Unease over expensive malls

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Rebosis Property Fund's planned acquisition of three regional shopping centres from unlisted sister company Billion Group, in a deal worth a huge R6bn, is a case in point.

The empowerment fund's share price fell nearly 7% in the week after the deal was announced on May 23, bringing the stock's total decline to about -14,5% over the past four weeks. That compares with a 2% rise in the SA listed property index over the same time.

Rebosis plans to buy 100% of the Eastern Cape's largest mall, the new Baywest City in Port Elizabeth, 100% of Forest Hill City in Centurion and a 50.1% stake in BT Ngebs City in Mthatha. The three malls, sized at 87,707m², 73,952m² and 60,163m² respectively, are each valued at between R1.7bn and R2.3bn. The R6bn transaction also includes the acquisition of two property services businesses - Billion Asset Managers and Billion Property Services - for a combined R589m.

The rationale for the deal is that Rebosis gets the opportunity to bulk up assets more than 60% in one fell swoop and to nearly double the number of malls in its portfolio, from four to seven.

Existing properties include another Eastern Cape regional centre, Hemingways in East London, as well as Sunnypark Shopping Centre and Bloed Street Mall in Pretoria.

Rebosis was listed in May 2011 by well-regarded lawyerturned-developer Sisa Ngebulana, positioning it as the JSE's first black-managed property fund.

While management has indicated it is confident that the transaction will get the go-ahead from the required minimum 50.1% of shareholders, it seems unlikely that the deal will be a shoo-in.

Some fund managers believe that Rebosis is paying too much for the three malls, particularly as it is a related party deal - Rebosis CEO Ngebulana is also the founder and chairman of developer Billion.

It is not uncommon for listed property funds to have first right of refusal on the pipelines of unlisted development partners. For instance, Attacq has a tie-up with Atterbury and Pivotal with Abland. But related party deals understandably invite more scrutiny to ensure there is no undue benefit for the parties involved.

In a Sens announcement issued last week to address initial market concerns about pricing and funding, Rebosis said the three malls had been independently valued at R5.418bn, which represents an estimated acquisition yield of 7.4% (excluding land for future development). Acquisition yield - the first year's rental income expressed as a percentage of the purchase price - is the general metric used by the commercial property industry to determine value.

Catalyst Fund Managers portfolio manager Zayd Sulaiman says that based on current information the transaction appears expensive. "We don't believe Rebosis will create value for shareholders by overpaying for new, immature malls that will take several years to bed down."

Sulaiman says the concern is the extent to which the deal will dilute long-term earnings and thus dividend growth by overpaying for assets. Rebosis is trading at a forward yield of more than 11% versus the sector's average 7.2%, and at a discount to net asset value of more than 30%.

Sulaiman says the potential R1bn capital raised to help fund the acquisition will be at a substantial discount to net asset value, which can also have a negative effect on the share price.

While Catalyst in principle supports the plan to internalise the asset management company as part of the R6bn deal, Sulaiman says it doesn't make financial sense to simultaneously acquire Billion's property management business.

"There's no way the property management business is worth R250m. You don't need to acquire a business to collect rent and pay expenses, as most companies simply outsource this function."

The two-year rental guarantee that Billion will provide to Rebosis as part of the deal is also potentially problematic, as there is likely to be a drop in income if the malls aren't fully let once the guarantee lapses, as no centre is 100% let all the time, says Sulaiman.

Nesi Chetty, head of property at MMI Investments & Savings, agrees that the deal appears expensive given that one can buy shopping centres in Europe and the UK for similar yields of 6%-7%.

He also notes that the valuation of Forest Hill and Baywest at R30,000/m² and R26,500/m² respectively seems high if one compares it with the R32,000/m² that a well-established shopping centre such as Rosebank Mall in Johannesburg is valued at.

The rent-to-sales ratio at Forest Hill of 8.3% and at Baywest of 8.7% also seems full, says Chetty. "It's hard to see upside from those levels in a weak consumer market."

However, Ngebulana argues that the proposed acquisition yield of 7.4% is fair and compares well with recent shopping centre acquisitions typically concluded at yields in the 6.5% to 7.5% range.

"Besides, large, dominant centres such as Baywest and Forest Hill are becoming scarce assets," Ngebulana says.

He concedes it takes three years for a new centre to settle down, but dismisses suggestions that Forest Hill and Baywest are not trading as successfully as initially expected. Ngebulana says that for any new shopping centre to be feasible, a trading density (turnover/m²) of around R16,500/m²/ month is required. "Baywest, which opened about a year ago, is already achieving R24,308/m² while Forest Hill, which was opened less than two years ago, is close to R26,000/m², up a substantial 27.4% on the prior year."

He notes that the market is seemingly fearing a much bigger dilutionary impact on dividend growth than warranted.

He stresses that the deal will affect dividend payouts only in the year to August 2017, with a forecast 9.1% dilution in dividend growth.

"Effectively that means the dividend for the 2017 financial year will show zero growth on 2016. But we should resume the projected 8%-10%/year dividend growth in the 2018 financial year. So the dilution will be short-lived."

Ngebulana says it would have been ideal to acquire the malls only once the Rebosis share price had rerated so that the deal wouldn't be dilutive.

"But it's a chicken-and-egg situation, because the stock probably won't rerate until we have bought the right assets, which makes it very difficult to find the right time to do a deal like this."

Ngebulana says while the company won't push through a deal that key shareholders are unhappy with, the reality of being a listed company is that "you can't please everybody".

He acknowledges that matters are complicated because it is a related party deal. "Yet shareholders have always known, since listing, that there was an agreement that Rebosis would have first right of refusal to Billion's assets."

Meago Asset Managers director Jay Padayatchi says Rebosis's intention from the outset to acquire the better-quality properties from Billion eventually was the initial attraction of its proposition.

"It removed the development risk for investors but provided the upside from pre-emptive access to these assets."

But the challenge, says Padayatchi, was always going to be the fact that acquiring regional malls from Billion into a high-yielding Rebosis portfolio was going to be dilutive.

"The belief was that Rebosis would rerate over time so that the eventual acquisition of these assets from Billion would not be significantly dilutive.

"This has, however, not materialised."

Padayatchi says Rebosis shareholders now need to decide what an acceptable dilution to earnings is and to what extent a potential capital re-rating, as well as other benefits such as increased size and liquidity following the completion of the deal, will compensate for the inevitable income dilution.

Other key shareholders, including Stanlib and Arrowhead, declined to comment given the complexity of the deal. "There are a lot of things to consider. We are not able to comment or commit to anything at this stage until the circular is published," says Stanlib head of listed property funds Keillen Ndlovu.

Rebosis is expected to provide a more detailed circular on the terms of the deal in the next week or two. The market will no doubt keep a close watch on developments.

Source: Financial Mail