Equity overhang removed

• $828.3m 1-for-1 rights at $0.59 each
• Financial metrics strengthened, gearing of <31%
• DPU adjusted c37%, ex-rights yield of 8.7-8.2% over FY09-10
• Upgrade to Buy, post rights TP of $0.93

A long anticipated exercise. CCT has finally announced a $828.3m fully underwritten and renounceable rights exercise via a 1-for-1 issue of 1403.9m units at $0.59 each. The rights price is at a 44.3% discount to the last close of $1.06 and a 60.9% discount to the ex-rights book NAV of $1.51. Proceeds are earmarked primarily for reducing borrowings, with the balance for capex, asset enhancements and working capital. CapitaLand has undertaken to fully subscribe for its pro rata 31.4% share.

Strengthening financial metrics. Post rights issue, gearing would drop to 30.7%, which is at the lower end of their target gearing range of 30-45% through the cycle, putting the group in a good position to navigate through the challenging operating environment. More importantly, even with a further 30% depreciation of asset values from hereon, in line with our peak/trough projection, gearing would rise back to the higher end of its stated range. Financial flexibility is maximized with higher interest cover of 3.1-3.4x and together with the recent refinancing exercises, the group would have $2b of unencumbered assets and $665m of unutilized credit lines from its MTN programme.

Ex rights yield of 8.7%. FY09-10 DPU will adjust by 37% to 7.2cts and 6.8cts due to expansion in share capital offset by interest savings. Based on the TERP of $0.825, yield works out to be 8.7% and 8.2% respectively. Our DCF backed target price is revised to $0.93 or a 14% upside from TERP. With the removal of the equity overhang we believe investors would refocus on the core strength of its portfolio backed by its blue chip tenants with long leases, which makes up 50% of income. Upgrade to BUY.

Did the market ‘talk’ CCT into a rights issue?

CAPITACOMMERCIAL Trust (CCT) last Friday announced an $828.3 million one-for-one rights issue.

The question, however, is whether the office trust really needs a rights issue at this point in time as it faces no immediate refinancing worries. After the successful refinancing of $580 million of debt early this year, CCT secured another $160 million term loan recently, clearing all its debt obligations in 2009. So the bulk of the proceeds from the rights issue are intended to be used to pay off borrowings due in 2010.

‘Despite CCT’s significant debt over 2010-12, we earlier believed that CCT would have the capacity to refinance with straight debt,’ said CIMB analyst Janice Ding. ‘We were disappointed by the announcement and the implied dilution.’

The rights issue seems especially unnecessary when the following factors are considered – parent company CapitaLand is well-capitalised; CCT’s average cost of debt remains low at 3.6 per cent; the trust has yet to tap on more than half of its existing $1 billion Medium Term Note programme; and some $2 billion worth of CCT’s assets (which can be used to secure loans) remain unencumbered.

Another office trust, Suntec Reit, also successfully refinanced more than $825 million of debt recently – even without a strong sponsor. There are plenty of other indications that the tight credit conditions that Reits were facing a year ago are beginning to ease.

So why the ‘painfully dilutive’ (as one analyst put it) rights issue? Could the market have played a large part in CCT’s decision?

The market had responded positively to a succession of cash calls from CCT’s parent CapitaLand and its retail trust CapitaMall Trust (CMT), as well as Keppel Land. All three stocks gained following their rights issue announcements.

In contrast, speculation that CCT will resort to a rights issue has dampened the Reit’s share price performance.

Over the past few months, analysts have repeatedly said that CCT would need to raise some form of equity.

In its April 15 update, for example, Nomura Research pointed out that CCT might need to raise additional equity of around $867.1 million to ensure gearing remains below 0.4 times. Macquarie Research also said in a recent note that there was still a risk of equity issuance in the next six to nine months.

It was something CCT appeared to have taken notice of. ‘I think the reality is that the market . . . has been expecting some form of equity fund raising (from CCT),’ Olivier Lim, CapitaLand’s chief financial officer, who is also a director of CCT’s manager, told analysts and media at a briefing on Friday.

Mr Lim also noted that earlier in the year, CMT and CCT took different routes to financing. CCT refinanced using bank loans, while CMT raised $1.23 billion in a 9-for-10 rights offer. CMT’s method proved more popular with the market, he said.

With the rights issue, CCT is taking a very conservative approach to its gearing. The trust saw the value of its portfolio fall 10.15 per cent in the latest valuation exercise, from $6.71 billion in December 2008 to $6.03 billion as at May 22.

The fall in portfolio value – which was caused by valuers factoring in falling office rents – would have pushed up the Reit’s gearing from 38.3 per cent to 43.1 per cent. With the rights issue, the gearing will instead fall to 30.7 per cent – close to the low end of the Reit’s target gearing range of 30 per cent to 45 per cent.

However, the Monetary Authority of Singapore has set a 60 per cent threshold for a Reit’s gearing – which means CCT still has some buffer. Although, with the outlook for office rents remaining bleak at least until 2011 with office asset values possibly falling even further, CCT’s pre-emptive rights issue could help prevent gearing from reaching truly uncomfortable levels over the next few years.

But it’s still debatable if that is enough to justify a rights issue that has a sharp dilutive effect.

First look

Friday in Singapore, CCT announced a 1-for-1 rights issue to raise S$828.3mn in gross proceeds — a move we anticipated but the rights units are priced at a steeper discount than what we had factored into our model. While this means our price target has to be lowered to reflect more dilution, adjusted for rights, the stock still trades at an undemanding implied EV of S$1,113psf for CCT’s office space. It appears CCT’s good quality, prime commercial assets remain undervalued.

Pre-empting revaluation deficit

Dilutive cash call

1-for-1 renounceable rights issue to raise S$828.3m

Last Friday, CCT proposed a renounceable 1-for-1 rights issue to raise gross proceeds of S$828.3m. The rights will be fully underwritten by DBS, Cazenove and UOB. All eligible unitholders will be entitled to subscribe for one rights unit offered at S$0.59/unit. This is a 44.3% discount to CCT’s closing price of S$1.06 on 21 May 09; a 28.5% discount to its theoretical ex-rights price (TERP) of S$0.825/unit; and a 60.9% discount to its adjusted NAV of S$1.51 (taking into account valuations as at 22 May 09 and the completion of the rights issue).

Parent CapitaLand (CAPL SP, S$3.43, Underperform, target price S$1.84) has committed to a full subscription of its pro-rated entitlement, thus maintaining its 31.4% shareholding in CCT.

New SGX measures: unitholders’ approval not required. In order to facilitate fundraising, the Singapore Exchange had announced on 19 Feb 09 that it would be allowing listed issuers to issue up to 100% of their issued share capitals via pro-rated renounceable rights issues, up from the previous limit of 50%. Hence, unitholders’ approval is not required for this proposed rights issue, although in-principle approval from SGX is still pending.

Asset values down 10% since Dec 08. CCT’s portfolio was valued at S$6,029.6m as at 22 May. Desktop valuations reflect asset-value declines of S$681m (or 10.1%) from 1 Dec 08. Cap rates for Raffles City had increased 0.1% for the three components (office, retail and hotel), while rates for the rest of the portfolio were unchanged. However, the valuers – Jones Lang LaSalle and Knight Frank – had assumed sharper rental declines of 47-70% between now and end-2012. These represent a projected straight-line decline of 20% p.a., in line with market expectations. We understand that occupancy assumptions have also been pared down although management did not elaborate on the extent. After this valuation, CCT’s asset leverage will be 43.1%, up from 38.3% as at 31 Mar 09.

Cash call to pare down debt. Management intends to allocate 85-95% of the gross proceeds to reduce borrowings of S$2.6bn as at 31 Mar 09. The balance will be used for capital expenditure, general corporate and working capital purposes, and expenses in connection with the rights issue. After the rights issue, the company estimates that its asset leverage will decrease to about 30.7% from 38.3% in 1Q09.

Valuation and recommendation

Disappointed but not surprised. CCT’s rights issue will be painfully dilutive, in our view. We note that last quarter’s stated NAV of S$2.49 will be eroded by 40% down to S$1.51 post rights issue. Out of this, only 10% is accounted by asset devaluation, and the remaining from the share base dilution. Nonetheless, at a 44.3% discount to its last traded price, there is little reason for investors not to take up the offer. Estimated dividend yields of 11.6% based on the rights price of S$0.59 are in line with CMT’s offer at 11.4%. Despite CCT’s significant debt over 2010-12, we earlier believed that CCT would have the capacity to refinance with straight debt. This stems from the fact that its parent remains well-capitalised. CCT’s average cost of debt remains low at 3.6%. About S$665m of CCT’s S$1bn MTN programme is still untapped, and S$2bn worth of assets remain unencumbered. Our belief had been further strengthened by Suntec REIT’s (SUN SP, Not Rated) successful refinancing of more than S$825m, even without a strong sponsor. Hence, we were disappointed by the announcement, and the implied dilution.

No doubt, the decision to make a cash call was catalysed by positive market reactions to the succession of cash calls from CapitaMall Trust, CapitaLand and KepLand. Conditions were encouraging after a 74% price rally (from a low of S$0.61 in Mar 09) and the timely waiver of the requirement for unitholders’ approval for up to 100% of its issued share capital via a pro-rated renounceable rights issue. A lower leverage will relieve pressure on the management to refinance consecutive years of large debt, which could grow increasingly difficult, particularly when the outlook for office-sector rents remains bleak for the next four years, and asset values may fall further.

Downgrade to Underperform from Outperform; new target price of S$0.71 (from S$1.12). We factor in an increased share base from the rights issue and our DPU estimates fall by 37-39% for 2009-11. Our post-rights target price is S$0.71, down from S$1.12. While the rights issue is likely to remove the funding overhang for CCT, and we could see a short-lived price rally till the end of “cum-rights” trading on 2 Jun 09, we see almost no reason for any earnings upgrade in the medium term, as upcoming office supply over the next few years remains significant.

We recommend existing investors to switch to our sector top pick Fraser Centrepoint Trust at 0.68x P/BV for its strong balance sheet, lack of refinancing concerns and exposure to the more resilient suburban mall sector.

Equity raising overhang removed

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