Suntec – CIMB

More details on MBFC 1 acquisition

Downgrade to Neutral from Outperform on limited upside. Suntec REIT has released a circular on its acquisition of a one-third stake in Phase 1 of Marina Bay Financial Centre (MBFC 1). The circular provides more information on the mode of funding for the acquisition, income support and DPU projections. We reduce our FY11-12 DPU estimates by 0-2% after factoring in the acquisition, partially offset by

stronger rental and occupancy assumptions for its office portfolio. Accordingly, our DDM-based target price drops to S$1.55 (discount rate 8.1%) from S$1.63. While we see the addition of MBFC 1 as a long-term strategic positive, we believe that deal is hardly accretive for minority shareholders. Near-term yield accretion is likely to be minimal in view of limited lease expiries and rent reviews within the next two years. Downgrade to Neutral on limited upside to our target price. Re-rating catalysts could come from lower-than-expected costs of borrowing and positive rental reversions.

The news and our comments

Funding through debt and equity. The acquisition will be funded by S$1,105m debt and S$428.2m proceeds from a private placement of new units. Loan tenures are expected to be 3.5 years (S$773.5m) and 4.5 years (S$331.5m) respectively. Following the acquisition, the Manager expects aggregate leverage to climb to 41.5% from 33.0% as at end-Sep 10, though the figure could fall to 37.3% with the intended

repayment of shareholders’ loans held at ORQ. All-in interest cost on the new loans will be an effective 3.12% while cash cost is expected to be lower at 2.7%. The issue price has not been finalised for the equity-raising portion though 301.6m units are expected to be issued at a placement price of S$1.42.

Income support. Aggregate income support remains S$113.9m, expected to be drawn down over five years. This amount will be fully paid out regardless of the eventual rentals of the asset. Apart from mitigating rent-free fit-out periods expected in the first year, income support will be utilised to make up for any shortfall to ensure an expected NPI yield (net of all applicable taxes) of 4.0%. Management has the option to change the quantum of each quarterly instalment subject to certain limits and the amount is expected to taper off.

Rental catch-up possible. The two office towers are 100% pre-committed while Marina Bay Link Mall is about 87% pre-committed. Most lease expiries and renewals are expected only from 2013. Income support over five years should thus help in managing yields while allowing rentals to revert to market levels, particularly after 2013 when most lease expiries and renewals are expected. Assuming a 10% annual growth in renewal rates, yields could actually surpass 4.0% during the income support period. While overall income from MBFC 1 (including income support) could still drop on the expiry of income support beyond 2015, we believe this is still manageable in view of the small contribution of income support to total income from MBFC 1 (estimated at 20-35% from years 2 to 5), the tapering effect of the support and a recovering office market. Particularly, we believe it may not be difficult for MBFC 1 to maintain a 4.0% yield beyond 2015, even without income support.

Risks

Weaker-than-expected rental reversions on MBFC 1. While rents have been mostly locked in for the first two years, a sharp fall in market rents in 2013-14 could affect rents and reversions for MBFC 1, which could then affect yields on the asset after the expiry of income support in 2016.

Financials

Moderate dilution. The acquisition is subject to the approval of minority shareholders at an EGM on 26 Nov. Assuming the completion of the transaction by end-2010, we factor in contributions from MBFC 1 starting FY11. For FY11, we assume an overall NPI yield (net of applicable taxes) of 4.0% for MBFC 1 though upside could come from higher-than-expected income support provisions. We expect income support to taper off over 2012-15. We lower our cost-of-borrowing assumption to 3.2% for FY11 to factor in a rollover of S$700m debt at lower spread margins of 1.5% in Oct 10 and new loans secured at 3.12% for the acquisition. Coupled with slight revisions to rental and occupancy assumptions for Suntec REIT’s office portfolio, we arrive at a higher distributable income of S$207m for FY11 from S$176m before the acquisition. Factoring in 302m units placed out at an assumed price of S$1.42, our DPU forecast for FY10 dips to 9.8 Scts from 10.0 Scts before the acquisition. A higher placement price and lower cost of borrowing could provide upside to our estimates.

Valuation and recommendation

Downgrade to Neutral from Outperform on limited upside. Overall, we reduce our FY11-12 DPU estimates by 0-2% after factoring in the acquisition, partially offset by stronger rental and occupancy assumptions for its office portfolio. Accordingly, our DDM-based target price drops to S$1.55 (discount rate 8.1%) from S$1.63. While the addition of MBFC 1 is a long-term strategic positive, near-term yield accretion is likely to be minimal in view of limited lease expiries and rent reviews within the next two years. Downgrade to Neutral on limited upside to our target price. Re-rating catalysts could come from lower-than-expected costs of borrowing and positive rental reversions.