DBS Group Research analysts Derek Tan and Geraldine Wong see that Paragon REIT could be acquired by CapitaLand Investment’s (CLI) ecosystem of fund partners, other consortium partners or third parties who may be interested in gaining a foothold within the prime Orchard Road belt.
“While the market expects Paragon REIT to be an acquisition target for CapitaLand Integrated Commercial Trust C38U (CICT), the capital allocated for ION Orchard could potentially mean that Paragon REIT’s suitor could be elsewhere,” the analysts write in their Sept 26 report.
CICT announced, on Sept 3, that it is proposing to acquire CLI’s 50% stake in ION Orchard at an agreed-upon property price of $1.85 billion, which implies a price of $5,928 per sq ft on a net lettable area (NLA) basis.
The agreed-upon price on a per sq ft basis is “justified”, note Tan and Wong, due to its trophy status with ION considered one of the “best and most visible malls” along Orchard Road.
“Regarded as one of the crown jewels along Orchard Road, ION Orchard enjoys direct MRT connectivity to Orchard Interchange Station and stands as one of the most dominant luxury malls within Singapore, spanning 660,000 sq ft,” the analysts write.
“The mall will onboard many new-to-portfolio tenants within the luxury space, in the likes of Louis Vuitton and Loewe, amongst others, and operates at an occupancy cost that is lower than CICT’s central mall average,” they add.
See also: UOBKH calls Centurion Corp a stock for ‘growth-minded investors’
Based on the property's reported 7.1% gross yield, the analysts estimate that the proposed price implies an acquisition net property income yield of 4.8% - 4.9%, or 4.1% - 4.2% on a post-tax basis. This is given that the entity that holds the asset does not offer tax transparency for now.
The transaction is deemed to be a “win-win” with positive implications for CICT and CLI.
Even though the deal would have been neutral or dilutive on a like-for-like basis, the analysts see that CICT could gain in the long term through tenant sales from the return of tourists, a below-optimal occupancy cost ratio and a potential lift in its distribution per unit (DPU). The final point will come upon achieving tax transparency if the holding company is restructured, subject to its partner’s agreement.
See also: With 300MW wind-solar project win in India, Sembcorp at 64% of 2028 renewable energy goal: CGSI
To this end, the analysts see a “few levers for CICT to pull” including refinancing its joint venture (JV)-level debt to 3.5% at the current market rate. The debt is currently financed at 3%. They also see asset enhancement opportunities to enhance the gross floor area (GFA) at ION, especially for the levels above the ground. In addition, CICT can consider shifting to a more tax-efficient structure from its current corporate rate bracket of 17%.
“Amongst the three, tax transparency will be the largest lever to pull, which can push DPU accretion from the current +0.9% to +2.0% on a pro-forma basis,” the analysts note. “That said, to achieve tax transparency, its needs the consent of its joint-venture partner, and should be prepared to incur the necessary costs.”
“Organically, we still see a strong runway for rents to grow sustainability, with passing rents recovering close to 2019 levels,” they add.
The analysts also see CICT divesting some of its properties to strengthen its balance sheet. The properties include the WeWork building and Bukit Panjang Plaza that could yield a collective $1 billion.
On CLI’s end, the group benefits from the deal in its transition towards its fee-income, asset-light business. CLI could also gain up to $100 million, thereby boosting its numbers in the 2HFY2024.
“Overall, the proceeds of $1.08 billion will bolster its already strong cash position, bringing the group’s net debt-to-equity ratio down by 6 percentage points to 0.53 times (from 0.59 times as of June 30),” write Tan and Wong. “Given a target net debt-to-equity ratio of 0.7 times, we see a potential for up to $3.0 billion in firepower for acquisitions.”
The deal is expected to be completed sometime in 4Q2024 and is subject to CICT’s unitholders via an extraordinary general meeting (EGM).
Units in CICT closed 4 cents higher or 1.91% up at $2.14 while shares in CLI closed 4 cents higher or 1.35% up at $3 on Sept 26.
