Starhub sale books gain; our preferred office company

What’s changed

On July 16, CCT announced the sale of office building Starhub Centre to Frasers Centrepoint for S$380mn or S$1,357psf. The divestment of Starhub Centre and an earlier sale of Robinson Point in 1Q10 for S$203mn (S$1,527psf, gain of S$19mn) are inline with its broader strategy to unlock value. The sale is done at a 42.5% or S$113.3mn, above the appraised valuation of S$266.7mn, and will book one-off gain of S$109.1 mn with net proceeds of about S$375.8mn. CCT’s appraised book will improve by 3% to S$1.43/share. Starhub Centre is a non-Grade A office building (280,069sqft NLA) located off shopping district Orchard Road, and has 85 yrs in its land lease; it accounts for about 5.0% of portfolio asset value, approximately 4.0% of NPI.

Implications

CCT’s decision to divest rather than participate in the redevelopment of the property into Residential is as expected, with the sale gain of S$109.1mn coming in above our expectations (est. S$80mn gain). The sale makes business sense; we estimate CCT would have had to achieve office rentals closer to S$6.9psf vs. current passing rents of below S$6psf in order for Starhub to have been revalued at S$380mn (assuming no change of use). We believe the recent asset sales could assure investors that progress is underway to upgrade its portfolio mix, addressing concerns that it may be losing its foothold in the office space with its older portfolio. With a strengthened cash position, CCT has the capacity to acquire Grade-A assets (up to S$1.2bn) without having to return for a cash call. With spot rents stabilizing and as confidence in appraised valuations grows, we believe CCT’s gap to BVPS will close.

Valuation

Valuation and our 12-m DCF-based TP of S$1.42 are unchanged. The sale could raise 2010E net income by 50%, but will lower core earnings and DPU by 4% with the fall in rentals.

Key risks

Key risk to our investment view includes a slowdown in job additions.

Starhub Centre Sold for S$109mn Gain; N/T Positive

Quick Comment: We maintain our Overweight rating on CapitaCommercial Trust (CCT) and see the recent profitable sale of Starhub Centre as providing near-term support for the stock. While the recent strong stock price performance of +13% in the last month (vs. +4% for the STI) no longer leaves valuation looking as attractive, news flow in the office sector should remain positive as we increasingly hear of rising rents and stronger office demand for 2010. We estimate a potential impact on NAV of +5%, and impact of forgone future rentals on DPU could be as much as -1%/-5%/-4% in 2010E/11E/12E (Ex. 1). With capital values already on the uptrend (Ex.3), we think the potential for accretive acquisitions to be limited in the current environment. Hence, to avoid the drag of excess cash, we think the sizable proceeds could be: 1) distributed to shareholders – potentially S$0.13 per share, 11% of the current stock price; or 2) used to reduce debt and interest expense – up to 4% addition to DPU (Ex. 2).

What’s new: CCT announced the sale of Starhub Centre to Frasers Centrepoint for S$380mn (net: S$375.8mn), expected to complete on September 16, 2010. CCT gains S$109.1mn from the sale of the 10-storey commercial building, which was valued at S$266.7mn in June 2010. Market talk of a potential sale began as early as January 2010, when CCT received URA approval for the change of use of the property to residential (up to 80%). SLA approval for a lease extension to 99 years was subsequently received on July 13, 2010.

Rationale for Sale: Part of its strategy to free up capital by divesting assets that have reached the optimal stage in their life cycle, CCT cited the benefits of the sale as :1) realizing value significantly above valuation; 2) strengthening cash position and financial flexibility.

Investment thesis:. CCT is currently trading at 0.9x 2010e P/B, implied capital value of S$1,480psf, and we recommend investors accumulate the stock on any potential share price weakness.

Sale of StarHub Centre – building up for acquisitions

What’s New

Sale of StarHub Centre. CapitaCommercial Trust (CCT) has sold StarHub Centre to a subsidiary of Frasers Centrepoint Ltd for S$390m. This amounts to a price of S$1393psf of Net Lettable Area (NLA) of

280,069sf.

Stock Impact

Divested at a gain of S$109.1m, though below expectations. The selling price is 11% below our estimate of S$1560psf. However, the price is 45.5% or S$122m higher than the valuation of S$268m as at 31 Dec 09 and 42.5% or S$123.3m higher than its valuation of S$266.7m as at 30 Jun 10. The sale price is also 5.1% above the highest valuation achieved at S$361.5m as at Jun 08. The estimated gain from the sale is S$109.1m or about 3.8 cents/share. This is 37% below our previous estimate of a gain of 6 cents/share.

Minimal impact on net property income. StarHub Centre currently accounts for about 4% of CCT’s net property income. The impact on CCT’s 2010 income will be minimal as occupancy is already at a low 68% and the completion of the sale will be close to end-3Q10. Potential acquisitions are likely to offset the impact on 2011 and 2012 earnings.

Maintaining focus on core portfolio. This sale comes on the heels of the sale of Robinson Point, another non-Grade A office building in Jan 10 for S$182.5m. CCT has opted not to participate in a JV or to develop the property itself so as to avoid exposure to the non-core residential segment. The sale will enable CCT to divest its non-core assets to maintain focus on Grade-A office developments.

Watch out for acquisitions. Net gearing will decrease from 29.1% to 25.5%, which gives CCT about S$700m debt headroom to fund Grade-A office acquisitions in Singapore assuming a target gearing of 37.5% (based on the target range of 30% to 45%).

Beneficiary of the office sector turnaround. CCT has the largest portfolio of prime office properties in Singapore, deriving about 72% of its value from this segment. The office segment is deep in value relative to other sectors with prime office rentals still at a 57% discount to the peak levels vs 12%, 15% and 19% discounts in the prime residential, retail and industrial segments respectively.

Starhub Centre sold

Starhub Centre sold for S$380m

Maintain OUTPERFORM and target price of S$1.37. CCT announced that it will be selling Starhub Centre to Fraser Centrepoint Limited (FCL) for S$380m or 42.5% above the last valuation. The proceeds from the sale are earmarked for acquisitions and debt repayment. We are positive on the sale due to the premium sale price and believe the lowered asset leverage positions CCT well for future refinancing needs.

We maintain our earnings estimates and DDM target price of S$1.37 (discount rate 7.8%), pending the announcement of their 2Q10 results on 21 Jul. More clarity on the repayment quantum, potential accretive acquisitions and early refinancing of debt will provide further catalysts for this stock. Our current DPU estimate of 7.99 Scts for FY10 represents a 6.1% yield and CCT remains the cheapest large cap stock in the SREIT space.

The news

Sale price of S$380m, 42.5% above valuation. The sale of Starhub Centre was conducted via a formal tender process by an appointed property consultant. The sale of Starhub Centre and the non-participation of CCT in the redevelopment of a nonoffice asset falls within our expectations (see our note entitled “Holding up well”, 19 Apr 2010) and is in line with the management’s intention to move away from non-core assets towards Grade A assets. Nevertheless, we are pleasantly surprised that the sale price of S$380m or S$1,354psf for NLA of 280,066 sq ft is 42.5% higher than Starhub Centre’s last valuation as at Jun 2010, which was S$266.7m or S$952psf. After adjusting for divestment-related costs, the estimated net gain to CCT is about S$109.1m. FCL intends to redevelop Starhub Centre as a high-end residential and retail development. The sale is expected to be completed around 16 Sep 2010.

Use of sale proceeds. Management intends to use the sale proceeds for acquisitions and/or to pare down debt. Management had also implied earlier that a special dividend is unlikely. We believe that CCT will acquire another office asset in the near term although potential targets are unclear at this point of time.

Valuation and recommendation

DPU for FY10 will fall 2-7% over FY10-11 with no debt repayment. Based on 1Q10 results, Starhub Centre contributed only 4% to CCT’s portfolio net property income. Assuming Starhub Centre contributes nine months of revenue (if the sale is completed by end-Sep) and there is no repayment of debt, DPU for FY10 will fall 2-7% over FY10-11. However, with the paring down of debt, the interest expense is likely to fall by 4Q10, moderating the fall in DPU, in our view.

Asset leverage to reach below 30% by Sep. The current asset leverage of CCT is 32% and we expect this to go down to about 26% after the completion of the sale in Sep, assuming there are no other key developments. We believe this highly improves CCT’s position to refinance its relatively chunky debt, which is due to expire in 2011, at more attractive interest rates.

Maintain estimates and target price for now. We are positive on the sale of Starhub Centre at an attractive premium over valuation and believe this will provide short-term catalysts for this stock. We maintain our current DPU estimates, pending the release of CCT’s 2Q10 results on 21 Jul. More clarity on the repayment quantum, potential accretive acquisitions and early refinancing of debt will provide further catalysts for this stock. Our current DPU estimate of 7.99 Scts for FY10 represents a 6.1% yield and CCT remains the cheapest large cap stock in the SREIT space. We maintain our OUTPERFORM call at an unchanged DDM target price of S$1.37 (discount rate 7.8%).

Divests Starhub Centre

• Sells Starhub Centre for $380m or $1357psf of NLA

• Locks in $109m gain, lifts book NAV to $1.41

• Maintain Hold, TP raised to $1.30

Sells Starhub Centre. CCT has announced it has entered into an agreement to sell Starhub Centre to Frasers Centrepoint Ltd for $380m or $1357psf of NLA. This is slightly ahead of our earlier expectation of $320-350m. URA has approved the change of use at Starhub Centre into a commercial-residential development where 20-40% of its 330000sf GFA must be retained for commercial use. Plot ratio remains unchanged at 4.9x. The Singapore Land Authority has also given an in-principle lease upgrade approval for an extension of the lease to a fresh 99-year lease.

Locks in $109m gain. The sale was expected and conducted as part of CCT’s portfolio evaluation strategy. The sale price is 42.5% above the latest valuation of $266.7m as at June 2010. CCT is expected to recognise a gain of $109.1m from the sale and boost book NAV to $1.41. The sale will give the group greater financial flexibility to pursue acquisitions or repay debt. Net proceeds of $375.8m would expand the group’s gross cash position to $548.5m and lowers gearing to an estimated 19.3%. Starhub Centre contributed about 4% to net property income in 1Q10 based on its current occupancy level of 68.2%.

Maintain Hold, TP raised to 1.30. In terms of earnings impact, FY11 DPU is lowered by 3% to 6.5cts taking into account earnings vacuum from the sale, offset by interest savings. However, DCF is raised to $1.30 with the additional cashflow from the divestment. Maintain Hold with a revised DCF-backed TP of $1.30. Catalysts, in our view, for the stock remains its ability to pursue yield accretive acquisitions to replenish its portfolio or potential redevelopment of some of its older properties.