Rationale for the Merger

Management has classified the rationale for the merger into 3 terms – Leadership, Growth and Resilience. These 3 terms are basically the potential benefits arising from having a larger platform. 

Leadership – By having a larger size, you gain greater visibility, which may in turn drive trading liquidity and positive re-rating.

Growth – This rationale has multiple prongs:

1. Foreign acquisitions – The enlarged platform will have a potential ability to acquire a whopping $4.6b of overseas properties. This assumes a target portfolio proportion of 20% overseas properties.
   
2. Ability to leverage on future real estate trends – This refers to the emergence of the “Live Work and Play” concept where mixed use development expertise is important
   
3. Higher development headroom – MAS regulations restricts the amount of development work REITs can perform to 10-15% of portfolio value. By merging, CICT have the potential for up to $6b of development headroom for potential rejuvenation and development work. 
   
4. Higher debt headroom – The combined debt headroom of the merged entity is a massive $2.9b, giving CICT more flexibility in funding acquisitions and development work with debt.
   
5. Resilience – This refers to the fact that size reduces single property risk and mitigates DPU impact when properties undergo redevelopment.

Indicative timeline

The Extraordinary General Meeting is expected to be held in May 2020 with the merger expected to close in Jun 2020.

Pro-forma Impact on REIT metrics

To understand if this merger is beneficial to investors, we have to examine the changes in REIT metrics.

For this, I am extremely grateful that the pro-forma figures used were based on the latest set of full year results announced on the same day. This means that we do not need to manually adjust the figure to reflect latest operational performance.

Metrics	CMT	CICT	CCT	CICT Value (For CCT Investors)
Operational metrics
WA Lease Expiry (WALE)	2.1 years	4.0 years	5.7 years	4.0 years
Estimated Occupancy	99.3%	98.9%	98.6%	98.9%
Capital management
Gearing	32.9%	38.3%	35.1%	38.3%
WA Cost of Debt	3.2%	2.75%	2.4%	2.75%
WA Debt Maturity	5.0 years	4.4 years	3.8 years	4.4 years
Valuation metrics
NAV per unit	$2.07	$2.11	$1.82	$1.78
DPU	11.97c	12.11c	8.88c	9.46c

For both CMT and CCT investors, most metrics see slight improvement. The main issue is the significant increase in gearing due to the need to raise debt to fund the Cash Consideration paid to CCT investors.

Valuation wise, it is generally favourable, with benefits being more favourable to CCT investors with larger DPU accretion overall.

Further insights from the Analyst / Media Briefing

CMT CEO Tony Tan and CCT CEO Kevin Chee took questions as part of a media briefing and webcast held for the merger. Here are some additional insights from the briefing:

On growth strategy and mandate

There were many questions clarifying many aspects of this. The consistent message is that anything or everything is fair game, as long as it makes sense within the investment mandate.

• Redevelopment with a hospitality aspect? Sure, if it makes sense.
• Overseas acquisitions in Japan? Great, if it makes sense.
• Greenfield developments? Let’s do it, if it makes sense.

The only thing explicitly out of bounds is emerging market real estate. Both CEOs reiterated a desire to focus on developed markets only, effectively ruling out a future merger with CRCT.

On fee structure

Existing CCT properties will follow CCT’s fee structure going into the merger. Future CICT properties and existing CMT properties will follow CMT’s current fee structure.

On semi-annual reporting

Management is currently working with SGX on clarifying the implications of semi-annual reporting and its relation with quarterly DPU payouts.

My thoughts on the merger

Personally, I’m actually quite excited about this merger and its possibilities. Metrics wise, I don’t think there can be any major complaints from investors.

On the merger rationale

To me, this merger is an alignment of CMT and CCT to the Singapore Government’s vision for Singapore. This vision is evident from the Urban Redevelopment Authority’s (URA) latest Master Plan of 2019.

The Masterplan has 5 broad themes:

1. Liveable and Inclusive communities
2. Local Hubs, Global Gateways
3. Rejuvenating Familiar Places
4. A Sustainable and Resilient City of the Future
5. Convenient & Sustainability Mobility

The implications of these themes generally leads to an intensification of land-use, a need for mixed use developments incorporating Live, Work and Play elements, and a need to rejuvenate aging real estate.

By merging CMT and CCT, it better positions both REITs to accelerate and take advantage of the opportunities presented as Singapore undergoes its rejuvenation process.

On whether big is always better

One of the questions raised during the media briefing was on whether bulking up is always delivers the synergies and reduction in cost of capital as desired.

This is a very interesting question as you do see pockets of small cap REITs that are able to do quite well and be awarded a premium valuation. This challenges the common perception that size does matter for REITs.

I do agree that size does not necessarily matter, but it does give a lot of flexibility and opens up the range of opportunities available to a REIT.

It is similar to managing your own investment portfolio. If your portfolio is very small, you will have less of a safety net to explore various investment styles and trading strategies.

In the case of a REIT, by growing bigger, you are able to do more redevelopment work and funding more acquisitions with debt due to the larger headroom available.

Ultimately, with any merger and acquisition, how the 2 parties manages the process and work through the finer details plays a lot into whether the theoretical benefits are eventually realised. 

CMT and CCT management has been working closely together for many years now and have proven themselves over a few market cycles now. I’m sure with their deep focus on generating unitholder returns in the long term, CICT should be able to realise the synergies and benefits of this merger.

Potential Strategies for Investors

Overall, I believe that to the average investor, the merger makes sense given current real estate trends in Singapore. As such, I’m of the opinion that CMT and CCT unitholders should be pleased to hold on to their units going into the merger.

However, if you do not agree with the rationale provided, you are always free to sell your units.

That said, there are several things to take note of if you are interested in:

• Avoiding odd lots for CCT unitholders
• Looking to increase your position in CICT

Avoiding odd lots for CCT unitholders

As you know, every CCT unit will be exchanged for 0.72 CICT units post merger. This creates a scenario where CCT unitholders potentially end up with CICT units that are not in multiples of 100.

This is a problem as there is a higher cost for liquidating odd lots.

If you wish to avoid this situation, simply top up or trim your position till it is a multiple of 2,500 units.

Investors looking to own CICT

Similar to the FLT-FCOT merger, new investors interested in owning CICT should look for arbitrage opportunities going forward as the share price of CMT and CCT should theoretically trade in lock step in accordance with the following formula:

CMT Price = 0.72 x CCT Price + $0.259

If any large deviation (my personal threshold is >3%) between CMT’s and CCT’s share price arises, simply buy the comparatively cheaper counter.

Final Thoughts

Overall, the merger of CMT and CCT seems to be truly transformative and a reflection of the evolution of commercial real estate. It challenges the concept of having distinct REIT sub-sectors in a world where mixed-use development is an emerging trend.

From a pure metrics point of view, both sets of investors should be happy with what they are getting from this merger. With the potential synergies from having a larger portfolio, and larger firepower for acquisitions and redevelopment work, CICT seems well equipped to deliver on its goals.

All that remains is for management to deliver on its promises.

As an existing CMT investor, I’ll be holding on to my units going into the merger.