KepLand, K-Reit shuffle assets in $2b deal

Some analysts taken by surprise over leg of swap involving Keppel Towers, GE Tower

Keppel Land and its unit K-Reit Asia have agreed to an asset swap with transaction values totalling almost $2 billion. Keppel Land is selling its one-third stake in Phase One of Marina Bay Financial Centre (MBFC) to K-Reit for $1.427 billion or $2,450 per sq ft of net lettable area, which includes a rental support. It will reap a net gain of some $321 million from the divestment.

MBFC Phase One comprises two fully leased Grade A office towers and the Marina Bay Link Mall. Keppel Land’s stake, including a rental support of up to $29 million, was valued at $1.421 billion as at Oct 5.

At the same time, K-Reit is offloading Keppel Towers and the adjacent GE Tower in Tanjong Pagar to Keppel Land for $573 million.

Keppel Land will convert both office towers into a freehold residential project and will fork out a development charge of some $5.8 million. This means the total price works out to $1,201 psf per plot ratio. Both buildings were valued at $576 million assuming they were put to residential use.

The transactions will bring Keppel Land net cash proceeds of $812 million and cut its gearing sharply. On a proforma basis, its net debt to equity ratio as at Dec 31 last year will drop to 0.5 per cent from 22 per cent.

This will support Keppel Land in its search for property deals in Singapore, China, Vietnam, Indonesia and India, said the group’s chief financial officer Lim Kei Hin at a briefing yesterday.

The proceeds ‘will allow us to have virtually zero debt and we will have enough fire-power in our arsenal to be able to pursue acquisitions of both residential and commercial properties,’ he said.

K-Reit, on the other hand, will have to borrow $821 million from banks to pay for the MBFC stake. This is after using $570 million from the sale of Keppel Towers and GE Tower and $41.5 million from its rights issue last year for the purchase. K-Reit’s aggregate leverage will rise to 39.1 per cent after the deals, up from 15.2 per cent as at June 30.

The bundled deal will be subject to the approval of Keppel Land’s minority shareholders and K-Reit’s minority unitholders at their respective extraordinary general meetings. Keppel Land owns a stake of 45.5 per cent in K-Reit as at March 2.

According to Mr Lim, Keppel Land got a good opportunity to acquire prime freehold land in the central business district and ride on growing demand for city living.

In particular, Tanjong Pagar has come under the spotlight as more high-end condominiums emerge in the area. Recent launches such as Altez and 76 Shenton have attracted buyers willing to splurge more than $2,000 psf. Plans to relocate the ports and the Malaysian railway station are also paving the way for rejuvenation.

The authorities have approved the conversion of Keppel Towers and GE Tower to residential use. Together, the sites have a gross floor area of 481,800 sq ft and Keppel Land plans to launch a 620-unit project there in two to three years’ time, after existing office leases end.

The residential project will comprise a 45-storey tower and a 26-storey tower, with commercial space at ground level.

For K-Reit, the transactions gave it a chance to expand and upgrade its portfolio, said CEO of the Reit’s manager Ng Hsueh Ling. While both Keppel Towers and GE Tower are enjoying ‘good’ occupancy levels, they are 19 and 17 years old respectively and will need more maintenance with time, she explained.

Meanwhile, the purchase of the MBFC stake will raise K-Reit’s presence in Raffles Place and Marina Bay. Analysts have long expected Keppel Land to divest its MBFC stake to K-Reit, but some were surprised by its purchase of Keppel Towers and GE Tower. At the briefing, several also raised questions about the pricings of the deals.

Asked if K-Reit’s MBFC stake purchase would be yield-accretive for unitholders, Ms Ng said that it would ‘generate greater returns’ but details would be released only when the circular has been lodged with and approved by the authorities.

According to Standard Chartered analysts Regina Lim and Wong Yan Ling in a note, the price K-Reit paid for the stake is above the ‘consensus estimate’ of $2,300 psf.

UOB-Kay Hian analyst Vikrant Pandey reckoned K-Reit might have obtained higher bids for Keppel Towers and GE Tower if there was an open tender.

Cushman & Wakefield managing director Donald Han felt that transaction prices for both the MBFC stake and Keppel Towers and GE Tower are in line with market levels. The bigger problem for investors today lies in finding deals to put their money in, he said.

KREIT acquires another Australian office building

What has changed?

• K-REIT Asia (KREIT) announced its 2Q FY10 results on 19 July 2010. The DPU of 1.64 cents was 2.5% above our estimate, while net-property income (NPI) of S$18.4m was 18.9% above our estimate.

Impact

• Gross revenue of S$ 22.7m was 11.8% above our estimate. We attribute the difference to higher-than-expected rental revenue from Prudential Tower and 275 George Street. This was offset largely by a lower-than-expected income contribution from ORQ and higher-than-expected trust expenses. As a result, total distribution of S$21.97m was 2.4% above our estimate.

• In the same briefing, the manager announced the acquisition of 77 King Street for A$120m. 77 King Street is a prime commercial building located in Sydney’s central business district (CBD). The building is fully occupied currently with a weighted-average lease expiry of 5.8 years. The building will add a net leasable area (NLA) of 147,250 sq ft to KREIT’s current property portfolio of about 1.5m sq ft. KREIT will have a total exposure (in terms of NLA) of about 22% to Australia after this acquisition.

• Management expects the acquisition to have DPU accretion of 6.6% on a proforma basis. This acquisition will be funded by a combination of debt and equity. We expect KREIT’s aggregate leverage to increase to 20.4% from 15.2% (at 30 June 2010) after the acquisition is completed in the 4Q10.

Valuation

• We maintain our six-month target price of S$0.99, based on our RNG valuation (a finite-life Gordon Growth model) at S$0.99. We have not changed our midcycle core revenue assumptions or our effective cap assumptions of 5.44% (consisting of a discount rate of 6.94% and an internal growth rate of 1.5%). We have assumed that the acquisition should be value-neutral.

Catalysts and action

• We maintain our 5 (Sell) rating on KREIT and believe its DPU yields are unattractive relative to those of other office S-REITs.

Deepens presence in Australia

• Results lifted by Brisbane contributions

• Acquiring Sydney CBD office building for A$120m

• Maintain Hold, TP $1.20

Performance boosted by Brisbane asset. Kreit reported a 27.6% sequential rise in topline to $23.2m in 2Q10 while NPI improved 32.4% to $18.4m, thanks largely to a full quarter’s income from the Brisbane office building and better performance from its S’pore properties. The S’pore portfolio enjoyed higher occupancies of 97.6%, which more than offset the dip in average rents to $8.19psf/mth as Kreit locked in some forward leases that carry higher existing rents. Distribution income rose 23.3% qoq to $22m, translating to a DPU of 1.97Scts.

Acquires Sydney office building. At the same time, Kreit announced the purchase of a 170,662sf Grade A office/retail property at 77 King St in the Sydney CBD for A$120m (S$145m) or at a 7.6% cap rate. The property has a WALE of 5.8 years and existing leases have inbuilt annual rental escalation clauses. As the property is currently 76.8% occupied, there is a 24-month rental guarantee of A$2m for any rental shortfall due to vacancies and a further A$4m income support for 6 years as the property is relatively under-rented compared to market rents in the vicinity. Major tenants include Fitch Australia, CapGemini, Herbert Greer and Expedia Australia. The deal is accretive and the long leases are likely to provide another stable income source to partially offset the expected dip in earnings when ORQ’s income support expires in FY12. The new buy will be funded by the remaining rights proceeds and new debt. Gearing is expected to increase from 15.2% to 20.4%.

Lifting FY11F earnings, TP raised to $1.20. FY11 DPU raised by 10.6% to 7.3Scts to factor in the additional income from the new purchase. The S’pore office rental market has bottomed out and will continue to benefit from increased demand as GDP is projected to grow by a strong 13-15% this year. This will underpin Kreit’s income. The stock is trading at FY10-11 yield of 5.6-6%. Maintain Hold with revised DCF-backed TP of $1.20.

Acquisition potential but fairly valued

• In line; upgrade to Neutral from Underperform with higher target price of S$1.21 (from S$1.01). 2Q10 DPU of 1.64 Scts met our expectation and consensus, forming 26% and 24% of the respective full-year forecasts. K-REIT took the opportunity to announce its acquisition of 77 King Street in Sydney. We raise our FY10-12 DPU estimates by 4-22% after raising portfolio occupancy and rental assumptions for 275 George Street and factoring in contributions from the newly acquired Sydney property. Accordingly, our DDM-based target price rises to S$1.21 (discount rate: 7.2%) from S$1.01. Upgrade to Neutral as K-REIT’s strong financial position presents opportunities for acquisition growth, though we prefer a Neutral rating on a lack of concrete details. Re-rating catalysts could come from increased clarity on yield accretion from asset injections like Phase 1 of Marina Bay Financial Centre and positive rent reviews for One Raffles Quay.

• NPI grew 49.3% yoy. Net property income of S$18.4m was up 49.3% yoy on additional stakes in Prudential Tower and 275 George Street. Qoq, NPI grew 32.4%, thanks to increased recognition of 275 George Street acquired in Mar 10. 2Q10 DPU of 1.64 Scts was, however, down 37.9% yoy due to an enlargement in the share base following its rights issue in Nov 09.

• Portfolio occupancy improved to 97.9%. 2Q10 portfolio occupancy jumped 1.9% pts qoq and 3.0% pts yoy. Average rentals for its Singapore portfolio edged lower to S$8.19 from S$8.30 as at Mar 10, though management believes rentals had bottomed in the quarter.

• Acquisition of 77 King Street in Sydney. K-REIT announced its agreement to acquire 77 King Street, a Grade A commercial building in Sydney for A$120m (S$145m). The acquisition will be made on a fully-leased basis with income top-up of up to A$2.0m (S$2.4m) will be provided to make up for any shortfall in rent for any space not fully-leased within a period of two years. Completion of the acquisition is expected in 4Q10. We raise our FY11-12 DPU estimates marginally as increased NPI contributions are partially offset by higher borrowing costs and withholding tax.

K-Reit net property income up 49% in Q2, but DPU falls 38%

It buys office, retail space in Sydney building for A$120 million

K-REIT Asia has acquired office and retail space at 77 King Street in Sydney, Australia, for A$120 million (S$145 million).

The trust announced the move yesterday – as well as improved results for the second quarter ended June 30. Boosted by recent acquisitions, net property income (NPI) jumped 49 per cent from a year back to $18.4 million. This raised distributable income to unit-holders 26 per cent to $22 million.

Distribution per unit (DPU) was 1.64 cents, falling 38 per cent from 2.64 cents a year ago as the unit base expanded due to a $620 million rights issue last November.

Adjusting for the rights issue, DPU in Q2 last year would have been 1.32 cents. Based on this, DPU would have risen 24 per cent year-on-year.

K-Reit’s latest purchase at 77 King Street comes hot on the heels of two other deals. It bought a 50 per cent stake in 275 George Street in Brisbane early this year, and an additional 29 per cent interest in Singapore’s Prudential Tower late last year.

77 King Street is in Sydney’s central business district and is owned by Kingvest Pty. K-Reit bought an 18-storey office block with 130,394 sq ft of space, and part of a retail component with 16,856 sq ft of space.

Rents at the property are around A$570 per sq metre a year – at the lower end of market rates – but the seller will provide K-Reit with an NPI guarantee of up to A$4 million for six years. The leases also come with fixed annual rental escalations.

The space will be fully leased by the time the acquisition is complete in Q4. Key tenants include CapGemini Australia and Fitch Australia.

K-Reit will fund the purchase with equity from its rights issue and debt. Its aggregate leverage at June 30 was 15.2 per cent, and is expected to rise to 20.4 per cent after the Sydney deal is done.

For the first half ended June 30, K-Reit’s NPI surged 40 per cent year on year to $32.3 million. Distributable income to unit-holders rose 20 per cent to $39.8 million.

DPU was 2.97 cents, down 41 per cent from five cents a year ago – also because of the rights issue. Adjusting for that, DPU last year would have been 2.49 cents, reflecting a 19 per cent year-on-year rise.

For the period Jan 1 to June 30, unit-holders will receive a distribution of 2.97 cents on Aug 26.

The chief executive of K-Reit’s manager, Ng Hsueh Ling, is upbeat. The Singapore office market is likely to have ‘passed the trough’ and the Reit has seen more sign-ons, she said at a briefing yesterday.

As at June 30, K-Reit’s portfolio occupancy rate was 97.9 per cent, up from 96 per cent a quarter earlier.

But the portfolio’s average gross monthly rent dipped slightly to $8.19 psf from $8.30 psf. According to Ms Ng, this was the result of a lease restructuring. K-Reit had negotiated for the extension of some leases and offered slightly lower rents in return, so lease expiries would be spread out better.