AllCo – Phillip
A Fresh Start
Allco Commercial REIT (Allco) announced that Fraser Centrepoint Limited (FCL) has bought over Allco Finance Group’s (AFG) stake of 17.7% in the REIT and also 100% of the REIT manager Allco (Singapore) Limited for a total consideration of S$180 million. The sale is expected to complete by 6 August 2008. Allco will be renamed Frasers Commercial Trust upon completion.
Under the agreement, FCL will acquire the units at a price of $0.83. This represents a discount of 42.3% from the NAV of $1.44.
This latest acquisition of Allco manifests the M&A story surrounding the REIT sector. We have at least seen some form of management changes among the smaller independent REITs. The rationale behind FCL’s move lies in its intention to establish a commercial REIT of its own. By acquiring Allco, FCL saved itself the trouble of going through the time consuming route of an IPO.
After the acquisition by FCL, Allco will have a sponsor who has a ready supply of properties to inject into the REIT. Currently FCL owns and manages two Grade A office towers – Alexandra Point and Valley Point, and a high-tech industrial park – Alexandra Technopark. These properties value at S$710 million will form the expansion pipeline for the REIT.
Following the sale, Allco’s income support agreement with Allco Finance Group Limited (AFGL) for Central Park will be terminated. As per the announcement on 6 May 2008, there is a potential claim of A$6.4 million for the period from 1 Jan 2008 to 29 Mar 2009.
In addition, Allco recorded valuation loses from its Cosmo Plaza and Centrelink Headquarters properties after valuations were done on 30 Jun 2008. Currently Allco has a property portfolio size of S$1.9 billion.
Strategic review. Following the acquisition by FCL, there is no formal announcement on the intended divestment of the Australian assets. This is dependent on the strategic direction of FCL. However looking at the Centrelink Headquarters revaluation, the divestment may net proceeds 10% lower than originally intended.
A quick recap on Allco debt profile. Allco has S$70 million of debt maturing in Nov 2008, which will be repaid with the redemption proceeds from AWPF. Another S$550 million is expiring in Dec 2009 and another S$268 million of Yen denominated debt in 2012. With the Fraser and Neave Group as the sponsor now, we believe this would strengthen Allco financial credibility.
Allco’s current gearing is 47.3%. Following the full redemption of AWPF and assuming all 3 proposed properties injected into the REIT are fully funded by debt, gearing would increase to 57.9%.
Analysis. We view some synergistic benefits to the acquisition by FCL, however there are also some issues that linger in our minds. First up, Allco gain a reputable sponsor that could act as a catalyst to close up the gap between the trading price and NAV. Under the agreement, FCL will pay S$104 million to acquire 17.7% stake from AFG and $76 million to acquire 100% of the manager. The manager currently holds 1.48% (10,491,300) of the outstanding units. There is a termination fee of $20 million if the manger is removed from its capacity. Therefore we reckon the implicit price paid by FCL to gain a controlling stake is actually $1.17 per unit, assuming FCL’s purchase price of the manager includes this termination fee. This would then represent an 18.7% discount from the NAV.
One of the uncertainties associated with non-developer sponsored REITs and independent REITs is the lack of acquisition opportunities. With FCL as the sponsor, there is more visibility to the expansion pipeline now. Secondly, we feel Allco will be in a better financial standing when it comes to funding negotiations. It will also have more funding options being part of the Fraser and Neave Group.
With this initial announcement of acquisition, there are a few doubts that we would like to seek clarity. The foremost question would be the future direction of the REIT. Allco started out as a commercial REIT focusing on the office sector. With the purchase of Keypoint building, it added retail spaces to its portfolio. And recently, it gained provisional permission from URA to develop a hotel tower at the China Square property. So we are seeing a shift in investment policy of the REIT. Secondly, it would be the probability of the divestment of the Australian properties.
Valuation and reccomendation. For our valuation, we took the conservative stance of impairing the potential A$6.4 miilion income support from AFGL. We also apply stringent parameters in our valuation model to reflect the bad market condition. Our revised valuation gives us a FY08F DPU of 6.41 cents. We lowered our fair value from $1.05 to $0.86. We believe Allco is a long term value play and keep our buy recommendation at the current price.
Risks to our valuation. The macro risk affecting Allco is the sustained economic slowdown leading to a drop in rental revenue. Poor credit environment couple with rising interest rates will increase the borrowing cost and interest expense. Current gearing of Allco is 47.3%. Concern exists over the leverage if Allco is to acquire using debt. Therefore in our view, Allco will need to raise equity at some point in time or divest the Australian properties to lower gearing.