When Westfield Retail Trust (WRT) and Westfield Group (WDC) vote on the group’s complicated proposed restructure later this month, the key sticking point for WRT’s 86,705 unitholders is the value of what they are buying.
The proposal
Westfield plans to merge the group’s Australian and New Zealand property assets with Westfield Retail Trust, to form Scentre Group. The remaining Westfield Group portfolio of shopping centres in the US, UK and Italy will be called Westfield Corporation.
The deal is effectively based on the operating “platform” that Scentre is being asked to buy. This platform represents Westfield Group’s Australian and New Zealand property funds management and development business.
Westfield Group (WDC) is contributing net assets of $5.7 billion to Scentre, including its half-share of the Westfield Carindale shopping centre in Brisbane (jointly owned with the Carindale Property Group, a single-asset property trust), while Westfield Retail (WRT) stumps up net assets of $9.6 billion – this is post the $850 million capital return that goes only to WRT holders. So WRT holders are being asked to contribute about 62% of the net assets to Scentre Group, but come out owning 51.4% of the new entity.
They are also being asked to lift the gearing of their entity from WRT’s current 22.5%, to 38.2%.
As it stands, the deal looks like it favours Westfield Group/Westfield Corporation markedly over WRT/Scentre.
This is reportedly the view of several major institutional investors in WRT, in particular UniSuper, which owns just under 8.5% of the stock. UniSuper is expected to vote against the proposal, which could make it difficult for Westfield to achieve the required 75% approval rate.
Asset quality
The “platform” itself is a good asset, for several reasons. Firstly, by “internalising” its management – that is, becoming self-managed – WRT/Scentre saves money, to the tune of about $55 million a year. Secondly, it will gain a new revenue stream by managing the shopping centre portfolio on the part of the non-Scentre investors. Thirdly, the Westfield development team has a good track record of creating value in re-developments, such as Westfield Miranda (a large shopping centre in southern Sydney’s Sutherland Shire.)
That’s great. But as with any asset purchase, it comes down to price.
It is difficult in this situation because this is an implied price – not a price per se. WRT is contributing 62% of the net assets to Scentre Group, but will own 51.4% of the new entity: the difference represents the value of the platform (plus half of Carindale.)
Under the proposal’s metrics, everything being vended into Scentre by the parent group is worth about $3.2 billion to $3.6 billion.
The deal has been priced on earnings from operations, not on net tangible assets (NTA) values, because the platform is an intangible asset. In effect, Westfield has taken the respective earnings that WRT and WDC bring to the merger, and valued them at the same multiple.
WDC brings to the merger its half-share of the Australian/New Zealand retail assets, along with the development/property fund management business earnings. WRT brings its half-share of the Australian/New Zealand retail assets.
The merger ratio has been calculated by treating the earnings from property funds management and development on the same basis as earnings from rent.
This is making a very big assumption – it effectively values a volatile earnings stream (from WDC’s management/development business) on the same basis as a stable, predictable and defensive earnings stream (the rental income from WRT’s half share of the high-quality shopping centre portfolio.)
At the higher end of the valuation, $3.6 billion, that is roughly an earnings multiple of 18 times.
It’s being done this way to be fairer to Westfield Group, to give it fair value for the management and development business.
But it isn’t really fair. The development business has delivered well, Westfield has very good capabilities in that area, but it simply should not attract the same multiple as a rental income stream, which would justify a multiple of 15–18 times. Something more like nine times would be more appropriate.
Who will benefit?
Both the independent experts engaged to report on the restructure, Grant Samuel & Associates for Westfield Group and KPMG Corporate Finance for Westfield Trust, found the restructure was fair, reasonable and in the shareholders’ best interests.
Longer-term, Scentre will be a high-quality investment, collecting the rental income from some of the best retail assets in the country: it will own stakes in 15 of the nation’s top shopping centres. Scentre’s FY14 distribution guidance is for 21.5 cents a share: assuming the new entity is given a 10% to 15% premium to NTA, to reflect the value of the platform, it should trade at about $3.20–$3.30. That would imply a FY14 distribution yield range of 6.51% to 6.72%.
But the crux of the objections from UniSuper and presumably other institutional holders appears to be that applying a higher multiple to development/property management earnings is not appropriate, because it inflates the value of the Westfield Group management business – which means that Westfield Group shareholders come out with a larger share of Scentre than they should.
Or in other words, that WRT shareholders are being asked to pay Westfield Group more than they should for the management business – and that their share of Scentre post-merger is less than it should be.
The other aspect to this is that WRT never traded above its NTA backing figure – there was a perceived ‘Westfield Group overhang.’ The Lowy family sold out of WRT in March 2013, selling its entire 7.1% stake at $3.09 a security, raising $682 million. In effect, if the current restructure proposal goes ahead, the family will come back in, holding about 4% of Scentre – for an NTA (net tangible asset value) of $2.81 a security. But the market won’t expect them to stay on the register for long.
Westfield Group could make the deal fairer by lifting WRT’s share of Scentre, or even to lower the amount of debt increase Scentre is taking on. This would bring down the implied price paid for the operating platform. Armed with the independent experts’ reports, Westfield Group does not think it has to do this. A ‘no’ vote later this month from WRT unitholders would change its mind: so could negotiations with unitholders prior to the vote. We think Westfield Group should sweeten the offer to WRT unitholders, and is likely to do so over the next fortnight to pre-empt an embarrassing rejection. As it stands, it’s not an attractive enough offer for WRT unitholders.
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