What’s in the news?

• ART will acquire all the issued and paid-up stapled units in AHT (not rated) for a consideration of S$1.0868 per share. Purchase consideration will be S$0.0543 per share in cash and 0.7942 units of ART.
• Consideration is based on a gross exchange ratio of 0.836x price to NAV and represents a 7% premium to AHT’s NAVPS and a 32% premium to 12-month VWAP.
• Combined entity will have an AUM of S$7.6bn (+33%) and more than 206,000 keys under management across 15 countries.
• The proposed merger is subject to shareholder votes at respective EGMs to be convened in October 2019. Both trusts require a 50%+1 vote majority (an additional requirement of ≥75% votes for AHT), from which ART and AHT affiliated unitholders will abstain from voting.

The Positives

• Proposed ART-AHT merger to be 2.5% DPU accretive and NAV neutral. The combination will see the injection of 14 income producing assets into the trust which lends a 2.5% DPU accretion for ART unitholders (DPU +1.8% for AHT).

• Enlarged portfolio into APAC with debt headroom of c.S$1bn. The diversification, growth and stability story remains intact. 66% of the middle-class population will be represented by Asia and ART’s increased presence in APAC (71%) will allow ART to capture the growth in disposal income and travel associated with this demographic. The portion of profit sourced from stable lease types (master lease and management contracts with minimum guaranteed income (MCMGI)) will increase by 400bps to 46%.

• Combined entity will be the largest hospitality trust in APAC and eighth largest trust globally, facilitating index inclusion. The enlarged trust will have better pricing power on their cost of borrowing and the increased market capitalisation helps the trust to meet the investable market cap criteria for inclusion into the FTSE Nareit Developed Index. 100% of earning from AHT assets are derived from development markets, putting ART’s earning from developed market post-combination at 82%, well above the 75% minimum for index inclusion. This is a positive externality of the increased size, which adds to the merit of the deal. The free float of the combined entity is expected to increase by c.50%.

The Negatives

• Increased exposure to soft markets, Australia (+9ppts) and Japan (+5ppts). These two geographies face substantial room supply coming onto the market in the next three years which will add downward pressure to ADRs. The addition of AHT’s assets to the portfolio will increase ART’s presence from 14 countries to 15 countries but the concentration risk in the top four geographies has increased marginally from 47% to 51%, with greatest exposure to soft markets Australia (18%) and Japan (18%).

  All six of the assets in Australia are under management contracts and dependent on the profitability of the hotels. All five hotels in Japan are operating under a master lease and have a minimum base rent with a variable component. Despite the supply coming online, Japan hotels will still stand to reap the potential upside from the 2019 Rugby World Cup and the 2020 Olympics, while remaining protected by fixed rents post 2020.

Outlook

Immediate DPU accretion is a strong case for the combination of ART-AHT. The combination will result in a more geographically diversified entity, positioned to capture growth in APAC markets. Inclusion in the FTSE Nareit Index will be the cherry on the top.

Downgrade to ACCUMULATE, unchanged target price of $1.36.

We downgrade our call to ACCUMULATE due to the recent appreciation in the share price. This translates to a dividend yield of 5.5% and a FY19e P/NAV of 0.88. No change in our target price as the transaction is still pending shareholder approval.