Second time lucky?

DBS has started to premarket a S$300 million S-REIT for CapitaLand. Last year''s attempt failed; can this succeed?

After Senegal beat France in the World Cup, and Korea beat Italy, it became clear that making predictions is not the easiest of affairs.

But will DBS prove all the naysayers wrong about S-REITs?

With the catastrophic failure of last November’s deal for CapitaLand, many thought that launching an S-REIT in Singapore would prove to be a ‘mission impossible’. But a plucky DBS is returning to the market with a new restructured deal that it hopes investors will find more enticing.

Market talk says DBS is premarketing a new, improved deal that is likely to be about half the size of the original deal at S$300 million. It will also offer more attractive pricing, and a sexier investment story.

The new deal for CapitaLand’s Capital Mall Trust will be priced with a dividend yield of around 7%, versus the previous yield of 5.75%. That will give the deal a total return of between 12% to14%. This is likely to be made possible thanks to CapitaLand’s more realistic approach to valuing the shopping malls being injected. It is thought it will take a 10% haircut on the properties - a number which is in line with how the stock market sees their value. Equity investors have long felt the net asset values (NAV) reported by Singapore property companies are at least 10% out of whack with reality.

Moreover, the new deal is being structured with a more appetizing growth story. Last time around investors had a sense that CapitaLand was simply dumping some overvalued properties into the trust and that there was no growth story to speak of.

This time CapitaLand will own around 45% of the real estate investment trust, versus 25% on the last try. It will also be paid a chunk of its fees for managing the trust in stock, which aligns its performance better with other shareholders. This stock will be paid to CapitaLand at the IPO price, which makes this scheme a bit like a stock option.

It will thus be in CapitaLand’s interest to enhance the value of the properties and their rental income stream (ie the cashflow of the REIT). Accordingly, the company will commit to enhancing the various malls in 2003 and 2004 by converting ‘dead’ space into new retail outlets that can be rented, and increase the total pool of rental income.

A REIT is a pure property play, where investors buy a trust which holds various buildings. Investors are paid a yield each year based on rental incomes. Meanwhile no earnings are retained by the trust. The buildings in the trust are revalued every year, and it is thus the most transparent property vehicle an investor can own, with investors having access to every detail of leases and their expiry dates. Unlike a listed property company, it doesn't undertake any development activities.

All in all, this new structure looks a lot more attractive than the last, although investors will need to take a view on where they see the Singapore economy and the property market going. If they expect a forthcoming boom and a soaring stock market, this defensive play will not offer anywhere near the same upside.

For CapitaLand the deal will still make sense so long as feedback from investors being sounded out does not suggest the dividend yield does not rise too much over 7% - as then it will be taking ever bigger haircuts on the property valuations. However, the S-REIT does fit in with its strategy of creating a fee stream (like Australia’s highly successful Westfield Holdings) and earning a higher return on equity as a result.

It also fits in with its ‘asset-light’ strategy of taking assets off the balance sheet and using funds to pay down debt. This strategy makes its ownership level of the S-REIT critical. Under Singapore law, it must own less than 50% of the S-REIT in order to deconsolidate it from itself.

DBS is marketing the structure to both domestic and international investors, but market sources say this deal will stand or fall based on the response of domestic investors. Particularly critical is the reaction of retail investors. Last time round, only S$50 million of retail demand was generated through DBS’ branch and ATM network. It is thought this number needs to double if the deal is to work this time around.

Unlike last time it won’t be disadvantaged by trying to sell the S-REIT in the same week as it tried to place S$2.1 billion of its own equity (to repair its capital ratios).

Then again, it wasn’t just retail. Domestic institutions were not keen last time either. The REIT product remains a somewhat bizarre hybrid of equity and debt for many of them.

FinanceAsia recently spoke to some of the CIOs at the biggest local insurance companies. Many think they will need to be anchor buyers if the deal is to work.

But they are not very excited with the REIT product. Joachim Toh of Great Eastern said of the last offering: "We have looked at it, but the problem is it is in between a bond and equity. So who looks at it? Should it be our equity department or bond department? Who analyses it? I pass it to equities, and they say this is giving me a 6% return, and they say they’d rather buy a property stock, which will make more than that over three years. So they’re not interested, and plus they’re stuck with three properties they don’t know much about. They’d rather analyse the stock than the properties themselves. And for us in the bond department, sure it has a 6% yield but there’s no maturity, so how do I analyse it?”

Will his view change now that the yield has been increased? That will be a key question for DBS as sole lead manager.

But the Singapore insurers already own a lot of property in the city state.  And regulations again seem to be stacked against a further investment. Says William Toh of Asia Life Insurance: "It’s the way the insurance funds are regulated. There are sub-limits on property and traditionally insurance companies have bought a lot of property. And given the property values have come off, many of these properties are held at higher than market cost. And the regulations at the moment mean a REIT is considered an equity and not a bond. So you are buying something that uses up your equity sub-limit and gives you bond like returns.”

DBS must get its market judgement right this time around, if market rumours are true that it will launch this transaction as a bought deal. After last year’s debacle, CapitaLand is justifiably keen not to lose face again and is thought to have suggested the lead manager hard underwrite the deal to ensure that it gets the S-REIT off the ground and the assets off its books.

This could prove expensive for DBS if the deal doesn’t clear and it is left with a chunk of the deal on its own books.

DBS will however take all the glory if the deal does fly. Many had thought Goldman Sachs would be involved in the deal and would overshadow the Singaporean bank. However, Goldman’s role will solely be as advisor to CapitaLand and it will have no involvement in the capital markets transaction.

On the last occasion the deal would have paid fees to the lead managers of 2.45%. It is not clear whether the number will be the same this time around.

To read why the last deal failed, click on the related link below.