DBS Group Research analysts Derek Tan, Jeff Yau, Rachel Tan, Geraldine Wong, Dale Lai and Percy Leung are taking a closer look into the interested buyers who have reportedly placed their bids for the retail malls under Mercatus Co-operative, a unit of NTUC Enterprise Co-operative.
See: Mercatus transaction to benefit CICT, FCT and LREIT: DBS
“Given the rare opportunity to gain (or deepen) one’s foothold in Singapore’s suburban retail landscape, we believe that a transaction (if materialised) will likely be at a tight cap rate,” says the team led by Tan in their Aug 10 report.
Among the reported contenders are names such as CapitaLand Integrated Commercial Trust (CICT), Hong Kong-listed Link REIT, as well as Frasers Centrepoint Trust (FCT) and Lendlease Global Commercial REIT (LREIT).
“We are not surprised by the strong interest from investors (including retail mall operators in Singapore and from overseas), given the significant operational scale offered, coupled with the scarce availability of suburban assets for sale in Singapore,” the team writes.
“With these assets, a buyer can gain a strong foothold in the suburban retail landscape in Singapore,” they point out.
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In their analysis of the potential bidders, the team has assumed the metrics of a portfolio valuation of $4.1 billion, an initial yield of 4.5% and 3.5% in debt-funding costs.
Due to the “significant size” of the portfolio as well as a potentially competitive bid, the analysts believe that the winning bidder will have to possess both financial muscle and access to capital, either from its sponsor or third-party capital, in order to digest this portfolio.
“A deal of this size could mean that potential buyers will be likely lining up debt financing (and/or equity) in order to fund this proposed acquisition,” the analysts write.
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“Upon assuming that the REITs are willing to gear up to their respective maximum debt levels of 35%-45%, we found that most Singapore REITs (S-REITs) will likely need to tap the market for new equity,” they add.
In their report, the analysts see the Mercatus portfolio as being a “good fit” with CICT’s portfolio. The REIT, which is the largest listed on the Singapore Exchange (SGX) with a market capitalisation of $13.5 billion as at Dec 31, 2021, is seen as “competitive” to the analysts. The REIT, backed by CapitaLand Investment (CLI) will also have the financial muscle to undertake this deal, the analysts add.
That said, CICT may need to raise close to $1.2 billion equity, which is the equivalent to around 8% of its market cap.
“[This] may be a tough endeavour in our view, given the current market conditions,” the analysts say. “That said, we believe that the likely strategy is to tap into its sponsor/third-party capital to reduce its own capital commitment in pursuing this deal.”
On its own, the REIT has the ability to undertake the deal, but it could see its gearing heading towards 45%, which is close to the statutory limit of 50%.
“It is unlikely the manager will want to gear up to 45% or raise [over] $1.2 billion in equity in a choppy equity market. Therefore, the actual equity exposure will likely be larger, or the REIT will likely tap into its sponsor to co-invest in this portfolio, if it does come out on top,” the analysts add.
Fellow bidder Link REIT, which is Asia’s largest REIT, will make its first foray into Singapore if it wins the bid.
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The way the analysts see it, the REIT’s pivot to having a more retail exposure is expected to be positive overall as the REIT has “significant scale and expertise managing such assets in Hong Kong”.
Link REIT also commands a “significant” capacity for debt with a headroom of HK$35 billion ($6.2 billion) for acquisitions before reaching a gearing level of 35%. To be sure, a fully debt-funded deal for the Mercatus portfolio will bring the REIT’s portfolio to only 32%, which is well below the statutory limit of 50%.
However, any hike in gearing levels of over 30% may trigger a credit rating downgrade, which could lead to higher borrowing cost, the analysts point out.
“Therefore, while Link REIT has significant debt-funded capacity, our analyst, Percy Leung believes that Link REIT will likely seek a capital partner in this potential acquisition and divest non-core assets in Hong Kong when the opportunity arises,” says the team.
“Overall, we believe that the current volatile markets could mean that it may not be the most opportune time to tap the equity markets for new capital, and that there could have an impact on accretion levels. That said, we believe that most bidders will most likely tap third-party capital or their sponsors for additional firepower in order to limit their equity fundraising needs,” it adds.
Beyond CICT and Link REIT, FCT and LREIT are potentially interested parties as well.
The Mercatus portfolio is seen as being the best fit for FCT in terms of suburban exposure, although the size of the deal may be a “stumbling block” with its sponsor. A capital partner may also be needed.
LREIT was reported to be one of the contenders as well, even though its manager recently took itself out of the running for the portfolio. The deal would have been a strategic move for the REIT as it takes a “giant leap” to be a major player in the suburban landscape.
DPU accretion
Should the deal go through, CICT will see a distribution per unit (DPU) accretion of up to 0.3%. This is given the positive spread between the analysts’ estimated asset yield (4.5%) and assumed funding costs (3.5%).
Link REIT is estimated to see a DPU accretion of up to 2.8%, again given the positive spread between the analysts’ projected asset yield and assumed funding costs. That said, every 25 basis point (bps) change in asset yields will reduce accretion by 0.7%.
Due to the large amount of fundraising required for FCT and LREIT, the deal may be a dilution to both REIT’s DPUs.
“We estimate that, given the significant fundraising need (as a percentage of market cap for both REITs), the REITs will have to tap their respective sponsors for a larger slice of the deal,” the analysts write.
As at 1.04pm, units in CICT, FCT and LREIT are trading $2.10, $2.34 and 81.5 cents respectively. Units in Link REIT are trading at HK$65.05.
