One for the future

More light on Clementi bid

Maintain Neutral and S$4.38 target price; further underperformance could provide buying opportunity. We earlier believed that SPH’s bid price of S$2,797psf for a Clementi mall site represented a hefty premium over comparable malls. Since then, SPH’s share price has weakened. The large premium it put in over the secondhighest bid (42% premium) meant that SPH was unlikely to lose the tender. Thus, it was not much of a surprise when SPH announced that it has won the tender. Given its recent share-price underperformance, we believe further downside is limited. In an analysts’ briefing yesterday, SPH took great pains to explain the rationale for its bid, conveying its optimism on the Singapore property market and making it clear that it intends to own attractive infrastructure to ride on Singapore’s population growth and/or undertake future residential development projects. No change to our earnings estimates for now as contributions from the mall are expected only further out. Our sum-of-the-parts target price remains S$4.38.

The details. SPH teamed up with NTUC for a joint bid for a Clementi mall site. SPH will own 60% of the venture, NTUC 40%. The bid price of S$542m is for a site with 269,100sf of retail/commercial GFA and NLA of 193,750sf. Part of the difference is accounted by the space occupied by a library (21,250sf) paying concessionary rents. The Housing Development Board will build the core structure and facade, and hand it
over to the SPH consortium in Aug 2010. SPH estimates fit-out costs at less than S$40m and expects the mall to start contribution in the first half of 2011. Adjusting for lower fit-out costs, the total consideration could be S$3,003 psf. The pricing still looks steep when compared with Ion Orchard (S$3,800 psf), Bishan Junction 8 (S$2,306 psf), Serangoon Nex (S$2,167 psf), Northpoint (S$2,129 psf) and Causeway Point (S$1,706 psf). Assuming gross rents of S$15psf, net property yield is only 4.8%. In contrast, mainstream landlords were bidding at closer to 6% yields.

SPH explained the bid differential. SPH gave three reasons for its aggressive bid. First, it had wrong intelligence that there was going to be an aggressive bid from a private equity firm. Second, its bid was based on expected rental rates in the future. SPH pointed to the neighbouring mall, CityVibe, where rents topping S$18psf had been achieved. Last but not least, SPH alluded to its ability to secure cheap financing, which can help push up the mall’s overall returns. No details on optimal gearing or cost of debt have been disclosed yet.

How good can it be? The wild card in this whole deal is really financing rates. Assuming SPH does achieve S$18psf rents and full occupancy in 2011, net property yields (un-geared) can rise up to 5.75%. If financing rates are low, effective property returns would look even better. Earlier in the year, REITs were refinancing at spreads of 200-300bp above cost of funds. By August, A-REIT had secured its refinancing at spreads of below 150bp. One could imagine banks pricing spreads for a retail asset with stable cash flow at below 150bp. The 5-year SGS is now about 1.36%. Taken together, the all-in cost of debt could end up at 2.5%-3.0%. Assuming the SPH consortium takes 60% debt for the project and borrows at 3%, the effective rate of returns (on a geared basis) goes up to 9.9%.

The quest for stable yields for ‘excess capital’. SPH’s declared dividends in FY09 amounted to about S$420m. FY10 dividends do not appear to be under threat from this property foray since there will be a similar amount of proceeds coming from Sky@Eleven in FY10. As at end-FY09, SPH had about S$993m worth of investible assets comprising S$299m cash, S$245m long-term investments (bonds) and S$449m short-term investments (equities, including stakes in Starhub and M1). SPH’s 60% share of the Clementi mall implies a share of project costs at about S$350m. Assuming the consortium does borrow up to 60% LTV, SPH would need to set aside S$140m for its equity portion, equivalent to half its idle cash hoard. Cash does not earn much these days, so the move to mobilise cash into retail malls can be viewed positively. We asked management if its dwindling cash hoard would imply an end to SPH’s property investments for now. Management’s answer: its potential property investments are not limited by current cash levels, but are assessed on each project’s expected returns vs. other investments within its S$1bn pool of investible assets. This is all done to provide adequate returns for its excess capital, outside its core media operations. We retain our view that the bid price was not low, but for a company in SPH’s position and given the current environment of population growth and low interest rates, one can understand the move.

SPH explains thinking behind mall bid

Winning bidders looking ahead at rentals upon lease renewal

Even as the Housing & Development Board yesterday awarded Clementi Mall to a Singapore Press Holdings-led consortium, members of SPH’s top management sought to explain the rationale for the bid price, which stockbroking analysts and market watchers have said was too high.

The consortium members are taking a long-term position on the investment and looking at forward rentals at the next lease renewal cycle – instead of just immediate returns when the mall begins operating in the first half of 2011, SPH’s management said at media and analyst briefings yesterday.

It also revealed that more than 300 interested parties have registered interest to potentially rent space at the mall.

And the projected fit-out cost will be under $40 million – lower than the $40-50 million that some analysts had assumed.

HDB is building only the mall’s core structure and facade, which it is scheduled to hand over in August next year to the joint venture, which will then finish the project and have naming rights for the property.

NTUC FairPrice, which has a 20 per cent stake in the venture, will lease 20,000-25,000 square feet for a supermarket at basement one of the mall. It may also take up additional space for a convenience store.

NTUC Income, which also has a 20 per cent stake, and SPH, the majority shareholder with 60 per cent, may also take up space in the property. The latter is likely to be for a kiosk selling newspapers and magazines.

Clementi Mall – the working name for the 99-year leasehold property – will have an air-conditioned bus interchange on the first level. The mall’s third level will be linked to Clementi MRT Station.

SPH’s management yesterday explained that the venture’s bid valuation was based on stabilised operations after the mall’s rental renewal cycle, and enhancing yield over time.

‘In other words, when we do our calculations, we are not using the rentals when we start operations. We are actually using after rental renewal cycle, whether it is after three years or six years,’ said SPH chief executive officer Alan Chan.

Had SPH used the typical strategy of real estate investment trusts (Reits), which assume say a 5-6 per cent return based on rents when the mall starts operating, it would have led to bids in the $300 million range – where four of the six bids came in for the mall at the close of HDB’s tender last Tuesday.

‘When you are a Reit, you have to ensure immediate returns. Whereas we are long-term players and we are prepared to place our bets based on forward rentals at the next cycle,’ Mr Chan said.

‘This is the challenge the bidder is always confronted with: Do you use standard metrics or do you think out of the box?’

The venture hopes to achieve the rentals that are obtained by the best suburban malls in Singapore.

Its winning bid of $541.898 million was the highest of six offers that HDB received for the mall. The winning bid is nearly 42 per cent more than the next highest offer of $382 million.

Earlier, analysts had forecast a valuation for the property – comprising the bid price as well as assuming fit-out costs of $40-50 million – of about $3,000 per square foot of net floor area of retail space.

But SPH management yesterday said that the projected fit-out costs would be under $40 million and hence the valuation would be ‘somewhere south of $3,000 psf’.

Along prime Orchard Road, ION Orchard was valued at $3,747 psf of net lettable area as at June 30 this year.

SPH said that it also worked in prospects for potential capital appreciation in the bid price, pointing to its successful track record with Paragon along Orchard Road.

Its valuation has increased from just under $800 million in 1997 to almost $2 billion today. Based on the current market price,

Paragon’s yield is well above 4 per cent. The return on equity is above 10 per cent – a result that was achieved over the years, not overnight.

Mr Chan also sought to allay concerns in some quarters that SPH’s investment in Clementi Mall could clip dividend payouts to shareholders.

Firstly, SPH’s stake in the venture is only 60 per cent – and for which it has enough internal funds to pay, with the rest to be funded through borrowings.

‘Secondly, our dividend track record is always a function of recurring earnings. So this investment is not going to affect the dividend track record.’

And when stabilised rental income starts streaming in from Clementi Mall, SPH’s recurring earnings will increase, he added.