Brief USA: Trade War Takes Its Toll and more

In this briefing:

  1. Trade War Takes Its Toll
  2. Telford Homes Takeout – A Disappointing End?
  3. Medallia Inc IPO Preview
  4. MergerTalk: Natura & Co/Avon Products -“Ding Dong, The Avon Spread Calling”
  5. Singapore REIT – Cautious Search for High Yield

1. Trade War Takes Its Toll

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The strength of the dollar and the US-China trade war have taken their toll on the world economy The erosion in global US dollar purchasing power is translating in weaker demand for Asian exports. The easing of US-China trade tensions following the G20 meeting is welcome. However, of equal importance is where the US dollar heads from here. The biggest risk here is that the ECB and the BoJ expand extraordinary monetary policy measures, and in doing so spark another round of competitive devaluation by non-US dollar areas and a further erosion in global US dollar purchasing power

2. Telford Homes Takeout – A Disappointing End?

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On July 3rd, US-based commercial real estate services company, CBRE Group Inc A (CBG US), announced that they had reached an agreement with the board of London-based residential real estate developer, AIM-listed Telford Homes (TEF LN), to acquire 100% of the shares of Telford Homes by way of a Scheme of Arrangement at a price of GBP3.50 per share. The offer values the target at a market cap of GBP 265 million. 

While the Offer Price translates to premia of 11.1%, 14.3%, and 21.3%  to the undisturbed price, 1-month VWAP and 3-month VWAP respectively, it remains 3.4% lower than the 1-year VWAP of Telford shares. Furthermore, the offer price also translates to discounts of 28.8% and 38.8% to the stock’s 1-year and 2-year highs respectively.

The urban Build-To-Rent market in the UK is less well-established than the market in the US, which has grown rapidly in the last couple of decades. If you were a big international player in the real estate brokerage and rental space, this might be an attractive opportunity for vertical expansion in the UK.

Although the offeror has basically stated that, unless there is a competitive bid, “the Acquisition Price is final and will not be increased”, Telford’s shares have been trading through terms at GBP and yesterday closed at GBP3.53. But the devil is always in the details. 

The Scheme requires the approval of 75% shareholders and Merger control approval from the European Commission, which should not be problematic. In the absence of any competitive situation, the Scheme is “expected to become Effective during the third quarter of 2019.” 

3. Medallia Inc IPO Preview

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  • Medallia Inc (MDLA US) is an enterprise software company in the US which is expected to complete its IPO in the US in the next two weeks. The IPO price range is between $16 and $18 per share and is expected to raise up to $240 million.
  • The company uses proprietary AI technology to analyze various data from customers and employees for better understanding the customer experience as well as how employees conduct their duties daily. 
  • Qualtrics and Survey Monkey are key competitors to Medallia. Qualtrics was preparing for an IPO last year but was acquired by SAP in November 2018.
  • Medallia generated sales of $313.6 million in FY2018, up 20.1% YoY. Its sales accelerated in 1Q19 when it had sales of $93.6 million, up 32.5% YoY. Most importantly, the company significantly reduced its operating losses in 1Q19 when it achieved an operating margin of -2.2% versus -38.3% in 1Q18. This tremendous improvement in operating margin was driven by higher gross margins as well as lower total operating expenses as a percentage of sales. 

4. MergerTalk: Natura & Co/Avon Products -“Ding Dong, The Avon Spread Calling”

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Brazilian Beauty Products Group Natura & Co’s (NATU3 BZ) agreed offer for  the  one time iconic but long-time struggling Avon Products (AVP US) has created an interesting opportunity. The prevailing 14% merger spread and the acheivable early 2020 deal close target combine to create a potentially lucrative prospect for arbs.

We believe that transaction risks associated with prospective merger are, but there is one  complicating factor, which we think is the main explanation for the magnitude of the spread at this time.  NATU3 is listed on the Brazilian Stock exchange (B3) and denominated in an historically volatile currency, the Brazilian Real, while AVP shares trade on the NYSE in US$.   While NATU3 will offer AVP shareholders the option to receive NATU3 shares in the form of Level-II ADRs to be traded on the NYSE or shares listed on B3 on completion of the transaction, NATU3 does not  have an ADR in issue at this time, meaning the volatile BRL/USD rate becomes an important variable of which to take account in any arb strategy. 

That said, and ignoring the availability of hedging mechanisms, our assessment indicates that the  current merger spread offers respectable double-digits IRR outcomes in the 11%-25% range for arbs even if the Brazilian Real were to depreciate by up to 5% against the US$ (as indicated by forward rates) over the next 6 to 9 months, the time period  during which the transaction is expected to close.

5. Singapore REIT – Cautious Search for High Yield

The Singapore REITs (SREIT) sector continued its outperformance since our April report Singapore REIT – The Draft Master Plan 2019 Boost and Q1 Scorecard.Year-to-date, the Singapore Industrial REITs gained the most by about 21%, followed by the Retail (+19%) and Office (+18%).  The REIT sector’s outperformance was mainly led by the large cap REITs, which currently trade at close to an all-time high based on valuations. Nonetheless, we remain positive on the sector in view of the dovish interest rate outlook which sustains yield-accretive acquisitions due to lower costs of capital. The recent proposal by the MAS to review gearing limits and streamline fundraising process to provide SREITs with better flexibility in managing their capital structure could further drive acquisition growth prospects for the sector.  

We have recalibrated a list of our preferred picks based on the same criteria of attractive valuation and acquisition pipeline/growth potential. Our top picks, which tend to carry higher risks than our larger cap REITs in the full list, are Frasers Commercial Trust (FCOT SP), Sasseur REIT (SASSR SP) and ESR-REIT (EREIT SP).

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