Cromwell’s Offshore Expansion Poorly Received

This story features CROMWELL PROPERTY GROUP, and other companies. For more info SHARE ANALYSIS: CMW

-Accretive but increases risk profile
-Replacing domestic leasing gaps
-Is this a return to 2005?
 

By Eva Brocklehurst

Cromwell Property ((CMW)) has sparked interest with the acquisition of a European property funds manager, Valad Europe, for $208m, which will be funded from the issue of a EUR150m convertible bond.

Macquarie questions the transaction in that a lack of opportunity in Australia is not necessarily a good reason to go seeking potential offshore. The broker observes many Australian real estate investment trusts (A-REITs) have spent the last five years divesting offshore exposures which were taken up ahead of the global financial crisis. The company's risk profile has changed markedly with the convertible bond and the introduction of currency risk via the AUD/EUR rate. Deutsche Bank also highlights the increased financial and business risk and is not attracted to to the transaction, believing it does not add to the stock's appeal.

The transaction is estimated by Macquarie to be around 10% accretive to FY16 earnings on a full year basis, prior to any conversion assumptions about the new convertible bond instrument. This reflects the high yield on the Valad business and the 2.375% coupon payable on the convertible bond. Deutsche Bank also calculates earnings accretion at around 11%. Both brokers note the company has made a more conservative 5.0%-plus estimate for earnings accretion, given there is no FY16 guidance.

Deutsche Bank suggests the company's forecasts imply de-gearing, given that will move to around 45% after this transaction, up from 37% last June. Cromwell divested around 15% of its asset base in FY14 and this is expected to continue. Macquarie notes the company was intent on de-gearing last year as it indicated asset values were becoming too elevated in Australia. Also, the broker warns about the potential conversion of the bond, as this would be dilutive to earnings. Cromwell has assigned a low probability of conversion in its forecasts but, nevertheless, the risk exists.

The transaction was likely undertaken in part to shore up earnings in the outer years to cover known lease expiries such as the Tuggeranong Office Park in the ACT, which is around 9.0% of group income by Macquarie's calculation. Brokers question the added complexity in seeking to replace domestic leasing gaps with European funds management earnings. Moreover, Macquarie suspects the company may hold its distribution below the trajectory for earnings growth, given capex requirements for the portfolio and the leasing uncertainty. The broker also understands Cromwell will leverage the new platform with South African investors who are looking for exposure in Europe.

While the foray into Europe may not be as aggressive as the headlines suggest, for Deutsche Bank it is tinged with deja vu. The broker recalls Australian developers and fund managers scouring the world in 2005 for accretive bolt-on acquisitions and gearing up their balance sheets. The broker acknowledges two key differences with the Valad Europe acquisition compared with most of the deals done overseas by A-REITs in 2005-07. Cromwell is not deploying a material portion of its balance sheet to European real estate thus far, and the platform is being acquired for around 6.4 times FY15 forecast earnings compared with the multiples that ranged from 8.5 to 12 times for European funds management platforms acquired in 2005-07.

Deutsche Bank also does not expect other A-REITs will follow suit. The likes of Goodman Group ((GMG)), Stockland ((SGP)) and GPT ((GPT)) still have boards with memories of the pain that ensued in 2008-09 from aggressive overseas expansion, rich acquisition pricing and excessive leverage. Moreover, the registers of A-REITs are now more skewed towards global investors and the appetite among these investor bases for overseas acquisitions is limited. There is also far less evidence that the sector is under pressure to keep up with the broader market's growth outlook, given this is muted.

FNArena's database contains one Hold rating and two Sell ratings for Cromwell. Consensus target is 95c, which suggests 9.2% downside to the last share price. Dividend yield on FY15 forecasts is 7.6% and on FY16 7.7%.
 

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