from Custodian REIT Plc (isin : GB00BJFLFT45)
Custodian Property Income REIT plc: Update on recommended all-share merger with abrdn Property Income Trust Limited
Custodian Property Income REIT plc (CREI) NOT FOR RELEASE, PUBLICATION OR DISTRIBUTION, IN WHOLE OR IN PART, DIRECTLY OR INDIRECTLY IN, INTO OR FROM ANY JURISDICTION WHERE TO DO SO WOULD CONSTITUTE A VIOLATION OF THE RELEVANT LAWS OR REGULATIONS OF SUCH JURISDICTION.
4 March 2024
Custodian Property Income REIT plc
(the “Company” or “CREI”)
Update on recommended all-share merger with abrdn Property Income Trust Limited (“API”) (the “Recommended Merger”)
CREI Board reaffirms its conviction that its Recommended Merger with API remains the optimal outcome for shareholders in both companies
Further to the previous announcement by the board of directors of CREI (the “CREI Board”) on 22 February 2024 regarding the recommended all-share merger of API and CREI, the CREI Board provides an update reaffirming its belief in the compelling strategic and financial rationale of the Recommended Merger. The CREI Board also notes the announcement by Urban Logistics REIT (“ULR”) on 20 February 2024 regarding its indicative share-for-share offer for API (the “ULR Indicative Offer”) and sets out below what it believes are the key factors API Shareholders should consider when assessing the credibility of the ULR Indicative Offer and future of the API business.
Summary highlights:
API has already recommended the Recommended Merger following a comprehensive review of strategic options
As detailed in the Recommended Merger Announcement, in light of the challenges faced by API, including its relatively small scale and low level of dividend cover, the API Board undertook a comprehensive review of strategic options in Q3 2023. During this review, the CREI Board was in discussions with API Board and had been over the course of several months. Having assessed a wide range of options in detail, the API Board provided API Shareholders with a unanimous recommendation of the Recommended Merger over alternative strategic options which the CREI Board expects would have included a managed wind-down.
The CREI Board remains firm in its agreement with the outcome of the API Board’s review and continues to believe that the Recommended Merger would bring together two complementary portfolios, with aligned strategies to create a differentiated REIT benefitting from enhanced diversification, share liquidity, a fully covered and sustainable dividend for the Combined Group's shareholders. The CREI and API Boards set out the background to, and reasons for, the Recommended Merger in previous documentation, which can be found here https://custodianreit.com/proposed-all-share-merger-with-abrdn-property-income-trust-limited/.
Conclusion
The CREI Board strongly advises API Shareholders not to take any action with regards to the ULR Indicative Offer and to vote in favour of the Scheme at the API Court Meeting and API General Meeting, adjourned to 20 March 2024.
A video briefing in support of this announcement is intended to be published on CREI's website, https://custodianreit.com, in the coming days.
Enquiries
Further compelling rationale
The CREI Board sets out further rationale below to support the Recommended Merger over alternative strategic options available to the API Board, including the ULR Indicative Offer and a managed wind-down.
Superior offer valuation of the Recommended Merger
On an undisturbed basis6 and using the closing prices per CREI Share and per ULR Share of 72.7 pence and 116.6 pence respectively on 1 March 2024 (being the last Business Day prior to this announcement), the Recommended Merger implied offer valuation is superior to the ULR Indicative Offer, as set out below.
Implied offer values
Over the twelve months prior to the Recommended Offer Announcement1, CREI traded at an approximate 11% discount to its published NAV versus ULR which has traded at an approximate 27% discount to its published NAV2. The CREI Board believes that the current CREI share price materially undervalues the Company and the short-term volatility is not reflective of the expected medium and long-term value of the Recommended Merger for the Combined Group. The CREI Board is therefore confident in the potential for the Combined Group to re-rate back to the historical premium share rating of CREI and, over time, to trade at an improved rating following completion of the Recommended Merger.
The Company was granted Shareholder authority to repurchase CREI Shares at the 2023 AGM and the Company confirms, in accordance with the disclosure in CREI's Combined Circular and Prospectus, that the Company may seek to address any significant discount to NAV at which the CREI Shares continue to trade by purchasing its own shares in the market on an ad hoc basis. Investors should note that the repurchase of CREI Shares is entirely at the discretion of the CREI Board which would exercise its authority to buy back CREI Shares only if it believes it would result in an increase in earnings per CREI Share or an increased NAV per CREI Share (or both) and would be likely to promote the success of the Company for the benefits of CREI Shareholders as a whole.
CREI and API have complementary strategies
Based on API’s stock market announcements and published investment policy, the CREI Board believes that API Shareholders invested in API on the basis that they desired access to a generalist UK property portfolio, diversified across sectors, with an income-focused strategy that is primarily achieved through exposure to below institutional sized assets. This approach is highly aligned with CREI and its intentions for the Combined Group. The CREI Board considers that the enhanced diversification of the combined portfolios will allow the Combined Group to better contend with the significant challenges facing the wider real estate sector which the CREI Board believes continue to impact investor sentiment, real estate capital values, transaction volumes and equity market liquidity, and which the CREI Board believes would pose a significant risk to a specialist portfolio, like ULR.
Based on ULR’s stock market announcements and published investment policy, the CREI Board believes that ULR shareholders invested in ULR on the basis that they were targeting a ‘pure play’ on exposure to logistics real estate, acquiring only ‘last mile’ assets which are well located close to urban areas7 and the ULR Indicative Offer states the combined group would “focus on the last-mile / last-touch mid-box area of UK logistics”. The ULR Indicative Offer also references the retention of API’s retail warehouse portfolio and the CREI Board notes that none of ULR’s half year report for the six months ended 30 September 2023 dated 9 November 2023, its Annual Report for the financial year ended 31 March 2023 dated 22 June 2023, or its published investment strategy mention an intention to invest in this asset class.
The CREI Board notes the API portfolio weighting to industrials is only 48% (as a % of API's portfolio by income as at 31 December 2023)8. The ULR specialist investment strategy for the combined group therefore would reflect a material divergence from the current API strategy. The CREI Board notes that this strategic shift would result in API Shareholders being invested in a strategy that is different from the strategy which they specifically invested in API to achieve.
The CREI Board considers the continued diversified approach of the Combined Group to be a fundamental attraction of the Recommended Merger and one that would be a key differentiator for the Combined Group amongst the wider sector of LSE listed REITs. The CREI Board believes the challenges the wider listed property sector has faced over the last 18 months highlight the merits of CREI's differentiated approach and operational robustness, which has contributed to CREI's strong historical performance relative to its peers9.
The Recommended Merger is a superior income proposition for API Shareholders with a 7.3% uplift in dividend
In the view of the CREI Board, CREI and API share an income-focused investment strategy with an emphasis on regional, below-institutional sized assets that are well-positioned to capture the rental growth and yield advantage available in order to generate higher income returns and capital growth for shareholders. CREI currently pays a quarterly dividend at an aggregate annualised level of 5.5 pence per share (representing a 5.9% yield on NAV10) which is fully covered by recurring earnings, with cover of approximately 102% for its financial year to 31 March 202311. Following the Recommended Merger, CREI is expected to continue paying a fully covered quarterly dividend in line with CREI's existing policy and practice since IPO, which would result in a 7.3% uplift in annual dividends payable to API Shareholders4. ULR currently pays a semi-annual dividend at an aggregate annualised level of 7.6 pence per share12 (representing a lower yield on NAV of 4.7%13) which is not covered by recurring earnings, with cover of approximately 91% for its financial year to 31 March 202314. The CREI Board notes that continuation of the existing ULR dividend policy following completion of the ULR Indicative Offer would imply a 10.9% reduction in annual dividends payable to API Shareholders which would continue to be paid on an uncovered basis, and a 20.4% reduction compared to annual dividends expected to be payable to API Shareholders following the Recommended Merger. Furthermore, the ULR Indicative Offer includes a 2.45 pence per share special dividend payable to ULR shareholders for the 3-month period to 31 December 2023. This payment reflects a greater than pro-rata dividend expected for the relevant period which API Shareholders would not benefit from as it is payable only to existing ULR shareholders15.
ULR’s near term refinancing requirements present a clear risk to earnings and dividend growth The two principal drivers of earnings per share in a property investment company are rental income and cost of debt. The CREI portfolio delivered an EPRA topped up net initial yield (“NIY”)16 of 6.4% as at 30 September 2023, which is comfortably in excess of its weighted average cost of debt of 4.2%17, thereby enhancing earnings. The near-term expiry of fixed rate debt at CREI is limited to a £20m fixed rate loan that expires in 2025. The CREI Board believes that based on current gilt rates it would be possible to re-finance this quantum at a rate below the EPRA topped up NIY of the portfolio, which would maintain the aforementioned accretion to earnings.
By contrast, the ULR portfolio delivered an EPRA topped up NIY of only 5.0% as at 30 September 2023, which is also in excess of its weighted average cost of debt of 4.1%18, thereby enhancing earnings albeit insufficiently to cover the prevailing rate of dividend. The near-term finance cost risk of ULR also occurs in 2025 when its £151m term loan facility and associated interest rate swaps expire. This is a significantly greater amount of borrowing that needs to be refinanced and potentially hedged and the CREI Board believes that based on current re-financing rates this would present a risk to the earnings of ULR given that it is likely that a market rate hedge for this portion of ULR’s debt would be at a higher rate than the EPRA topped up NIY of 5.0%.
Potential value erosion from “value optimising” asset disposals
The CREI Board believes the continuation of its diversified approach will allow the Combined Group to undertake sales and acquisitions across all sectors, in line with the ongoing routine disposal programmes of both companies, where and when there are opportunities to optimise shareholder value, as evidenced by CREI’s most recent disposal update on 28 February 2024. The CREI Board believes this will prevent potential value erosion from required sale of assets in the near or medium term, where conditions may be suboptimal for such activity in certain sectors of the market.
In contrast, the ULR Indicative Offer is stated to involve a “value optimisation approach for all of the assets outside Logistics and Retail Warehouses” and such assets represented 41% of API’s portfolio by income as at 31 December 20238. Given the current challenging conditions for the UK real estate sales market, the CREI Board believes that such an approach would be unlikely to maximise value for API Shareholders, particularly by reference to the office sector which comprised approximately 25% of API’s portfolio by income as at 31 December 20238.
Furthermore, the CREI Board notes the estimated rental value of the API portfolio is £7.0m above the current contracted rent, representing significant reversionary potential in the portfolio19. The CREI Board expects a sector-led disposal programme of API assets by ULR to restrict the extent to which API Shareholders would be able to capture this potential latent value.
Significant execution risk in the ULR Indicative Offer
The CREI Board believes the ULR Indicative Offer introduces material execution risks for API Shareholders, including:
Material change in investment strategy for ULR shareholders – the CREI Board notes that 52% of the API portfolio (as a % of API's portfolio by income as at 31 December 20238) does not represent industrial properties and therefore is not within the scope of the ULR published investment policy20. Furthermore, the ULR Indicative Offer suggests that following the transaction, the ULR strategy will not solely focus on industrial properties but will also incorporate retail warehousing (noting the change to investment strategy retail warehousing presents in itself referred to above). The CREI Board believes execution of the ULR Indicative Offer is therefore likely to require a material change to ULR’s published investment policy to broaden its remit beyond industrials assets only, which will require FCA and ULR shareholder approval. In contrast the Recommended Merger is within the scope of CREI’s investment policy and CREI only requires its shareholders to vote in favour of the single share allotment resolution to be proposed at the adjourned CREI General Meeting to implement the Recommended Merger.
Cost and transaction risks – The CREI Board considers the additional reciprocal due diligence and documentation requirements in considering and implementing the ULR Indicative Offer would incur unnecessary significant additional costs for API Shareholders, particularly given that the Recommended Merger followed a thorough strategic review of API's options by the API Board. Furthermore, the CREI Board believes the Recommended Merger represents a superior strategic and financial fit for API Shareholders in comparison to the ULR Indicative Offer. The CREI Board believes that further execution risk will be introduced through the requirement for extensive shareholder documentation, including the potential requirement for a prospectus and circular from ULR, significant additional transaction costs and the requirement for ULR shareholder approvals.
API shareholder returns potentially available from a managed wind-down of API are inferior to those from the Recommended Merger
The CREI Board believes that the API shareholder returns potentially available from a managed wind-down of the API portfolio are inferior to those from the Recommended Merger, with the managed wind-down potentially involving the following:
Value erosion from the sale of assets in the near term where conditions may be suboptimal for such activity. Consistent with the above observations about the asset disposals in the ULR Offer, the CREI Board believes that current and anticipated market conditions are not conducive to a wholesale programme of disposals, with the offices sector being a particular area of concern. While the CREI Board acknowledges that the property market is cyclical and an orderly managed wind-down may therefore over time be seen as a route to fair value, it believes that the below-institutional sized property segment in which API’s portfolio is invested does not tend to benefit from the early stages of a cyclical recovery phase. Typically, this segment of the market is dominated by debt funded buyers, so the CREI Board would not consider it an optimal time to dispose of properties until interest rates have fallen and commercial property debt costs look more attractive. Additionally, operating such a programme for API as a public investment company may be particularly challenging given its transparency to the market and the likelihood therefore of opportunistic buyers seeking to extract value.
Potentially prolonged process. The CREI Board anticipates that a prolonged period would be required for a wind-down to deliver material distributions to API Shareholders. Factors in this assessment include the practical processes to realise assets even where such assets are deemed saleable (including preparation of property for sale, appointment of agents, coordination of auction process, and completion conditions including financing), the requirement for a market recovery in respect of certain sectors to which API’s portfolio is significantly exposed, and the fact that distributions to API shareholders are likely to require consent from API’s bank lender given that API’s £85 million term loan is due to expire in 2026 or would have been refinanced before a managed wind-down is completed. Additionally, the CREI Board anticipates that API would through a wind-down process be exposed to increasing portfolio concentration with a growing focus over time on a rump of residual assets which, often regardless of their ability to produce income, have proven unsaleable for fair value.
Potential for reducing income in the medium term. The CREI Board anticipates that this could occur, for example, due to an increasing expense ratio as the costs of administrating a public company are to a significant extent fixed, and also earnings being depleted by proceeds of disposals being used to pay down attractively priced debt. API’s current disposal pipeline is estimated to be sufficient to repay the majority of its relatively expensive RCF21, and the CREI Board believes that this may act as an impediment to significant capital returns in the meantime as disposal proceeds will likely need to be retained to maintain loan covenant compliance.
The CREI Board believes that the above are explanatory factors for the market trend for property and other alternative asset investment companies which are placed into a managed wind-down process to trade at relatively wide discounts to NAV and for their shares to experience declining secondary market liquidity.
Sources and Bases of Information
Source: ULR annual report (2023) p136.
Important Notices
Numis Securities Limited (which is trading for these purposes as Deutsche Numis) ("Deutsche Numis"), which is authorised and regulated by the Financial Conduct Authority in the United Kingdom, is acting exclusively for CREI and for no one else in connection with the Recommended Merger and/or any other matter referred to in this announcement and will neither regard any other person as its client nor be responsible to anyone other than CREI for providing the protections afforded to its clients or for providing advice in connection with the Recommended Merger, the contents of this announcement, or any other matters referred to in this announcement. Neither Deutsche Numis nor any of its affiliates owes or accepts any duty, liability or responsibility whatsoever (whether direct, indirect, consequential, whether in contract, in tort, under statute or otherwise) to any person who is not a client of Deutsche Numis in connection with this announcement, any statement or other matter or arrangement referred to herein or otherwise.
Further information
Capitalised terms used in this announcement, unless otherwise defined, shall have the meanings given to them in the Scheme Document in relation to the Recommended Merger published by API on 1 February 2024.
This announcement is not intended to and does not constitute an offer to sell or the solicitation of an offer to subscribe for or buy or an invitation to purchase or subscribe for any securities or the solicitation of any vote in any jurisdiction. No person should construe the contents of this announcement as legal, financial or tax advice. If you are in any doubt about the contents of this announcement or the action you should take, you are recommended to seek your own independent financial advice immediately from your stockbroker, bank manager, solicitor, accountant or from an independent financial adviser duly authorised under FSMA if you are resident in the United Kingdom, or another appropriately authorised independent financial adviser, if you are in a territory outside the United Kingdom. The release, publication or distribution of this announcement in jurisdictions outside the United Kingdom may be restricted by law and therefore persons into whose possession this announcement comes should inform themselves about, and observe such restrictions. Any failure to comply with such restrictions may constitute a violation of the securities law of any such jurisdiction. | ||||||||||||||||||||||||||