Will Dexus Secure Commonwealth Property?

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-Dexus JV bids for Comm Property
-Offer implies $1.15 per unit
-Internalisation likely stepped up
-More bidding probable
 

By Eva Brocklehurst

Dexus Property ((DXS)) has finally made a move on Commonwealth Property Office ((CPA)). The assets of CPA have been up for grabs since Commonwealth Bank ((CBA)) decided to offload the business, either through a sale or internalisation of management. Subsequently, Dexus acquired a 14.9% stake and speculation has been rife for some months about the company's plans.

Now Dexus, along with the Canada Pension Plan Investment Board (CPPIB) in a 50:50 JV, has lodged an indicative, non-binding proposal to acquire all CPA units by way of an informal trust scheme. Such a scheme would require 75% of CPA's unit holders to approve the transaction and Commonwealth Bank would be unable to vote. The offer comprises 68c cash plus 0.4516 Dexus securities for each CPA unit. The implied value is around $1.15 for each CPA unit, before distributions. Dexus has also made an undisclosed ancillary offer to Commonwealth Bank for the management rights, which Dexus believes will contribute $6m in profit per annum.

Based on this offer, JP Morgan notes the consortium does not appear to be offering much of a premium for control. In making the case to CPA stake holders, Dexus states they would receive the benefit of its $6.1bn in third-party funds business. Dexus argues that transaction costs dilute CPA's Net Tangible Assets (NTA), in particular the premium to be paid to convertible bond holders in the event of a change of control, even with internalisation. The transaction is likely to result in material costs for Dexus. These are transaction costs, debt break costs and management costs – via a proposed but undisclosed cash payment to Commonwealth Bank. Nevertheless, JP Morgan suspects they are likely to be similar to the costs involved to internalise management of CPA.

Credit Suisse thinks the offer looks a little light. CPA's overheads would fall materially, probably by as much as 50%, as a Dexus-managed unlisted fund. This would be somewhat offset by the facilitation fee paid to Commonwealth Bank in relation to management rights. The broker lifts CPA's rating to Neutral from Underperform but, despite the takeover potential, finds better value in Dexus, with an Outperform rating, or Investa Office ((IOF)) for that matter, also Outperform.

Commonwealth Bank must now respond. The Dexus bid facilitates an exit for the bank but Credit Suisse suspects the internalisation proposal will now be accelerated. Internalisation could be funded with debt, which would allow for 3% earnings accretion and marginal net asset value (NAV) accretion, depending on prices. Dexus would then need to respond with a better offer. The current offer represents a 7.3% premium to the 30-day VWAP prior to the preliminary internalisation proposal in late June and is effectively situated around CPA's NTA – to be funded partially with Dexus scrip that's just below that company's NTA.

BA-Merrill Lynch gives the move a tick of approval for strategy. There are two key benefits for Dexus. Firstly is the fact that CPPIB, a major global investor, is prepared to back Dexus to manage a $3.8 billion office portfolio which increases total assets under management to $17bn with $3.2bn in development. Dexus could also sell down its 50% stake to other wholesale investors and increase fee streams. The other benefit is that Dexus would become a dominate player with 26% of the Sydney premium and A-grade CBD office towers, and this would provide economies of scale and competitive advantage. Were it to go ahead, the proposal would be 2.5% accretive to Merrills' forecast FY14/FY15 funds from operations and would reduce NTA valuation by 2-3%, to $1.02-1.03. Merrills' discounted cash flow valuation of CPA is $1.19, equal to the bid including the distribution from CPA.

Credit Suisse does not expect a deal will be done without a revised offer or an alternative – such as the internalisation. Moreover, the broker has concerns about the leasing intensity of a diminished quality portfolio at a tough point in the cycle. Over the past year Dexus has traded more favourably relative to NTA compared with CPA and this probably reflected the quality of the portfolio.

No action is required by unit holders. The manager, or responsible entity, of CPA will consider this proposal along with the internalisation proposal, as well as any other offer that may emerge, and decide whether to recommend it or not. Meanwhile, Commonwealth Bank will consider the ancilliary proposal. The proposal will only proceed if acceptable terms can be agreed and satisfactory due diligence is received by the manager by November 10.
 

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