There are two ways to view retail Australian Real Estate Investment Trusts (A-REITs). The first is that retail REITs faces immense structural disruption as Amazon and other online stars crush traditional retail, forcing higher vacancies at shopping centres and lower rents.
Anchor tenants, such as department stores, have signalled store closures, meaning some shopping centres will have much floor space to re-let, possibly for less. Iconic British retailer Marks & Spencer this week announced 100-plus store closures by 2022, a slashing of floor space devoted to fashion and homewares, and higher investment in online retailing.
The second view says parts of the retail REIT sector will prosper as others struggle. Mid-tier shopping centres that rely on discretionary retail are ripe for disruption as more people buy goods online. In contrast, neighbourhood and sub-regional shopping centres that focus on basics, such as those owned by Shopping Centres Australasia Property Group, are well placed.
The so-called “fortress malls” will prosper. These giant shopping centres dominate their market and provide a destination shopping “experience”. Centres such as Chadstone in Melbourne or Westfield in Sydney’s Bondi Junction, offer a wider range of services and are strong in food and other lifestyle areas. In many cases, they are their area’s de facto “main street”.
Paris-based shopping-centre giant Unibail-Rodamco SE clearly supports the bullish view on fortress malls, judging by its announcement in December 2017 that it would acquire Australia’s Westfield Corporation in a $30-billion deal. Westfield shareholders voted a series of proposals for the merger this week; the outcome was unknown when this column was written (approvals seems likely.)
Westfield has been among my favoured A-REITS for the past two years – a position I have outlined previously for The Switzer Report. I took a contrarian positive view on the retail sector last year when pessimism about an Amazon-led Armageddon for Australian retail stocks peaked, nominating the large retail property REITs as the safest way to play the turnaround.
Had I owned Westfield shares (I don’t own any shares directly, to avoid perceived conflicts of interest when writing on stocks) I would have supported the deal. But not for reasons one might think.
The Unibail-Rodamco deal looks marginally beneficial for Westfield shareholders at the current price. On my maths, using Unibail’s latest share price and adjusting for currency translation, the deal values Westfield at $9.04 a share, a slight premium to its current $8.85. Unibail’s offer was initially pitched at a 17.8% premium to Westfield’s then share price.
Chart 1: Westfield Corporation
Source: ASX
The deal was more attractive for Westfield shareholders on December 12 (the date of the announcement) when Unibail’s share price was €215. It is now €192, having fallen after the deal was announced.
Currency movements have also changed the deal parameters, given Unibail trades in euro, while the cash consideration is in US dollars and must be converted to Australian dollars.
Chart 2: Unibail-Rodamco
Source: Google Finance
To recap, Unibail’s offer to Westfield shareholders comprised 0.01844 Unibail-Rodamco stapled securities, plus US$2.67 in cash for each Westfield security. Westfield shareholders can choose to receive Chess Depositary Interests on ASX in exchange for its stapled securities listed on Euronext Amsterdam and Paris exchange. Unibail’s ASX-listed CDIs will be part of the ASX 200.
Assuming the merger is approved, Westfield will demerge its retail technology platform, OneMarket, and list it on the ASX, with 90% of it vesting with Westfield shareholders. OneMarket has good prospects and could be worth more than the market realises.
Merger complexities
Before commenting on the deal’s merits, some quick housekeeping. The deal is complex and Westfield’s structure as a stapled entity adds other issues. As mentioned earlier, Unibail’s bid for Westfield is largely based on the value of its shares and a cash consideration in US dollars. There are lots of moving parts with share prices and currency conversions.
As a stapled entity, each Westfield security has three parts: one Westfield Corporation Share, one WFD Trust Unit and one Westfield America Trust Unit. Capital Gains Tax rollover relief only applies to the Westfield Corporation shares, not the trusts. Investors who want to sell their shares post the Unibail deal must think through the tax implications and get good advice.
As an aside, active investors and traders should consider the impact of the deal on the broader A-REIT sector. The US$2.67 cash consideration equates to more than $7 billion flowing to Westfield shareholders. Fund managers will have to reinvest a chunk of it back into ASX A-REITs to maintain asset allocations in the sector. In turn, the A-REIT sector could get a small bounce, so keep an eye on Exchange Traded Funds over A-REIT indices in the next few weeks.
Also, index investors will have to readjust sector weightings. Unibail’s CDIs are expected to be worth about 10% of the A-REIT index, less than Westfield accounted for. That means index asset managers will have to buy other A-REITs to mirror stock weightings in the index.
Deal merits
Unibail and Westfield’s joint release in December had a long list of selling points for the deal. Westfield’s shopping-centre portfolio, across nine cities, was described as a “perfect strategic fit” with Unibail. The transaction would create the world’s premier developer and operator of flagship shopping destinations with 104 prime assets in 13 countries and 1.2 billion visits annually.
An international shopping-centre platform of this magnitude gives Unibail greater bargaining power with global retailers of luxury goods. A network of the best shopping centres in the world’s wealthiest cities is a fabulous, hard-to-replicate asset.
Short term, Unibail has identified €100 million of expected run-rate synergies from the deal, €40 million of which will come from better leasing deals by leveraging the combined group, and €60 million through the reduction of corporate overheads.
As mentioned earlier, I am a long-term bull on fortress malls. Bears who fret about disruption from online retailing have a point with lower-quality shopping centres. But the star fortress malls are well placed to adjust their product/service mix: consumers who used to visit them only to buy groceries, clothes or other products might now eat a gourmet meal there, go to the movies or gym, get a massage, or organise their life through a range of business and personal services. They might visit the centre for entertainment, not just the weekly shop.
Fortress malls are evolving before our eyes. For all the retail gloom, the best shopping centres keep expanding and have a long queue of tenants that must be part of their retail mix, to maintain brand awareness and profile. Also, top malls have high barriers to entry because of their size and location. There is opportunity for residential, office and other forms of property development that create integrated fortress malls.
In some ways, the best malls resemble online platforms that benefit from “network effects”: as fortress malls attract more consumers, they attract more retailers, which in turn attract more consumers. Smaller centres struggle to compete because time-poor customers gravitate to the dominant centre in each market given the breadth of its offering.
Positive long-term story
Two other long-term factors support fortress malls. First, population growth is most evident in super-cities where Unibail and Westfield have malls. Witness the growth in Sydney and Melbourne and what that has done for Chadstone and other giant shopping malls.
The second factor is the boom in Asian middle-class consumption, a trend I have analysed many times for this report over the past five years. As emerging-market incomes rise, a new breed of wealthy Asian consumer is flocking to fortress malls and holidaying in super cities.
Chadstone Shopping Centre, among the Southern Hemisphere’s largest, has noticeably changed its retail mix. Chadstone is positioning for the boom in inbound tourism to Australia and appealing to cashed-up Asian consumers who want luxury brands and love shopping malls.
These megatrends favour the biggest malls in the biggest global cities. Westfield’s decision to focus on high-quality malls was a masterstroke and again showed why it has paid to back the Lowy family over a long period. Their retail instincts are as good as they get.
The Lowy’s decision to support the deal; have family members on the Unibail supervisory board; and maintain a substantial investment in the merged business is the deal’s best endorsement. Frank Lowy’s remarkable achievement with Westfield deserves support from shareholders for a deal he and the Westfield board/family support.
Great entrepreneurs know when it is time to exit either partially or fully. I’m guessing the Lowy family and Westfield board see global scale as the best way to beat the online retail threat and ultimately benefit from a large blending of online and bricks-and-mortar retailing. For that reason, it’s worth supporting the deal and maintaining exposure to Unibail-Rodamco.
It’s hard to see Unibail rallying this year as the market digests the Westfield deal. A consensus share-price target of €233, based on the average of 15 broking firms, suggests Unibail is undervalued at the current price.
That may be the case, but Unibail’s best selling point is its dominance in top malls in top cities – a position that will reward investors, including new shareholders who own the stock via Westfield, in the long run.
- Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor All prices and analysis at May 23, 2018.
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