Suntec City Reit: IPO back on track

Competing bid rejected, ergo institutional roadshows will begin early next week.

Joint lead managers Citigroup, DBS and Deutsche Bank will formally launch a S$700 million to S$722 million ($423 million to $436 million) Reit for Suntec City today (November 12). Fund managers say that roadshows for the 722 million unit deal will begin early next week, probably Tuesday, with pricing scheduled for Monday December 6.

Until yesterday, the deal had been looking extremely uncertain thanks to a competing bid for the underlying assets by Munich Re subsidiary Ergo, which owns a number of Singapore property developments including Temasek Tower, the Pidemco Centre and part of Wisma Atria. The group had bid S$2.3 billion ($1.39 billion) for the Suntec City Development, which comprises 1.7 million square feet of office space, 990,000 square feet of retail space and a 1 million square foot convention centre.

The bid was to take the form of a securitization, giving the development's diverse owners a means of exiting their investment. However at a board meeting convened late yesterday afternoon, it was decided to reject the bid in favour of the Reit, which has already undergone two weeks of pre-marketing.

The price range for the deal has been set at S$0.97 to S$1 per unit. The assets have been injected into the Reit in range that spans the group's NAV of S$2.1 billion. This range equates to a dividend yield of 5.8% to 6%.

This represents a 12% to 16.5% discount to the 5.14% blended dividend yield of CapitaCommercial Trust and CapitMall, which were respectively yielding 4.54% and 5.74% at yesterday's close. The leads have decided to use a blended yield because Suntec City combines a commercial and retail income stream, with a slight tilt in favour of retail.

As such it will be the first blended Reit in Singapore. There are currently four Reits listed on the local exchange, of which: CapitaCommercial Trust is a pure office play; CapitaMall a pure retail play; Ascendas Reit an industrial play and Fortune Reit, a retail play on Hong Kong.

Since CapitaMall Trust was IPO'd in July 2002 the sector has performed extremely well, generating total annual returns of 40% to50% for investors. The sector is considered a perfect equity play for uncertain global markets and a declining yield environment.

A Reit is a pure property play in which investors buy a trust that holds various assets. Investors are paid an annual yield based on rental incomes and the underlying assets are revalued each year, making a Reit the most transparent property vehicle an investor can own.

The trust undertakes no development, but returns all earnings back to shareholders through dividend payments. Growth is normally derived from making yield accretive acquisitions and rising underlying rental yields. As such Reits are normally structured to incentive the manager of the Reit properties, in this case ARA Asset Management, owned by Hong Kong's Cheung Kong group.

ARA will earn a 4.5% performance fee based on net property income, but will receive 80% of this fee in new units for the first six years of the Reit's life.

Pre greenshoe, Suntec City Reit will have a freefloat of 56%. The offering comprises all new shares and the existing Suntec City owners will all be diluted on a pro rata basis. All of the greenshoe, which could bump the freefloat up to 64%, will come out of the sponsors' shares.

Some of the units being issued to the sponsors have been deferred in order to boost the upfront dividend yield per share. These units will be issued in six monthly installments from three years after the IPO. This date has been chosen since two new MRT stations will come on line from the end of 2007 and the increased rental yields that should ensue, may mitigate the 14% dilution of the deferred units.

Gearing will be 33%, in line with the Singaporean average and below both Australia (35% to 40%) and the US (45% to 60%).

Suntec City Development is owned by a consortium of Hong Kong property developers. A group of five developers are believed to own stakes of 15% - Cheung Kong's Li ka-shing; New World's Cheng Yu-tung; Henderson's Lee Shau-kee; Shaw Brothers Run Run Shaw and IMC's Frank Tsao. A further two developers own about 12% each - Windsor's Chou Wen-hsien and Chow Chung-kai.

Key questions for prospective institutional investors will include how well Reits are likely to perform in a rising interest rate environment and in the face of increasing supply from Singapore, Malaysia and Hong Kong. Where the former is concerned, analysts acknowledge that returns are likely to fall, but believe 20% should still be achievable over the medium term.

Where the latter is concerned, lead managers are likely to argue that an expanded listed Reit pool will in turn increase international interest in Asia rather than cannibalize it. The three will be clearly focused on an upcoming and competing Reit by the Hong Kong government, but believe greater competition may encourage the Singaporean government to make the local asset class more attractive. Potentially positive changes include removing stamp duty on Reit acquisitions and the 20% witholding tax on foreign institutional investors.

Where Suntec City itself is concerned, investors will be focused on where it will be able to source new acquisitions and what direction retail and commercial yields are likely to move in over the coming few years. In terms of new acquisitions, specialists concede that the group does not have a parent with a huge property portfolio behind it. CapitaCommercial Trust, by contrast, is owned by CapitaLand, South East Asia's largest property developer by assets.

But they do say there are a couple of obvious immediate acquisition targets. One is the 47,500 square foot City Link Development, which adjoins Suntec City. The convention centre, however, will not be included until it becomes profitable.

In terms of rental yields, some analysts have argued that upside potential for the commercial sector could be as high as 50% through to the end of 2006 as yields bounce back from their 17 year lows earlier in this year. Suntec City currently has an occupancy ratio of 83% versus a sector average of 92%. Specialists say it is currently lower, because the group refused to cut rents at the bottom of the cycle.

They also argue that the development will benefit from a shift in the CBD away from Raffles Place towards Suntec City. Suggestions that the government's new Downtown project will provide stiff competition are downplayed on the basis that it is not due to come on stream until at least 2009 and is primarily a "lifestyle" development.

Suntec City currently has 300 tenants with no one tenant accounting for more than 7% of revenue.

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