Brokers Cool On Novion-Federation Centres Merger

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-Counter bid hard to envisage
-Views differ on which entity gains
-Lack of cash for Novion holders
-Potentially third largest A-REIT
 

By Eva Brocklehurst

Novion ((NVN)) and Federation Centres ((FDC)) have put the cat among the Australian real estate investment trusts (A-REIT) by announcing plans to merge. Each Novion security will be offered 0.8225 Federation Centres securities, implying a value of $2.55 for Novion stock, a 10% premium to the prior close.

Brokers are now speculating whether others in the sector may circle, although they acknowledge a counter-bid would be challenging as the deal has support from Novion’s major shareholder, Gandel. While there is strategic merit, the synergies are overstated in Credit Suisse’s view. The broker considers the deal is more favourable for Federation Centres as its asset base will improve, while Novion increases its exposure to more structurally challenged sub-regional assets. Federation Centres is also taking a calculated risk in Morgan Stanley’s opinion, as its risk profile will increase with the transaction. The broker suspects the deal could nevertheless drive a wave of interest as the sector warms to the idea of creating scale and global relevance.

This is Groundhog Day in Deutsche Bank’s view. A return to 2003 when scale, cost synergies and diversification were the default rationale for such mergers. Given the premium inherent in Federation Centres’ proposal, and the support from Gandel, the broker considers it unlikely a competing bid will emerge. Deutsche Bank differs from other brokers in that it regards the earnings accretion for Novion investors is more material, offering a superior medium-term growth profile versus that of the standalone entity.

The benefits for Federation Centres on the other hand are less clear, on current assumptions. Deutsche Bank’s initial estimates suggest it to be value destructive by around 10%. Management estimates earnings accretion is 5.8% on a FY15 pro forma basis, but Deutsche Bank suspects this would decline over the medium term as Novion’s lower growth profile dilutes the benefits.

JP Morgan takes the opposing tack, believing the rationale for Federation Centres is clear but whether it is the best possible outcome for Novion remains to be seen. The broker’s sticking point is the lack of a cash reward for Novion security holders. The offer is fully comprised of FDC scrip. JP Morgan considers this lack of cash opens the door for other interested parties but acknowledges FDC has a first mover advantage. As is usual in real estate deals, the broker observes, there are minimal revenue synergies. Cost savings underpin the earnings accretion from the merger.

Furthermore, Macquarie observes a large portion of this earnings accretion arises from the refinancing of all debt facilities, which could have been done in the absence of the proposed merger. The deal’s rationale, in this broker’s opinion, is based on Federation Centres being able to draw on the development experience of the Novion team, along with enhanced scale. Macquarie will look for further details in support of the deal but suspects that some of the value options that are expected to ensue would have been available to either entity on a standalone basis.

Moelis believes the merger is, at best, neutral for Federation Centres and dilutive for both. The majority of the initial synergy and interest savings are transferred to Novion unit holders through the merger ratio. The broker envisages a holder of FDC units needs to balance potential longer term scale with the difficulties of growing a larger vehicle. Moelis is not convinced that Federation Centres would be able to capture the necessary benefits to justify the merger and downgrades to Sell from Neutral on the news.

In regard to a new bidder emerging, Moelis finds it difficult to justify why a direct property buyer would pay the premiums to net tangible assets inherent in these vehicles. Hence, a rival bid would need to be from another listed entity using scrip and this is considered unlikely. There is also the $40m break fee.

Goldman Sachs estimates, should the merger be implemented, the group would become the third largest A-REIT within the S&P/ASX 200 index. It would manage or own in excess of $22bn in assets across 102 shopping centres and become the largest landlord in Australia to tenants Coles ((WES)) and Woolworths ((WOW)). Goldman Sachs expects the portfolio would include some competing assets which management may look to dispose of via a joint venture or wholesale vehicles.

The broker also observes there are no recent precedents for such a merger, as the 2004 attempt by Lend Lease (LLC)) and GPT ((GPT)) was unsuccessful. Goldman retains a Neutral rating on both stocks, expecting the market will be wanting more information at the upcoming results.

At this juncture FNArena’s database reveals two Hold ratings and three Sell for Novion and two Buy, two Hold and two Sell for Federation Centres. The consensus target price for FDC is $2.78, suggesting 9.7% downside to the last share price. Dividend yield on FY15 and FY16 forecasts is 5.4% and 5.7% respectively. For Novion the consensus target at $2.26 suggests 10.4% downside to the last share price and the dividend yield on FY15 and FY16 forecasts is 5.3% and 5.5% respectively.
 

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