CFX, CPA Proposal Sparks Speculation

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

-Internalisation only marginally accretive
-CPA the most likely for takeover
-Some CFX assets may be eyed
-Governance hurdles and a price to come yet
 

By Eva Brocklehurst

Commonwealth Bank ((CBA)) has put forward a proposal that sets the stage for the internalisation of the management of CFS Retail ((CFX)) and Commonwealth Property Office ((CPA)) trusts. It is also proposed that CFX would acquire the wholesale funds and shopping centre management businesses of  Colonial First State Global. Financial institutions have been under pressure to divest real estate, given the Basel III changes, so this move by CBA is not surprising. A transaction is some way off as the proposal is conditional and incomplete. Nevertheless, it has provoked speculation among brokers as to the benefits, or otherwise, of an internalisation of management on the said trusts (REITs).

Given the trust ceases to pay a margin to the manager, internalisations are typically earnings accretive. For CPA it opens up the prospect of potential corporate activity. Macquarie assumes an earnings multiple of 10 times the results in consideration for management rights of $51 million. A debt funded acquisition of the management rights would be marginally accretive to earnings, but less than 1%. CPA seems to be the most likely target for listed competitors. The register looks more accessible and an alternative proposal directly to unit holders is possible. The competitor could gain synergy benefits from additional scale. Deutsche Bank crunches the numbers and finds that, while the internalisation of CPA puts the trust on notice for takeover, it doesn't look a compelling proposition at current levels, with CPA trading at 0.98 times net tangible assets.

JP Morgan acknowledges, while privatisation is a genuine option, it will be harder than it was six months ago. Motivated parties could include Charter Hall ((CHC)), AMP ((AMP)) or Lend Lease ((LLC)) but a deal involving pure third party capital is considered remote now that the big pension funds have less desire to own Australian office assets. Others that may get in on the act, according to JP Morgan, are Dexus ((DXS)) and Investa Office ((IOF)). GPT ((GPT)) is seen less likely to want CPA assets as it is a step down in quality. Mirvac ((MGR)) looks more suited to getting involved in Australand ((ALZ)), in the broker's opinion.

Looking at CFX, Macquarie estimates a debt funded acquisition of management rights including the wholesale platform to also be marginally accretive. As CFX's gearing will decline from around 28.9% to around 25% after the conditional sale of four sub-regional assets to Pacific REIT, Macquarie believes debt funding is likely. Given CFX's size, Macquarie does not believe this changes the corporate appeal although internalised vehicles typically trade at a premium to external vehicles. JP Morgan is inclined to discount M&A activity because four interested parties control 34% of the register and John Gandel has rights over CBA's stock, as well as a private stake in CFX's Chadstone asset.

Despite discounting M&A activity, JP Morgan does a roll call of potential interests in a deal over CFX assets. Charter Hall is unlikely to be involved, although JP Morgan thought at one time it might have been a candidate in a rights sale by CBA and Gandel. Westfield ((WDC)) cannot be overlooked and would be most attracted to getting hands on Chadstone. There could be ACCC implications on some of the better assets of CFX for Westfield and there would be many assets the company is not interested in.

Lend Lease ((LLC)) may be another candidate but would be even less likely than Westfield to commit significant amounts of its own capital. Blackstone has been acquiring shopping centres in Australia and has deep pockets. It is a logical party in combination with an established player such as Westfield. Simon, CapitaMalls Asia or other global players are possible, but look prospective only in a full bid for CFX. Coming back to the Gandel stake that looks problematic, as nothing suggests to JP Morgan that Gandel wants to sell out.

JP Morgan views the move as a first step. The second step would be for CBA to sell its REIT stakes. Of course, there's no price yet. JP Morgan estimates that the entire platform generates around $70m in earnings and, if put to the market, could sell for $650m. The broker does not believe internalisation is the best way for CBA to extract top dollar for rights, particularly in the case of CPA, but then the bank has investments in the funds to take into account as well.

Now that CBA has put forward this proposal, JP Morgan considers the previous Underweight calls on both trusts are irrelevant and these have been upgraded to Neutral in the case of CFX and Overweight in the case of CPA.

On the FNArena database CPA has one Buy rating, five Hold and one Sell. The consensus price target is $1.14, signalling 2.6% downside to the last unit price. The dividend yield on both FY13 and FY14 consensus earnings forecasts is 5.7%. CFX has three Buy ratings, three Hold and one Sell. The consensus price target is $2.09, suggesting 4.2% upside to the last unit price. The dividend yield for FY13 consensus earnings forecasts is 6.8% and for FY14 it is 6.9%.

The responsible entity's board sub-committee will now review the proposal. A notice of meeting should then be forthcoming and a 75% unit holder vote would be required to pass a resolution. CBA is unlikely to be able to vote its stakes. There are governance risks in the process now being played out that come from having the same responsible entity across vehicles and having the same directors on each board.

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