Hey, dividend investors! Welcome back to ‘The Dividend Uncle’. Today, I’m going to do something a bit different, something that might even risk me facing the wrath of the investing community. You see, every news article, blogger, and YouTuber out there seems to be raving about the proposed acquisition of ION Orchard by CapitaLand Integrated Commercial Trust or CICT. And they’ve got good reasons too. But today, I’m going to flip the script and focus purely on the downsides and things to dislike about this deal.

Don’t get me wrong, I still like this acquisition, and I’ll likely be supporting it at the EGM. as an investor. But we all know there’s no such thing as a perfect deal. And as your friendly neighborhood Dividend Uncle, it’s my job to give you the full picture, warts and all, so you can make a well-informed decision.

So, if you want to hear about all the glowing praises, I’ll leave it to you to watch those other videos or read those articles. Here, we’re diving deep into what you might not like about this acquisition.

Now, if you appreciate videos that aren’t afraid to dig into the less popular perspectives, then do me a favor and hit that ‘like’ button. And if you haven’t already, keep a lookout for the latest posts in this website, and subscribe to my YouTube channel, for more no-nonsense takes on REITs and dividend stocks. Think of it as a small ‘reward’ for me, taking the risk of “getting scolded” by both the investing community and REIT managers to give you the complete picture!

Before we dive in, I must let you know that this content is for informational and educational purposes only and does not constitute financial advice. The opinions expressed are based on publicly available information and personal analysis, and they are not tailored to your specific financial situation. The REITs and institutions mentioned are cited purely as examples. While I have no affiliations, sponsorships, or financial relationships with any of them, I may personally hold positions in some of the investments discussed. Before making any investment decisions, you are strongly encouraged to consult a licensed financial adviser.

With that out of the way, buckle up folks, and let’s get into it!

What to Dislike About the ION Orchard Acquisition

Alright, let’s kick off with the concerns.

1) Pay Up or Be Diluted

Now, the most glaring downside of this deal is the equity fund raising. We’re talking about a whopping $1.1 billion acquisition, and guess what? It’s going to be funded entirely by equity, that is zero debt. For those who aren’t so familiar, for REITs which pay out almost all of their earnings, that means existing investors like you and me will have to put up more money or face dilution.

In simple terms, “dilution” means that if you don’t take up your share in this new equity offering, your percentage ownership in CICT. will shrink. The rights issue is on a pro-rata basis of 56 new units for every 1,000 units you hold. So, you’d need to cough up an additional 5.6% of the value of your current holdings. And let’s face it, if you’re a cash-strapped or retired investor, this could be quite the blow.

But here’s the other side of the story. The base price for this preferential offer is around $2, which, if you look at a 5-year price chart, is historically considered quite low, right below the average of $2.07. The management is making a shrewd and calculated move here by going for a full equity deal. Why? Because interest rates are still high right now, but they’re expected to fall soon. And with share prices not having gone up that much, raising equity at this point is more cost-effective. Plus, by doing this, the gearing ratio stays under 40%, which is a comfortable threshold for us as investors.

And for those who do get diluted, it’s not all bad news. Even if your ownership percentage shrinks, the proceeds from the acquisition could enhance the value of the overall portfolio, potentially leading to capital gains and more stable income in the long run.

2) Small Accretion and the Lack of NPI Yield Details—A Red Flag?

Alright, let’s move on to accretion. For those of you hoping for a big bump in dividends, brace yourselves. The distribution per unit or DPU accretion for the first half of 2024 is only 0.9%. What does that mean? If you were getting $1,000 in dividends from C.I.C.T., after this deal, you’d be getting $1,009. Not exactly life-changing, right? This could indicate that CICT might be acquiring ION Orchard at a price that isn’t the most attractive.

What’s more concerning is that the presentation slides mention a gross yield of 7.1%, but they don’t give us the Net Property Income or NPI yield, which is usually a key metric in these kinds of deals. Based on standard benchmarks where NPI is about 70-75% of gross revenue, we’re looking at an estimated NPI yield of around 5%. Not bad, considering that Frasers Centrepoint Trust purchased NEX mall at an NPI yield of 4.8%.

However, if you think about it, keeping up the high-end image of ION Orchard might require more expenses than your average mall. That could mean lower net yields. As an investor who has been around for a while, I remember when Frasers Centrepoint Trust first launched, and everyone asked why Centrepoint Mall in Orchard wasn’t included. They said the yield wasn’t attractive enough. It’s been over a decade, and Centrepoint still isn’t part of the portfolio. Maybe there’s something about Orchard Road malls and their lower NPI yields.

In my view, this is where CICT becomes a victim of its own success. It’s grown so big that even a $1.1 billion acquisition barely moves the needle. We won’t know the exact NPI yield until the preferential offering circulars come out. But given that CICT’s current dividend yield is around 5.1% and ION Orchard is said to be yield-accretive, I’m cautiously optimistic that the NPI yield won’t be too shabby.

3) High Acquisition Fees That Benefit Managers, Not Investors?

Next, let’s talk about the acquisition fees. This deal comes with a $25 million acquisition fee and associated expenses. And guess who’s footing that bill? That’s right, us, the investors. This is money that’s coming out of our hard-earned cash and going straight into the pockets of the REIT managers, lawyers, and accountants. Not exactly music to our ears, is it?

But here’s another way to look at it. While $25 million sounds like a lot, it’s actually only about 2.3% of the $1.1 billion deal. That’s actually less than the commissions we’d typically pay when buying our own homes. This fee can be seen as a necessary incentive for management to bring quality deals to the table.

But of course, we’ve got to stay vigilant. If management starts stuffing their pockets with fees from lousy acquisitions, that’s when we need to start worrying. With this proposed acquisition of a quality asset though, I think the folks at CapitaLand did well!

4) Volatile Tourism Spending vs. Stable Suburban Mall Appeal

Now let’s talk about a different kind of risk—one that comes with relying heavily on tourism. Orchard Road, where ION Orchard is located, is known as a shopping paradise for tourists. But here’s the catch: tourism spending is often volatile. It’s great when the good times roll, but during downturns, pandemics, or geopolitical tensions, tourism can dry up faster than your wallet at ION Orchard.

On the flip side, suburban malls, which cater more to local residents, tend to be far more resilient. A great example of this is Frasers Centrepoint Trust, which owns a portfolio of well-regarded suburban malls. Frasers Centrepoint Trust’s unit prices are known for being stable and resilient because local spending is far more consistent. Even in tough times, people will still go to their nearby malls to pick up essentials, dine out, or meet friends. This inherent stability is what makes suburban malls so appealing to many investors.

Now, some might argue that the tourism sector is still on the road to recovery, especially after the initial surge in “revenge traveling” following the pandemic. However, there are already signs that this rebound is tapering off. For example, tourist arrivals in Singapore have been slowing down according to recent reports. This indicates that we might not see the same level of robust tourism growth going forward as we did immediately after Covid-19.

However, here’s where the story gets interesting for CICT. As the largest REIT in Singapore and often seen as a bellwether for the entire property market, adding an iconic mall like ION Orchard could actually be a smart move. While ION Orchard, on its own, might experience more volatility due to its reliance on tourism, when it’s part of CICT’s massive and diverse portfolio, the volatility could be significantly smoothed out. This is because CICT’s portfolio includes a wide range of assets, from commercial properties to suburban malls, that generate more stable, recurring income on a portfolio basis.

The Dividend Uncle’s Take

So, there you have it, four things to dislike about CICT’s proposed acquisition of ION Orchard. I know this perspective might not be the most popular one out there, and I might even face the flak for it! But someone’s gotta take the plunge to give you the full picture.

Despite all these potential downsides, I think there’s value in this acquisition. Yes, there are risks, but the potential for long-term gains is there. If the ION Orchard acquisition fits into your overall strategy and you believe in CICT’s management, it could still be a good move. Just make sure you weigh all the pros and cons before making your decision.

As always, remember to do your own research and make the choice that aligns with your investment goals. Until next time, happy investing!

[Post publication updates: Managed to link up with CICT’s management and they very kindly clarified on the following:
1) The NPI yield for ION Orchard will not be published in the EGM Circular, but they noted that my estimated NPI yield of around 5% above is roughly there. This would make the acquisition rather attractive.
2) The rental reversion for downturn and suburban malls in CICT’s portfolio are above 9.0% for 1H 2024, and they expect the full year to be positive high single digit %. This underlying operational performance is quite good.
3) There are no known new retail supply in Orchard Road.]