K-REIT – BT

Win-win for Keppel Land and K-Reit?

FOR economics students weaned on the principle of profit maximisation, the term ‘win-win’ which buyers and sellers use so often to describe deals might sound like an incongruity.

Looking at how the market reacted to the proposed asset swap between Keppel Land and K-Reit Asia, there must be many such sceptics around. Although both parties said that the deal would enhance value for their shareholders and unitholders, investors chose to buy into the property developer and sell their stakes in the Reit.

Keppel Land rose to an intraday high of $4.23 yesterday before closing at $4.16, five cents higher than on Monday. At least four research houses – CIMB, Standard Chartered, DBS Vickers and DMG & Partners – raised the target price for the stock.

In contrast, K-Reit lost two cents to end trading at $1.35. CIMB downgraded the counter to ‘underperform’ from ‘neutral’.

The market clearly thought there was just one winner in the deal. Is the judgement fair? The way to answer this is to see if Keppel Land got too good a price for its one-third stake in Phase One of Marina Bay Financial Centre (MBFC), or underpaid K-Reit for Keppel Towers and GE Tower.

In one leg of the swap, Keppel Land will sell its MBFC stake to K-Reit for $1.4268 billion or $2,450 per sq ft of net lettable area. This is just a slight 0.4 per cent more than the open market valuation of $1.4205 billion. So far, so good.

What’s worth noting is that the sale price is higher than many analysts’ projections. Standard Chartered said that the consensus estimate was $2,300 psf; DMG & Partners valued MBFC Phase One at $2,100 psf in its model. To the research community at least, the stake sale leans in Keppel Land’s favour.

Also, compared with other office spaces sold recently downtown, the MBFC stake secured a higher price. For instance, four floors at Samsung Hub changed hands for $2,125 psf in August. It is true that MBFC is newer, has many established tenants and is in a glitzier district, but the amount of premium these factors command is debatable.

Most importantly, some market watchers do not see K-Reit benefiting much from buying the MBFC stake, at least in the short term. It will have to take on a huge debt of $821 million, which raises its aggregate leverage to 39.1 per cent. It is also not clear at this point if the transaction would be yield accretive. One research house, CIMB, expects a 6-7 per cent drop in K-Reit’s distribution per unit for FY2011-12.

In short, while Keppel Land is selling its MBFC stake to K-Reit in line with market valuation, there are some who expected a lower price, or think that K-Reit would be burdened.

In the second part of the swap, K-Reit will sell Keppel Towers and GE Tower to Keppel Land for $573 million. This is just 0.5 per cent less than the valuation of $576 million, assuming the buildings are put to residential use. Again, nothing to raise eyebrows here.

The bigger question which many observers have is whether K-Reit could have gotten a higher price if it put the two towers up for bidding. With liquidity still surging in Asia, there could be other property developers or funds willing to pay above valuation.

Some would recall that when CapitaCommercial Trust sold StarHub Centre through an expression of interest exercise and a private tender in July, it managed to secure a price that was 42.5 per cent higher than the asset’s latest valuation.

Near Keppel Towers and GE Tower, Singapore Technologies Building is up for sale with a price tag of at least $1,500 psf of net lettable area. Hypothetically, if Keppel Towers and GE Tower were sold at just $1,350 psf, they would already fetch $581 million.

In this case, while Keppel Land is paying K-Reit according to market valuation, some wonder if K-Reit could have gotten more if there was competition for the assets.

At a briefing on Monday, management from Keppel Land and K-Reit reiterated several times that the prices were in line with market valuations, and that both companies stand to gain from the bundled deal. They should illustrate more clearly what the benefits are – particularly for K-Reit unitholders – in order to get investors to buy into the ‘win-win’ theory.