Published: 14 May 2005
Lend Lease Corp group chief executive Greg Clarke & chief financial officer Roger Burrows made a 50-page presentation to analysts in Sydney on 11 May, on why they believed GPT’s investors shouldn’t support the internalisation structure, particularly the sale of prime retail assets to Westfield Group and entry into a European investment joint venture with Babcock & Brown.
This article is split into 3 pages:
the opening page, covering some general issues
considerable comment from Grant Samuel on the GPT proposal, and
a damning critique from Lend Lease (this page).
Not much to us, butâ€¦..
While the Lend Lease chiefs said the GPT internalisation “is of limited consequence to Lend Lease,” they proposed in their vote-no option that Lend Lease, as GPT’s responsible entity, would manage GPT at cost from 1 July until an “unencumbered alternative internalisation” was completed by the end of the year, forego performance fees and not exercise pre-emptive rights on 2 developments, Rouse Hill & Twin Waters.
What Lend Lease has offered is a route to internal management without the need to sell 3 assets at a discount and without switching the money from those mall investments into a predominantly residential European portfolio, which Lend Lease raised doubts about in terms of quality, risk & future investment value.
Mr Clarke said the sale of assets to Westfield would be at a discount to market, not through a competitive process, further value would be transferred through management & development agreements & pre-emptive rights and those assets were going to GPT’s largest competitor.
On the joint venture, Mr Clark said:
the fees payable to Babcock & Brown were excessive
the relative returns on investment heavily favoured Babcock & Brown
returns would be generated from 100% leverage of assets rather than quality property investment
the potential for excess total returns (including capital growth) was questionable
the forecast increased distribution/unit would arise from short-term underwriting & branding fees and didn’t reflect returns from long-term property investment
the proposal wouldn’t enhance long-term distribution/unit growth as the joint venture investment was capped at 15% of GPT’s total assets
acquiring up to $A5.6 billion in overseas property assets within 18 months “does not represent â€˜controlled expansion’ into offshore markets”
gearing would be increase substantially, from 30% to as much as 45% on “see through” basis and S&P had indicated a downgrade from A+ to BBB+ or A-
the proposal would dilute any premium for control.
“Investors will exchange 15% & 20%-plus returns for 10-11%”
Roger Burrows, Lend Lease’s chief financial officer, said Woden Plaza earned GPT more than 15%/year over the past 5 years and the other 2 malls more than 20%/year. He said the proposed joint venture offered returns of 10-11%, “with a significant proportion of that flowing from financial engineering.
“It appears to us that the transactions have been structured to produce apparent short-term earnings growth. Almost 10% of GPT’s forecast 2006 earnings are based on a short-term underwriting from Babcock & Brown and the branding fee from Westfield. In our view, there is a significant risk that GPT’s earnings will decline in 2007.”
Mr Burrows said malls returned an average 17% over the past 5 years compared to 9% from office. Penrith & Sunshine were GPT’s 2nd & 3rd-best earners, Woden 9th. In a comparison of Australian regional shopping centres based on moving annual turnover/mÂ², Mr Burrows said Penrith & Sunshine were 3rd & 4th ($A7172 & $A7206/Â²), Woden 6th ($A6960/mÂ²).
Burrows says sale will seriously weaken GPT in retail
He said their sale would weaken the strategic importance of GPT’s retail portfolio and it would mean GPT wouldn’t have a strategic regional shopping centre management platform: “The largest regional centres in which GPT is invested will be managed by others â€“ either Lend Lease or Westfield. Given the mature nature of the Australian retail sector, there is very limited ability for GPT to rebuild this platform.”
Mr Burrows’ next statement is particularly interesting in light of the Lend Lease & GPT behaviour over valuations in 2004. Lend Lease tried to take over (“merge with”) GPT on a basis which included a number of old valuations during a rising market. When Stockland made an offer a few months later, those old (2003) valuations were suddenly updated, making the Stockland bid look even worse than it already was.
This week, Mr Burrows said: “We know that many others in the market share our concerns that these 3 centres are being sold below their true value. Given other comparable transactions, it is clear that GPT could have obtained a far higher price if it had conducted an open market sale process.”
This contrasts with GPT’s view in its meeting memorandum this week: “GPT has achieved sale prices for 50% of its interests in 3 retail assets which are the most attractive (in yield terms) of any retail asset it has ever sold. This has been achieved arguably at the high point of the property cycle with interest rates at historic lows, which have risen further since the proposal was announced on 17 February. Increasing interest rates typically reduce property asset prices.”
The sales to Westfield have been done on the basis of valuations dated 31 December 2004. Westfield is to get half the GPT interest in each. In GPT’s annual report, the 3 centres are shown as:
Penrith Plaza, 100% owned by GPT, book value $A704.9 million, December 2004 valuation $A672.8 million (Penrith Plaza alone, $A688.1 million including Riley Square), current cap rate 5.75%
Sunshine Plaza, 50%, book $A281.8 million, valuation $A264.75 million, 6%
Woden Plaza, 100%, book $A484 million, valuation $A470 million, 6.25%
Total book value $A1470.7 million, valuation total (including Riley Square) $A1422.85 million.
Mr Burrows estimated these sales would give rise to a higher tax liability this year â€“ A12.8c/unit â€“ from an $A258 million capital gain.
By giving Westfield management & development rights, Mr Burrows said GPT would forego an implied development & construction margin, which on Westfield’s portfolio this year was forecast at 14.6%, next year 23.1%. Westfield would also get a pre-emptive right over GPT’s remaining ownership interests in these 3 centres. Mr Burrows said this would reduce GPT’s ability to maximize long-term value.
Joint venture in a hurry to make risk-laden investments
Under the “very aggressive” acquisition programme for the joint venture, Mr Burrows said $A4 billion would have to be invested in just 18 months. “That represents up to half of GPT’s existing portfolio built up over the past 30 years. You then overlay the fact that the GPT board & management team will be
required to approve these investments in geographies & markets in which they have little or no experience or track record. Alternatively, if they do not secure sufficient acquisitions, GPT’s earnings will decline post-2006.”
Babcock & Brown was upbeat about the prospects for its German investments when the joint venture was announced in February, saying there was scope within the acquisition portfolios to add value and a ready institutional market to sell upgraded residential properties to.
Lend Lease’s view is, at best, highly sceptical: “The majority of assets to be acquired are German apartments that have had a track record of underwhelming capital growth over the past 10 years. In addition, the outlook for these assets in general points to continued underperformance, with oversupply and poor underlying demand dynamics.”
He said the apartments had a history of weak rental growth, there was downward pressure on residential rentals in some locations, and some of the residential blocks had asbestos contamination.
The Cologne Technology Park was 19% vacant, its value was underpinned by a â‚¬18 million rental guarantee from the previous vendor to support vacancies & near-term lease expiries, no minority discount was applied for the 30% ownership interest, estimated rental growth rates were only 1-2%/year and the 6% initial yield was significantly lower than for most Australian office portfolios.
At the Galerie Butovice, vacancy was 15% and that was subject to a short-term rental guarantee, while the Royal Ahold lease on the supermarket & 67% of office space had no rental increases for the first 5 years.
Mr Burrows added 2 points from Deutsche Bank Research at the end of March:
During the mid-90s incentives were provided to developers to increase supply & quality of the accommodation in West Germanyâ€¦creating an oversupply
“Our economist expects Germany to have one of the lowest rates of population growth in Europe, with the population of Germany to peak by 2012 and then decline by up to 10% by 2050.”
Mr Burrows said the joint venture contained a poison pill & the wrong incentives for GPT: “It is difficult for GPT to reject any investment by the joint venture proposed by Babcock & Brown,” he said:
Refusal to continue to invest in assets proposed by Babcock & Brown triggers a termination right
Babcock & Brown can terminate the joint venture on change of control of GPT
Babcock & Brown has first right to acquire assets it introduced to the joint venture at “market value” on termination (about $A600 million premium to asset backing implicit in Grant Samuel’s GPT valuation would disappear), equating to A30c/unit premium for these assets in GPT’s unit price not being sustainable in a takeover
GPT provides 90% of funding but has no effective veto over investment decisions.
This group of stories:
11 May 2005: Lend Lease tells GPT unitholders to vote no
10 May 2005: GPT split from Lend Lease gets nasty
22 March 2005: GPT’s European investment venture outlined
4 March 2005: Stockland still under 1% of GPT as bid closes
Websites: GPT internalisation proposal