DBS Group Research analysts Dale Lai, Derek Tan and Ho Peihwa suggest that an asset swap between Keppel DC REIT’s (KDC REIT) Guangdong data centre properties worth $275 million and a 23% stake in Keppel Limited’s Genting Lane data centre will be a “win-win”.
“[The move] could effectively demonstrate to investors the strength of Keppel’s fund management and operational capability ecosystem,” the analysts write in their report dated May 31. They note that as the issues in the Guangdong data centre properties are tenant-related and not asset-related, this means that the “time for reworking and reletting is necessary” to fully optimise returns.
In this regard, Keppel, which is the sponsor of the REIT, has this luxury while KDC REIT, due to expectations of consistent returns, has less flexibility.
The concerns surrounding the Guangdong data centre were first spotlighted in mid-2023 when the financial health of Hong Kong-listed Neo Telemedia was highlighted after consecutive quarters of losses. The losses were partly due to rising interest rates and a decline in utilisation rates at the data centres they were managing.
Neo Telemedia’s subsidiary, Bluesea, is the master tenant of the Guangdong data centres, which KDC REIT had acquired in phases from July 2021. There is a 15-year master lease for each of the three data centres.
Win-win outcome
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A swap in assets will be accretive to Keppel’s value in both the immediate and long term while giving KDC REIT the opportunity to repair its cost of capital, say the analysts.
Should a successful asset swap happen, Keppel will see “immediate financial benefits” from a 20% stake in KDC REIT through higher dividends and share prices. It will also enable the conglomerate to monetise the value of the recently-completed Genting Lane data centre.
“At the same time, it enables investment in Guangdong data centre, which would serve as a pipeline for KDC REIT once it has stabilised,” the analysts note.
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Other additional benefits include Keppel enjoying the profile of being a “committed and supportive sponsor” to its REITs. The group can also cement its foothold in Guangdong, which is the gateway to South China, the analysts add.
Finally, the swap may help Keppel’s desire to expand its presence in the fast-growing China data centre market. At the same time, the group may simultaneously generate attractive returns with an estimated internal rate of return (IRR) of 8% to 11% over a “relatively short” gestation period, the analysts point out.
For KDC REIT, the benefit comes in the form of a lifted overhang in its unit price. Unitholders’ confidence may also be boosted on the back of stronger earnings and a quality portfolio, say the analysts.
Since October 2023 when concerns surrounding Bluesea’s master lease at the Guangdong data centres surfaced, KDC REIT’s unit price has corrected by more than 20%.
The REIT’s unit price of $1.79 as at the analysts’ report represents 1.3 times its P/B, which is a “substantial drop” from its average of 1.6 times and a steeper discount compared to its five-year historical average of 1.8 times.
“We see potential upside of around 30% to KDCREIT’s share price (to mean valuation) if a transaction materialises, returning the REIT to a path of sustained growth,” the analysts write. “With a 23% stake in Genting Lane data centre at [around an] 6.5% yield, we see 4% - 5% uplift to distributions per unit (DPUs) in FY2024 – FY2025, bringing the REIT closer to its historical DPU highs.”
The analysts have kept their “buy” calls on both Keppel and KDC REIT with target prices of $9 and $2.20 respectively.
Shares in Keppel closed flat at $6.72 while units in KDC REIT closed at $1.80, 1 cent higher or 0.56% up on May 31.
