Sunday, December 1, 2019

Special Report: My Thoughts on FLT + FCOT Merger

Hi SFFians,

Bet you have read the mega REIT merger news between Frasers Logistics & Industrial Trust (FLT) and Frasers Commercial Trust (FCOT), and I just happen to be heavily vested in both REITs. To complicate the analysis, FLT is looking to acquire 50% interest in Farnborough business park using 100% debt and promise to be DPU accretive. Of course it will be accretive as long as debt is cheap. Well, being on both sides of the fence, does this deal make good sense to me or to either side of the shareholders? Let me walk through the key things of this deal without tackling too much financial details.

FLT (the Acquirer) is proposing to "swallow" FCOT (the Target) by paying cash  ($0.151 per FCOT unit) and FLT unit (1.233 new FLT units per FCOT unit). If the purchase consideration is fully cash funded, the total price would be crystal clear. With an equity swap scenario, the purchase price will be a moving target as FLT unit price is constantly moving too.

With the trading halt being lifted right now, FLT trades at $1.28 and FCOT trades at $1.72. Fixing these moving prices, FCOT unit is worth $1.28 x 1.233 + $0.151 = $1.73 (seems tough to arbitrage the difference). Both the acquirer and target's market capitalization have shot up post announcement, seems like a win-win situation for both shareholders.

Impressive merged statistics for one of the largest S-REITs (from current position #15 and #24 to new position #9) with very rosy occupancy rate and long WALE. Size is really important in the REIT too, as it will have superior bargaining power over lenders, vendors, employees, shareholders and even its tenants. That will the synergistic value increase which is not easily quantifiable until it is extracted successfully integrated. Given that they are the same Fraser family, the cultural fit won't be much of an issue.

Indeed, FLT shareholders should be laughing a fair bit for the accretion to its DPU and NAV, and find no reason to reject this deal. In addition, the portfolio quality, tenant mix etc seem to be marginally better due to a larger base. You can refer to more details in their presentation here.

Well, surely there will be some catch to it. Yes, something not highlighted is the combined gearing. FCOT has a gearing of 28.6%, while FLT gearing is 33.4%. Post merger and debt-funded acquisition, combined gearing shot up to 37% (very near towards the regulatory limit of 45%). This merger consumes cash at FLT's level and adds huge debt for 50% in Farnborough business park. Debt cost is tapering off due to flattening of yield curve, it's definitely a wiser choice to go full debt to maximise DPU accretion.

While I am not an expert in UK business park asset, the face value of this 50% acquisition seems fair and not overly aggressive given the portfolio quality, tenant mix and rental reversion potential. Due to these 2 deals happening simultaneously, it does mask the dangers of increased gearing issue.

My take is that both FLT and FCOT unit-holders stand to gain from this merger and acquisition (though it seems like FCOT is getting the shorter end of the stick), mainly driven by the full debt-funded purchase. Hence, based on their trading prices, there is no apparent advantage to make alpha by buying into any of them right now. Unit-holders can either hold on or either cash out now if they are overly concerned over the much higher gearing to come.

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