CityDev, Suntec Reit settle $788m dispute

CITY Developments (CityDev) and Suntec Reit have settled their dispute over an aborted $788 million property deal.

In 2005, CityDev rejected Suntec Reit’s move to terminate the deal under which Suntec Reit was to have bought 11 properties from CityDev for $788 million. Suntec Reit called off the deal on grounds that it could not obtain regulatory approvals in time to convene an extraordinary general meeting of unit-holders.

Yesterday, Suntec Reit trustee HSBC Institutional Trust Services (HSBCIT), Suntec Reit manager ARA Trust Management and CityDev and its subsidiaries entered into a settlement agreement under which HSBCIT will get a refund of $5 million, being the total of various deposits it made. CityDev will be paid all the interest earned on each deposit. The payments are expected to be made to HSBCIT and CityDev by tomorrow.

The parties said that the terms of the settlement agreement constitute full and final settlement of the matter without admission of any liability by the parties.

Valuation not compelling

Results are in line. Suntec REIT reported its 1Q07 revenue at S$45.9m; +16.5% YoY and +2% QoQ. Distributable income was equally strong at S$27.0m; +21.7% YoY and +9% QoQ. DPU came in at 1.963 cents; +14.5% YoY and +8.5% QoQ. Growth in earnings was mainly attributed to the acquisition of 12,045sf in Suntec strata office space. This was supplemented by higher rentals from increased office occupancy at Suntec City, higher passing rents of retail space as well as additional incomes from more intensive use of space. Suntec also managed its cost well with cost to income ratio at 24%, as compared to 28% in 1Q06 and 25% in 4Q06. The results are in line with our estimates.

Outlook remains positive. Suntec continues to benefit from the buoyant office/retail market. Going forward, a substantial portion of its space is coming up for renewal. Suntec’s office portfolio will see about 16% of space up for renewal in 2007, and a further 32% leases up for renewal in 2008. For the retail side, about 16% of space is up for renewal in 2007 and a further 34% of space is up for renewal in 2008. All these renewals are likely to be the key drivers to earnings over the next 2 years.

Continues to acquire strata space. Last year Suntec revealed its intention to acquire all the strata office space that it does not own in Suntec City. To date, it has bought about 26,426 sf of the strata space at about $1,335psf, which has a total value of S$35.5m at property yield of about 4.4% (assuming no gearing). We believe there is no financing issue, as Suntec had earlier placed out about 120m new units at S$1.50. It potentially has a war-chest of about S$300m, assuming that it gears up to 40% for the new acquisitions. Assuming that it manages to buy more space at the same value (i.e. S$1,335psf), we estimate it can acquire about 197,752 sf of space. The issue is whether strata owners are willing to sell out. We estimate there to be over 1.0 m sf of strata space not owned by Suntec.

Raised fair value to S$1.82. In light of the recent high valuation achieved for office and retail space, we have revised up our fair value for Suntec from S$1.57 to S$1.82. At current trading range, the investment case for Suntec is not compelling; its price to book ratio is 1.33 times, and DPU yield is just above 4%. Thus, we maintain our HOLD rating on Suntec.

Its office story has been fully priced in

● SUNT is favoured for its exposure to the rising office market given that 87% of its office leases are due for renewal in FY07-09, of which close to 91% of leases up for renewal are paying ~S$4.10psf against the recently achieved S$6.50 – 8.00psf.

● SUNT purchased 2.5% of its 1.05mn sq ft of Suntec office strata unit acquisition target at a 5% property yield. In our forecasts, we have assumed the entire 1.05mn sq ft to be purchased by end-FY2010.

● The first instalment of 34.5mn of the total 207mn deferred units, part of its purchase settlement at IPO, is due in June 2008. As the deferred units are not subject to any lockup period, there could potentially be a share overhang. Including the deferred units, SUNT’ DPU yields are lower at 3.7-4.4% versus the 4.3-4.8%.

● Our new target price of S$1.81 is based on a lower FY07-09 average required yield of 4.2%, and is supported by our DCFvalued NAV of S$1.74 or S$1.55 on a fully diluted basis. Downgrade to a NEUTRAL from Outperform.

Comment on Results
Suntec reported results slightly below expectations, delivering 1.963 cents for 1Q07 which grew by 14% y-o-y. Revenue grew 16.5% y-o-y, mainly due to full recognition from Park Mall and Chijmes as well as organic growth of office and retail portfolio. Office revenue grew 18.3% while retail revenue grew 15.6%. Stripping out growth through acquisitions, organic growth attributed to 14.5% and 4.7% for the office and retail portfolios respectively. With lower maintenance offset by higher property tax and property expenses, net property income grew by 21.7% y-o-y. Mitigated by rising interest costs, distribution income grew by 21.7% yo-y to S$27m. Note that for 4Q06 distribution, 0.762 cents for the period 1 October to 5 November 06 has already been distributed on 29 November 06.

Outlook
We continue to like Suntec for its exposure to the office sector on the back of bullish fundamentals. Recently, URA reported 4Q06 property market data which reflected office rentals and capital values rising 30.3% and 17% respectively. We expect office rents to continue the upward momentum and Suntec would be a prime beneficiary of spillover demand from tight vacancy in prime CBD. Moving forward, we note that Suntec is likely to enjoy three waves of positive rental reversions for its office portfolio with 92.6% of leases expiring in the next three years. With 21.1% (15.9% YTD to Dec) and 31.9% of office NLA expiring in FY07 and FY08 respectively – currently under-rented at average of low S$4 levels -there would be strong rental kicker in FY07 and FY08 with Suntec office asking rents now at S$8.50-S$9.00.

Recommendation
Despite the lack of visibility on acquisitions without the backing of a sponsor, we continue to like Suntec for: i) Its office exposure which is currently underrented ii) Retail enhancements well under progress and average retail rents continuing to deliver growth iii) Beneficiary of circle line – once completed in 2010 and for both the Suntec office and retail portfolios iv) kicker in traffic flow with Singapore’s position as major MICE hub and Integrated Resorts. We bring forward our assumption that closing rent will reach S$8 in FY07 from FY08 for Suntec’s office portfolio on the back of strong organic growth. Hence we are raising our DCF valuation for Suntec to S$2.20. Maintain Buy. Key risk to our recommendation include deferred payment in the form of units with full effect by 2011 which we have taken into account in our DCF valuation.