A merged Federation will be a formidable force

It was Commonwealth Bank's decision last year to exit the property trust sector and internalise the management of three trusts that opened the door to today's $22 billion merger of Federation Centres and Novion.

Until Novion (formerly CFS Retail) was set free by CBA there were few large-scale opportunities to consolidate a sector dominated by Scentre Group, the re-badged Australasian arm of the Westfield Group.

The restructuring of Novion was completed in March. By October the two big A-REITs were talking after an approach to Novion by Federation's Steven Sewell. It may or may not have been a coincidence, but the approach came a month after speculation that the US retail property giant, Simon Property Group, might have Novion in its sights.

Sewell has re-built Federation -- the old Centro property group -- from an entity with a very solid asset base but a very stressed balance sheet to a group with a market capitalisation approaching $4.25bn.

He was well aware -- and after conducting its own due diligence, Novion concurred -- that there was a unique opportunity to create, not just the second-largest retail property trust in the country but a global top 10 retail property owner.

Despite the disparity in sizes (Novion's market capitalisation is about twice Federation's), the merger is being effected via a Federation scheme of arrangement acquisition of Novion. That suggests the two groups were wary about the potential for a gate-crasher.

The largest securityholder in Novion, and the co-owner of its biggest and best asset, the Chadstone shopping centre in Victoria, is the Gandel Group. Gandel owns 21.6 per cent of Novion and is supporting the merger. That holding, which would translate to a 13.8 per cent interest in the merged entity, would make it difficult for anyone else to disrupt the merger without Gandel's support.

There is strong logic, both strategic and financial, to the merger. It will create a group with more than $22bn of assets under management and a market capitalisation of $11bn. As the third-largest A-REIT of any description that ought to see its securities re-rated while the far bigger and more diverse balance sheet should lower its funding costs.

The groups estimate that there will be total cost savings of at least $84m a year from the combination and enhanced earnings and distributions for both sets of securityholders.

The new entity will have a deeper and more diverse retail property portfolio covering the full spectrum of retail property assets and tenants and a broader geographic spread.

It will also have a $2.5bn development pipeline and a broader range of options, if Sewell pursues the same strategies that he has at Federation, to recycle and release and leverage capital through selective divestments and acquisitions and the introduction of partnerships.

The governance structure for the merged group has been agreed in detail, with Sewell as chief executive and Novion non-executive director, Peter Hay, becoming chairman. Novion's chairman, Richard Haddock, will continue as a non-executive but Federation's Bob Edgar -- a key figure in the rehabilitation of the group -- will depart. Novion's CEO, Angus McNaughton, will also go.

The merger, if Novion securityholders endorse it, is expected to be completed by June. Under the terms of the exchange ratio -- 0.8225 Federation securities for each Novion security -- the enlarged Federation would be owned about 64 per cent by former Novion securityholders and 36 per cent by Federation's existing investors.

In the absence of a spoiler and an unlikely change in stance by Gandel, which has its own interests in Chadstone to protect, it would appear inevitable that the deal will be completed, given the unanimous support of the existing boards and management and the underlying strength of the rationale for that consensus.