Australia | Dec 11 2013
-Fully internalised Scentre a positive
-Proposal slightly favours WDC shareholders
-WRT should obtain more scope
-US listing for WDC unlikely to bring re-rating
By Eva Brocklehurst
Westfield Group ((WDC)) plans to divest its Australian and New Zealand shopping centres into new entity that will be merged with Westfield Retail Trust ((WRT)). It will be known as Scentre, a $28 billion, fully internalised vehicle. This transaction will create the largest internally managed shopping centre group in Australasia. The major advantage, according to brokers, is the removal of perceived conflicts between owner and manager.
The proposal considers giving WRT unit holders $285 and 918 securities for every 1,000 WRT securities held. The cash payment will be made through a $850m capital return. The transaction is expected to be 5.2% accretive to FY14 funds from operations (FFO) while gearing is forecast to increase to 38.1% from 22%. The merger ratios mean WRT unit holders will own 51.4% of Scentre and WDC shareholders will own 48.6%. WDC shareholders will also receive 1000 securities in the new corporatised Westfield Group for every 1000 WDC securities. The Lowy family will retain an 8% interest in WDC and have 4% interest in the merged company. Both Frank and Steven Lowy will be on the boards of the two companies while Peter Lowy will step down from executive management and remain as a non-executive director of WDC.
Macquarie considers the idea is strategically sensible, so the issue is all about price. The broker crunches the numbers on several return scenarios but comes to the conclusion that the price being paid by Westfield Retail unit holders is too high. There's a potential for stock overhang arising from WDC holders receiving units in Scentre and Westfield Retail is unlikely to outperform now without an amendment in the terms of the proposal, in Macquarie's view. The strategic benefits of a well managed domestic vehicle should not be underestimated, according to UBS. UBS notes WRT has often traded at a discount to reflect an external management entity with no independent path for growth in a difficult retailing environment. Hence, the deal should allow WRT to obtain superior growth prospects than otherwise would be the case.
It's about returns on equity and arbitraging foreign markets, in BA-Merill Lynch's opinion. Westfield Corp will provide investors with a lower geared, $18bn US and UK portfolio. Lower gearing, down to 32% from 60%, enables the company to fund its $9bn development pipeline accretively via debt, as well as provide investors with greater leverage to a change in the Australian dollar. Merrills notes a 10% Australian dollar move would result in a 10% change in earnings compared with the much lower impact currently. The broker thinks the company will marginally improve returns, despite getting out of the Australian business and de-gearing. Importantly, future returns should lift more quickly.
WDC has indicated a listing in a new domicile where its peers trade on higher FFO multiples. Merrills suspects WDC will garner global support in anticipation of the spin-off, as investors seek exposure to the company's higher growth markets and opportunities. Domestic investors on the other hand that seek secure yields will be attracted to Scentre, which will offer a more compelling proposition after the merger.
For Citi, the consideration is how to add value in re-slicing an existing pie. The broker thinks the buy-back programs of the two companies will remain inactive. The positive aspect for WDC is the exposure to higher growth markets. The downside is that WDC shareholders will receive Scentre shares and more exposure to a slower Australasian market. The broker considers the positives probably outweigh negatives, as many of the negatives were those already faced by WDC shareholders. The proposal is a net positive for WRT, in Citi's view, as management is internalised and concerns about the sell-down of WDC assets are eliminated. Moreover, there is the potential to increase fee streams from third parties via joint venture, something WRT has been unable to do. The increase in the new entity's gearing is a major negative, while volatility will be heightened by the potential for very significant register turnover. Citi also thinks the merger ratios favour WDC, as they are based on firm multiples for the Aust/NZ business and WRT's above-market debt costs.
Citi questions whether the new Westfield Corp would trade at similar multiple to US peers, given that the development assets as a percentage of gross asset value are 8%. The broker observes that US investors have not historically valued development earnings as highly as have Australian investors. The future development pipeline is also large, opening up a potential funding issue. In addition, the broker notes many of the WDC assets are already in joint ventures. Another issue is the tax efficiency and what the structure of a US-listed Westfield Corp might be. For these reasons, Citi thinks a re-rating to US multiples is unlikely in the near term.
For Scentre, Citi considers retail peers as the benchmark of value. This is a little limited in that Scentre will derive 10-11% of FFO from project and management income, while many peers are more passive in nature and derive the bulk of earnings from rental income. All-in-all, the broker finds it hard to see how re-constructing the existing assets changes the underlying value.
Deutsche Bank also notes the terms are more favourable to WDC and agrees there's little likelihood of a multiple re-rating with a US listing for WDC. US mall REITs are trading on an average of 15.8 times FY14 FFO and on Deutsche Bank's estimates WDC is trading on 15.4 times. Adjusting for the value of the fee streams to be acquired from WDC, the capital return to WRT unit holders and applying the merger ratio in Deutsche Bank's calculations gives a notional merger value of $3.37 per WRT security. This is only slightly below the current valuation.
On the FNArena database WRT has three Buy ratings and two Hold. The consensus target price is $3.37, suggesting 15.9% upside to the last share price. The dividend yield on 2013 forecasts is 6.9% and on 2014 it's 7.1%. For WDC the database has one Buy (Deutsche Bank), four Hold and one Sell (Macquarie). The consensus target price is $11.77, suggesting 13.8% upside to the last share price. The dividend yield on 2013 forecasts is 4.9% and on 2014 it's 5.0%.
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