One George Street option: raising the risk profile – ALERT

• CapitaCommercial Trust (CCT) granted an option to buy One George Street (OGS) from CapitaLand for S$1,165million, or S$2,600psf capital value. OGS is a prime grade A office building with 447,999sq ft of net lettable area at the edge of the Raffles Place CBD micro-market. As the property is currently significantly under-rented (average base rents are around S$7.40psf per month on our estimates, compared with current spot rents of S$15psf), the prospective vendor CapitaLand will provide yield support to ensure a minimum net property income of S$49.5million per annum, or a 4.25% yield at the purchase price.

• Few details available; more information when circular to unitholders is released in May/Jun 08. CCT intends to fully finance the acquisition with debt and has committed funding lines in place already, according to the REIT manager. Assuming a cost of debt of around 3.5%, we estimate DPU accretion to CCT of about 1.4% resulting from this acquisition, with the trust’s gearing rising from 27% currently to 40%. Our DDM-based net present value for CCT would drop post-acquisition however as the amount of accretion would not compensate sufficiently for the increased leverage on our initial calculations.

• CapitaLand raising another S$1.1billion divestment proceeds in this proposed sale. The OGS transaction is a connected party transaction and CCT’s unitholders will get to approve the acquisition (CapitaLand cannot vote its 30% stake). If approved, the divestment proceeds would raise CapitaLand’s consolidated cash position to over S$5billion on our estimates, putting them in a prime position to tap investment opportunities in an increasingly capital-constrained Asian real estate sector.

Option to buy One George St

First look
CapitaCommercial Trust has obtained an option to acquire One George Street for S$1.165bn, equivalent to S$2,600/sf. The deal is underscored by the vendor’s income guarantee of S$49.5mn pa, ensuring that the deal will deliver a yield of 4.25%. We view the acquisition price as fair given recent comparables. We expect the 100% debt financed deal to be yield accretive by about 1.2-2.9% for FY09F, though the level of accretion is sensitive to funding costs.

Buying One George St with yield support

Thumbs up to potential S$1.2 bn purchase of 1 George Street

What’s changed
CCT has been granted a call option by CapitaLand (CATL.SI; Buy) to purchase 1 George Street (OGS), an office building located in the heart of Singapore’s CBD, for S$1.165 bn, or S$2,600 psf of NLA. CapitaLand will provide yield protection to ensure minimum NPI of S$49.5 mn pa, or 4.25% of the purchase price for 5 years until 2013. This implies a rental rate of S$10.50 psf per mo. CCT has secured committed funding from banks to finance 100% of purchase price. More details on the lease profile of OGS and the debt facilities will be provided in due course. Deal is subject to approval by CCT’s shareholders and targeted for completion before end July.

Implications
Acquisition is in line with our expectations. In Aug 2007, when CapitaLand upped its stake in OGS to 100% from 50%, we argued that CCT was the biggest winner, as the transaction enhanced CCT’s acquisition pipeline. We see this deal as positive for CCT, as we think OGS can fetch rents of over S$13 psfpm when rents revert to market, which implies potential improvement to NPI yield at purchase price of 100 bps or more. Assuming 4.25% initial NPI yield and 3.7% debt cost, DPU uplift for CCT is 0.22 cents / 0.43 cents for FY08/09E (or +2.0% / +3.3%) respectively, by our analysis. Post acquisition, CCT’s gearing would increase from 26.9% to 40%, which we view as reasonable. Asset size would rise to ~S$6.5 bn. NPI yield of 4.25% for OGS compares favorably with 3.2% for CCT’s Grade A office assets.

Valuation
We like CCT’s strong near-term DPU growth and over 30% discount to RNAV. We maintain our DCF-based 12-mo. TP of S$2.75 and Buy rating. We look for the share price to react favorably to the successful execution of the transaction, and investors gaining confidence that REITs can tap debt facilities at competitive rates.

Key risks
On the downside, a slowdown in office rental demand.

Option for One George St

Story: CCT has been granted a call option to buy One George St from Capitaland for S$1.165b or S$2600psf. The deal comes with a yield protection agreement that guarantees a minimum NPI of S$49.5m p.a. or 4.25% yield for a period of 5 years till 2013. One George St is a building with 447,999sf NLA, of which 435,560sf is office area and 12,439sf retail space. The building is fully leased. The deal is expected to be completed by July 2008 subject to due diligence by CCT, and unitholders’ approval.

Point: The purchase was not unexpected, albeit a little earlier than anticipated given that CCT has a target to grow AUM to S$6b by 2009. The purchase will expand its asset base to S$6.5b, and give the Trust greater exposure to the office leasing market. The deal is expected to be fully funded by debt; this will increase CCT’s gearing from 27% to 40%, still below the allowable 60% limit. There is no information released about the building’s lease expiry profile or funding cost.

Relevance: We view this deal as slightly positive for CCT because it is likely to be earnings accretive, and should limit downside with potential for more upside when average achieved rents at the building exceed S$10.50psf/mth, the level which the yield protection is based on. Our initial assessment, assuming cost of debt of 3.9% – similar to what CCT is currently paying – DPU would be enhanced by 1.0-1.5%. At our adjusted FY08F and FY09F DPU of 10.8cts and 13.1cts, the yields work out to 5.1% and 6.2%, respectively. Maintain Buy with a DCFbacked price target of S$3.08.