Property consolidation: let the M&A begin

After an uneventful two years on the corporate action front, mergers & acquisitions activity among property stocks is hotting up.

The timing is opportune as Covid-induced income and valuation losses have created a number of cheap takeover targets for those with healthy balance sheets.

The M&A revival follows last year’s lull during which real estate investment trusts (Reits) were forced to focus inwards, given slumping earnings and rising loan-to-value (LTV) ratios.

The latter, especially, raised fears of companies breaching debt covenants, which would typically prompt banks to call in loans.

Instead, a number of Reits have sold noncore assets over the past year to pay down debt and have successfully recapitalised their businesses. Some have already reduced LTVs to below 35%, which means they are now well-placed to cash in on growth opportunities — such as there are in a sector that is still awash with "to let" signs. Some companies have also started to resume dividend payouts, which has further supported the 50% recovery in the listed property index since early November.

However, many stocks are still trading at five-year lows, which of course makes M&A more viable from a pricing point of view.

As Catalyst Fund Managers portfolio manager Mvula Seroto puts it: "Some Reits are trading at material discounts to NAV and attractive forward yields, which presents bargain-hunting opportunities for patient investors with well-capitalised balance sheets."

Nedbank CIB analyst Ridwaan Loonat says there’s no doubt that property stocks are starting to review strategy on the back of improved liquidity and stronger balance sheets. "With potentially the worst behind them, more companies are likely to identify possible mispricing caused by the pandemic. Some counters offer dividend yields that could make deals accretive to the acquirer," he says.

A case in point is Rebosis, which has laboured under sky-high debt levels for some time. Its share price has plunged over the past 18 months and the struggling mall owner, which also has exposure to the government-tenanted office market, is now believed to be the target of a potential buyout. The company last week renewed a cautionary relating to a pending transaction.

Dipula is also under cautionary. The company, which owns a number of retail centres that cater to lower-income shoppers, among others, last week released a solid set of results for the six months to February. Distributable earnings grew an impressive 8.5%, which helped management maintain a 100% dividend payout ratio. So in this case, Dipula is likely driving the action.

Last month, Emira advised shareholders that two investors — one of which was Maitlantic 10, a subsidiary of the I Group, which was co-founded by former Emira CEO and current board member James Templeton — had increased their shareholding in Emira to above 35%. That triggered a mandatory offer to other investors — a regulatory requirement in terms of the Companies Act. However, two shareholders that each hold about 5% of Emira have indicated they will reject the mandatory offer, the final outcome of which is expected within the next few weeks.

Resilient Reit, which owns one of the largest nonmetropolitan shopping centre portfolios in SA, was placed in a similar position when it increased its shareholding in former rand hedge stablemate Lighthouse Capital from 19% to 40% last year. Resilient’s mandatory offer for Lighthouse shares it doesn’t already own stems from a share swap that formed part of an equity raise. However, Resilient earlier this month said about 33% of shareholders have already indicated they won’t accept the offer. So a takeover looks unlikely at this stage.

One of the most interesting deals currently on the table involves retail-focused market darling Fairvest, which is eyeing Arrowhead.

Fairvest announced last week it has concluded share swap agreements to acquire 50.1% of Arrowhead (A and B shares) subject to certain conditions. Fairvest CEO Darren Wilder says the company has already received support from 63.7% of its own shareholders who are likely to vote in favour of the deal. A majority of 75% is needed. If achieved, it will pave the way for Fairvest to make a mandatory buyout offer for the remaining Arrowhead shares it doesn’t yet own.

At first glance, it seems Fairvest and Arrowhead might not be a perfect fit given that Fairvest owns a niche portfolio of smaller and mid-sized shopping centres focused on lower-income shoppers while Arrowhead’s portfolio is more diversified between retail, office and industrial buildings. It also owns a 60% stake in rental housing fund Indluplace.

There is some concern that the deal could dilute Fairvest’s investment case as a niche retail offering — one of the key attractions for investors in recent years. In fact, Fairvest is one of the three best-performing property stocks over one, three and five years, according to latest SA Reit Association figures.

However, Wilder argues that the value unlock benefits of a merger for both companies’ shareholders outweigh any potential dilution of Fairvest’s specialist focus. "Initially, the initiative will address Fairvest’s own size and liquidity constraints and create a platform for a broader range of investors to access a well-rated Reit of scale," he says. "It will also give Fairvest access to a much larger balance sheet and lead to operating cost efficiencies."

Wilder believes Arrowhead’s retail assets are complementary to Fairvest’s portfolio. Besides, he says the idea is to recycle some of Arrowhead’s noncore assets and use the proceeds to bulk up Fairvest’s portfolio of lower-income shopping centres. A successful merger of the two companies will increase Fairvest’s current asset value of R3.42bn nearly fourfold as Arrowhead’s portfolio is worth about R10bn.

Analysts appear to be in favour of the deal. Seroto says: "Though we’ve seen deals being done to the detriment of shareholder value in the past, we do think the Fairvest/Arrowhead merger should unlock value for shareholders over the long term." Loonat has a similar view: "A larger entity with increased liquidity that could be considered for index inclusion is attractive to investors."

But is bigger always better? Not necessarily. Craig Smith, head of research at Anchor Stockbrokers, says not all M&As make sense. "Investors need to be quite circumspect. There need to be tangible synergies, both in terms of revenues and cost savings." However, Smith reckons while some deals may dilute the specialisation proposition that a niche fund offers, there is currently a greater desire for scale. "I guess it’s a tussle between liquidity and specialisation."

Seroto agrees each deal needs to be assessed on its own merits. He says consideration should be given to the impact on earnings; capital structures before and after the transaction; potential synergies and cost savings; and the capital allocation track record of the management team.

But he notes that the significant sell-off in 2020 means property stocks have become much smaller in terms of market cap. "As such, we believe corporate activity is now required to increase size and relevance as well as to replace poor management teams."