Arrowhead and Gemgrow weigh up merger
Move pleases fund managers who have been calling for consolidation to create larger more liquid companies that can perform in a slow growth economy
A second merger within the space of two weeks has been announced in the listed property sector, pleasing fund managers who have been clamouring for consolidation to improve liquidity and help increase the size of smaller struggling companies.
Arrowhead Properties and Gemgrow have announced an intention to merge, which has pleased to investors who believe Gemgrow’s management has underperformed and that the small fund should not have listed in the first place as it was too illiquid. Fairvest also recently announced its proposed merger with Safari Investments.
The boards of Arrowhead and Gemgrow said that they had agreed in principle to a transaction, which would result in the reverse takeover of Gemgrow by Arrowhead.
Gemgrow is structured into A and B shares, which appeal to investors with different risk appetites. A shares holders, shareholders who tend to be risk averse, have a preferential claim to earnings and are paid their dividends before the B shares investors shareholders are paid. The growth in their dividends is capped at around at the lower of 5% and the prevailing consumer price inflation rate.
Arrowhead owns 53.3% of Gemgrow.
Arrowhead’s CEO Mark Kaplan said he had found that investors liked the option of buying A and B shares and as a result to keep this in place, Gemgrow would be the acquirer of the Arrowhead shares.
Gemgrow would acquire all of the shares in Arrowhead and would issue 0.8237 Gemgrow B shares for every Arrowhead share acquired. Arrowhead would then be de-listed. The combined entity would have a market capitalisation of about R6.8bn based on current share price levels.
"This transaction structure was chosen so that the merged entity will continue to leverage off Gemgrow’s dual-class share structure, which remains a valuable 'differentiator' in the real estate investment trust sector," Kaplan said.
Nesi Chetty, head of listed property at Momentum, said Arrowhead’s share price had risen around 4% following the announcement while the Gemgrow A and B share prices were flat, indicating that a merger would better suit Arrowhead.
“One will need to see what the potential balance sheet synergies between the two companies will be,” said Chetty.
But Indluplace Properties, which was listed with Arrowhead’s residential assets a few years ago, would continue to be listed separately.
Some critics have said that Arrowhead, Gemgrow and Indluplace should merge into one company to avoid paying listing fees and that it should have one focused executive management team.
Gemgrow was listed three years ago out of the consolidation of Synergy Income Fund and Cumulative Properties. Cumulative was formed when Arrowhead spun out its smaller assets into a separate company.
Chief investment officer at Reitway Global, Garreth Elston, said that in hindsight Gemgrow should not have listed.
“With hindsight, it is an easy call to have made that the listings of Gemgrow and Indluplace should not have occurred. However, at the times the listings occurred in 2015 Indluplace and Gemgrow in 2016 it was a less clear, and they did occur during the halcyon days of multiple listings and nonstop capital raising, where very few market participants were raising red flags about the industry,” he said.
Elston said if the economy had seen good growth and robust economic activity, the listings would have naturally been more successful, as in a normal economy they made strategic sense and at the time were the correct option.
“Unfortunately SA’s economic reality negated any benefits rather rapidly,” he said
Since listing, Gemgrow has grown its property portfolio's value from about R4.3bn to R5.6bn. It has sold some of the small assets which were worth less than R100m each and bought higher quality, larger assets. As a result, Gemgrow’s property portfolio is now more closely aligned with that of Arrowhead.
Vukile Property Fund which holds 7.48% of Gemgrow’s A shares and 28% of the B shares, making Vukile Gemgrow’s second largest shareholder, said it would support the proposed merger.
Arrowhead's share price closed 4.37% higher at R3.82 on Wednesday.