SPH - CIMB

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.