ARA Asset Management: Consent the change concerning change of control conditions?

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On 3 November, shareholders of ESR Cayman Ltd (“ESR”) will vote to approve the acquisition of ARA Asset Management Limited (“ARA”). Concurrently, ARA is holding a Consent Solicitation Exercise (“CSE”) to approve changes to the conditions of the change of control event for their perpetual bonds.

The two perpetual bonds in question are the ARASP 5.600% Perpetual Corp (SGD) (Series 004) and ARASP 5.650% Perpetual Corp (SGD) (Series 002). The first change is the replacement of the benchmark rate, which will most likely be the SORA-OIS rate. This change is trivial and we will focus more on the second one.

Figure 1: SGD SOR curve is slightly higher than SORA-OIS curve

Source: Bloomberg Finance L.P., iFAST compilations
Data as of 29 October 2021.

For the second change, ARA will amend Condition 5(f) – the conditions for redemption upon a change of control. The change is as shown:

    “(i) “Change of Control Event” means:

(1)   Mr Lim Hwee Chiang John, The Straits Trading Company Limited, Cheung Kong Property Limited, Warburg Pincus LLP and/or AVIC Trust ESR Cayman Limited, cease to own (whether singly or otherwise) 30 per cent. in aggregate, direct or indirect shareholding interest in the Issuer…”

This effectively circumvents the step-up of 300 basis points (“bps”) upon a change of control, and thus, the perps are likely not to be called. However, there will be no changes for the ARASP 5.200% Perpetual Corp (SGD) which is callable in 19 Jul 2022. If the acquisition of ARA goes through, this ARASP 5.2% perp is almost certain to be called.

Should bondholders consent?

Currently, the two perps are trading extremely close to par and there are very few SGD perps out there that offer a yield-to-call (“YTC”) upwards of 5%. Adding the consent fees, investors’ total return from holding these bonds will slightly increase too.

Figure 1: Other SGD perpetual bonds

We examine ARA’s credit ratios, the pro-forma numbers of ESR post-acquisition and other companies to help us come to a better decision.

Table 1: Credit ratios of other issuers

	ARA	ESR	FPL	AAREIT*
Total debt/asset	30.2%	30.5%	-	28.2%
Net debt/equity	22.9%	34.1%	80.8%	33.4%
Net debt/equity (treating perp as debt)	80.8%	48.2%	94.5%	83.8%
Interest coverage ratio (X)	21.8	5.8	4	4.5
Interest coverage ratio (incl. perp) (X)	8.0	5.3	-	-

Source: Companies’ announcements, iFAST estimates
Data as of 30 June 2021. *AAREIT data as of 30 September 2021.

Using the pro-forma numbers, ESR appears to be in good credit health on a general basis. Here, interest coverage ratio is the trailing 12-month EBITDA/interest expense. However, for ARA and ESR they are based on past six-month numbers.

If bondholders were to vote no and the acquisition goes through, the two perps are supposed to have a step-up margin of 300bps if not called. However, it is unlikely this will happen. Instead, ESR is likely to call the two perps and probably issue new perps for refinancing. The new group will have 1.37b in cash, more than enough to call the three ARA worth about SGD 950m. Then, they will issue new perps where fees will be paid to investment banks instead of consent fees being paid to you, the investors.

We can use the ESRCAY 5.650% Perpetual Corp (SGD) to estimate the coupon rates of the new perps. The perp has an I-spread of 384bps as of 28 October 2021 where the I-spread is the spread between the bond and the interpolated yield from the SGD Swap Offer Rate (“SOR”) curve. As its next call date is in 4.35 years, if we assume ESR issues a new perp callable in 5-years and a 5-year SGD SOR of 1.515%, its coupon rate is likely going to be about 5.3-5.6%, similar to the current YTCs of the two ARA perps. It may even be lower as the acquisition of ARA adds to their earnings and still keeps the gearing ratios at acceptable levels.

Furthermore, if the perps were to be called, alternatives include perps issued by AAREIT, FPLSP, Credit Suisse, Olam International and Societe Generale. We have recent articles on these issuers but their yields fall short to that of ARA’s perps. ARA’s credit ratios are also acceptable and for the yields the perps are giving, they are still worthy of remaining in your portfolio.

So, do vote yes before 5pm on 9 Nov 2021 to collect your early consent fee of 0.4% if you are holding the two perpetual bonds.

Figure 3: Timeline of the CSE

Source: iFAST Financial

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a position in ARASP 5.200% Perpetual Corp (SGD) and ESRCAY 5.650% Perpetual Corp (SGD) and the analyst who produced this report holds a NIL position in the abovementioned securities.

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