Profiting from Pricing Abnormalities- Merger of Frasers Commercial Trust and Frasers Logistics & Industrial Trust

Ever since the announcement of the upcoming merger between Frasers Commercial Trust ("FCOT") and Frasers Logistics & Industrial Trust ("FLT"), it gave rise to the strange situation of an arbitrage forming due to wide pricing fluctuation between the 2 REITs. Arbitrage is the process of exploiting differences in the price of an asset by simultaneously buying and selling it and in the process, the arbitrageur pockets an almost risk free return. For example,  On 3rd December 2019, the price of FCOT suddenly shot up to S$1.72 when the offered price for the merger exercise valued it at S$1.68.

Extract of Merger Scheme for FCOT and FLIT

1. Market apparently is trying to price in who received the shorter end of the stick

Now, this is a matter of differences in perspectives that lead to the see-saw pricing of both FCOT and FLT ever since the merger announcement. Some view that FCOT got the shorter end of the stick as the deal did not take into account the improving signing rents at Alexandra Technopark post AEI. FCOT also have a much lower gearing relative to FLT. Valuing it at S$1.68 from the merger thus undervalued the fair pricing of as high as expected S$1.76 per unit.

As for FLT supporters, they view the earnings of the REIT as more resilient and have annual rental escalations in its leases as well as a steady proven organic growth profile. Pricing the exchange of shares at S$1.24 per unit to FCOT unit holders thus severely underpin the fair value of at least S$1.30 per unit.

2. The pricing offered in the exercise are actually quite fair

Frasers Property sweeten the deal by also throwing in the proposed acquisition of the remaining 50% of Farnborough Business Park based in UK conditional to the completion of the merger. This acquisition will be yield accretive and I reckon it is thrown in to incentivise the unitholders of both FCOT and FLT for them to support the merger deal. As such, personally, I would think that the pricing of S$1.68 per unit for FCOT and S$1.24 per unit for FLT are supported and fair.

3. Opportunity to make small profit out of the merger exercise

One good example as mentioned above is on 3rd December. The pricing of FCOT shot up to S$1.72 from S$1.68. Those who managed to get a unit at S$1.68 per unit can simply sell off at S$1.71 to S$1.72 per unit and then buy FLT which is being priced at S$1.24 per unit. Of course, one have to be careful on which price to enter into for FLT which is also similarly going up and down like a yoyo. 

Another example would be on 4th December, prices for FCOT at one point dropped to S$1.65 to $1.66 per unit range. One could purchase and then hold on till completion of the exercise. Alternatively, one can chose to just do a simple sell off of FCOT when it rebounded to S$1.68 per unit.

On 3rd December 2019, I have sold off all my FCOT positions at S$1.71 per unit and used it to buy up FLT at S$1.23 per unit during the pricing mismatch at different times of the day. In addition, as I was on annual leave for the past 2 days and have nothing much to do, I decided to monitor the daily fluctuation in price and do a quick buy and sell and lock in some small profits of a few hundred dollars. The downside is that this is not entirely risk free and you maybe forced to hold on to the units but I believe in the long term prospect of FLT and market pricing shall revert to its fair value eventually.

Parting Thoughts

The entire merger exercise will probably take another 3 to 4 months to complete. I do hope that the deal is completed as soon as possible as the new business entity will enjoy better diversification in terms of its property portfolio and also better leverage during negotiation with bankers on financing.

Surprising Upcoming Merger between Frasers Commercial Trust and Frasers Logistics & Industrial Trust

In a surprising twist of fate, both Frasers Commercial Trust ("FCT") and Frasers Logistics & Industrial Trust ("FLIT") announced a trading halt. According to the Business Times, their ''secret sources" revealed that both REITs will be joined in holy matrimony and merged into one entity. The "secret sources" identity also cannot be revealed as the information is still private. As always, news seems to have leaked ahead of the trading suspension and the unit price of both REITs increased suddenly above their normal trading range for no apparent reason over the past few days. FCT and FLIT seems to have jumped onto the bandwagon of Capitaland and OUE Group by suddenly deciding to just merge the 2 REITs. 

I am currently holding on to both FCT and FLIT with almost similar weightage in terms of quantum in my margin portfolio. So the question of whether one particular REIT's shareholders will benefit more from any bias or favorable pricing over the other REIT in the new entity will appear to be non-relevant to me. As I intend to hold on to Frasers REITs for the long term for their dividends, the post merger will not increase the distributions automatically. It does make it more financially stable and probably be able to obtain cheaper re-financing by virtue of its mammoth size. If these are the good points, then Frasers Property can probably do a merger every year by injecting its other REIT and business trust, that is, retail and hospitality arms into one super giant stapled Business Trust. But then, it will make it murkier than mud and take away one's freedom to choose the business that one specifically wanted to invest. 

The only other benefit in my view will be the reduction of statutory compliance cost from one listed entity instead of the current two entities. Will await further details from Frasers Group regarding their upcoming plans for these 2 REITS. 

Frasers Commercial Trust DPU May Not Be Sustainable Even With New Tenant Google Coming On Board

Frasers Commercial Trust (“FCT”) recently announced the signing of a major tenant, Google, at Alexander Technopark. Of course, with this being a done deal, many folks including myself were thus expecting the DPU to increase upon commencement of the lease next year. Upon perusal of the financial announcements of FCT in the third quarter ending 30 June 2019 and examining it in details, I decided to reduce my shareholdings by half to mitigate any downside risk at the current high valuation of S$1.60-S$1.65 range. The free cashflow available to pay out quarterly distribution turns out to be unsustainable even if you add in the upcoming contribution from Google to replace the capital component in current distribution.

1. Free cashflow assessment

Screenshot 1: Cashflow Statement Extract

FCT financial year is from 1st October 2018 to 30th September 2019. Hence we need to annualise the cashflow from 1/10/2018 to 30/6/2019. To work out free cashflow available for distribution, use S$49.81Mil (cashflow from Ops activities subtotal), add net income from joint venture of S$4.5Mil and less off the CAPEX line item <S$21,39Mil>.  

Note that in the workings in screenshot 2 Free Cashflow template below, I have decided to exclude CAPEX of <S$21.39Mil> as I presume that they are relating to part of the asset enhancement work for China Square Retail Podium of S$38Mil and non-recurring in nature hence it will not be fair to include one-off items in the computation of available free cashflow for distribution.

1.1- Current free cashflow concept is inadequate- Need to take into account financing cost to complete the picture.

I will go on further to subtract the line item “financing cost paid” of <S$11.63Mil> from the aforesaid mentioned to assess whether sustainability stress test will hold out. The funny thing about the current “Free Cashflow” definition is that it only talks about “Cashflow from Operating Activities” less off “capital expenditure” as essential cash left for distribution activities but it has omitted the all very important financing cost to service debt. Bank loan and other perpetual securities makes up a substantial portion of the capital structure setup of every REITS and Business Trusts in order to get yield accretive assets for their shareholders. So how can Free Cashflow be free when this critical and substantial part of REITS and Business Trusts is missing from the consideration?

Hence taking into account the financing cost paid, the revised Free Cashfllow is S$56.96Mil as illustrated in screenshot 2 below.

1.2- Dividends paid and lack of cashflow generated from the business even if add back expected rental from Google

Based on annualized dividends payout of <S$86.67Mil> against Free Cashflow of S$56.96Mil, we are now staring at a colossal gap of <S$29.7Mil> per annum even when I have taken the liberty to assume zero CAPEX. 

For Google, it took up 344,100sqft of space at Alexandra Technopark. It is widely believe that the average price achieved is around S$4psf which translates to a forecasted annual contribution of S$16.5Mil Adding this S$16.5Mil into the free cashflow deficit <S$29.7Mil>, one will still need to plug the remaining deficit of <S$13.2Mil> per annum. 

Screenshot 2: Free Cashflow Computation

1.3- AEI completion at China Square retail podium

The lettable area post Asset Enhancement Initiative is expected to increase to 78,000sqft. Based on Commercial Guru, the asking psf is S$20. Hence monthly rental income contribution if fully leased out will be S$1.56Mil and annual income contribution will be S$18.72Mil. Therefore, the key assumption will be that FCT must ensure that they can lease out all retail space of 78,000sqft at the targeted rate of S$20psf per mth in order to maintain the distribution and plug the deficit of <S$13.2Mil> as alluded to Pt 1.2 aforesaid mentioned above.

1.4- How about other REITS and Business Trusts? Are they also in the same deficit state?

Nope, look at SPH REIT, even if one includes in financing cost repayment, its distributions are in a very healthy and sustainable range relative to FCT. 

For Business Trust, Netlink Trust is another problematic business that actually borrows from the bank to finance its current high dividend distribution of 5.7% and it will not be sustainable in the long run. The sustainable dividend yield is actually only around 4.02%. I will probably write another post on Netlink Trust which many folks are viewing as an extremely safe haven to park their cash. My personal thought is that this is another potential Asian Pay TV Trust waiting to self-implode. Short term holding on to this should be alright due to the current non-stable macro-economic environment against the perceived safe government regulated business activities but for the long term, one should re-look at whether the current yield is high enough to compensate for future downside risks. There is a big hole of <S$33Mil> per annum to plug for this one.

Conclusion

FCT pays out high distributions to its unitholders, ostensibly from its current businesses. On further evaluation and in actual fact, FCT seems to be paying the high quarterly distribution via the previous cash reserves built up from the (i) gain on disposal of S$144 Mil of 55 Market Street in August 2018 and (ii) Distribution Reinvestment Plan whereby investors opt to receive dividends in equivalent units instead of cash. 

The crucial points for investors are thus whether FCT management can continue to backfill the remaining unoccupied Alexander Technopark as well as finding tenants for the China Square retail podium post asset enhancement work in order to maintain the current distribution rate. Given the circumstances as it is, this can be quite challenging.

Frasers Commercial Trust Finally Snagged Google as Major Tenant

The much anticipated Google deal at Alexandra Technopark finally went through and was formally announced on 25 June 2019 by Frasers Commercial Trust (“FCT”). Since my last posting on 19 January 2019, there has been no more news after the Business Times announced that FCT and Google Asia Pacific Pte Ltd were discussing taking up space at Alexandra Technopark. For the past few months, I thought that Google Asia Pacific had walked away from the lease negotiation and was very worried over how FCT would fare should the global economic downturn happen by end of this year. When I saw the price hitting a record high of S$1.66 per unit last week, my sixth sense tells me that FCT must have announced some major news on the Google deal and quickly checked their SGX announcement. True enough, Google had signed up with FCT.

It is simply wonderful that Google Asia Pacific has decided to expand further into Singapore and to take up 344,100sqft of space which represents 33.3% of the current total net lettable area of Alexandra Technopark to drive the committed occupancy rate to 93.7% as at 25 June 2019. What sweetens the deal, even more, is that Google has committed to a 5 years long lease term. It is widely believed that the average price achieved is around S$4psf which translates to an annual contribution of S$16.5Mil and a total contractual value worth a staggering S$82.6Mil. FCT Management team has scored a major victory in winning this major tenant. The tenancy agreement will commence in the 1st quarter of 2020.

With such a high-quality tenant win in the portfolio of FCT, its earning sustainability will be greatly enhanced even in the event of an economic downturn. As such, its share price may continue to soar and hit S$1.70 per unit as the market should re-rate it closer to the yield spread by other commercial REITs such as Capitaland Commercial Trust. Anyway, I will not be selling away FCT anytime soon unless there are significant changes in its earnings visibility and business fundamentals. 

Frasers Commercial Trust Roared Back Into Life With News of Google In Talks For 400,000sqft of Space At Alexandra Technopark

Fraser Commercial Trust("FCT") bounced back strongly this week with news that Google is on an expansion drive in Singapore and in talks with Fraser Commercial Trust for 400,000sqft of space at Alexandra Technopark. Its unit price which used to hover around S$1.36 to S$1.40 for the past 2 months shot up yesterday and even hit S$1.48 at its highest point for the week. It eventually closed off at S$1.45 as at 18 Jan 2019, Friday.

Completion of AEI at Alexandra Technopark and Google Expansion into Singapore

Alexandra Technopark is a high tech business space campus located at the prominent Alexandra business corridor. A $$45Mil asset enhancement initiative was announced on 23 January 2017 and is currently nearing full completion. It aimed to transform and reposition Alexandra Technopark into a contemporary, vibrant, and engaging business campus. A new 13,300sqft amenity hub has been added, which provides seamless connectivity to the two business space blocks and houses a wide array of food and beverage, social and other amenities. Its current occupancy rate is around 68.6%.

If Google were to really take up the 400,000sqft, this will drive occupancy rate to more than 90%. Market analysts have been suggesting the rental cost will be S$4 per sqft. This will mean S$1.6Mil per month or S$19.2 Mil per annum of rental income contribution.

Financial Results Review for Q1 FY2019 Announcement:

As we can see, the results show a deterioration mainly due to the divestment of 55 Market Street as well as the AEI work for Alexandra Technopark and also China Square Retail podium.

If FCT managed to sign up Google, its earnings will get boost up and support the unit price.

Note that FCT equity accounts for the UK Farnborough Business Park on a 50% stake basis. The current Brexit crisis might have some detrimental impact on the rental income but not expected to be significant due to the high-quality tenants and long WALE of 7.3 years at the UK Business Park.

Parting Thoughts:
With a healthy gearing of 28.4%, FCT will be able to tap on the opportunity to acquire new assets that are yield accretive following the divestment of 55 Market Street property last year. The completion of the AEI on Alexandra Technopark and China Square Retail Podium in this year should also further strengthen the REIT for long term growth.