CapitaLand Retail China Trust (CRCT) announced on 28 Nov 2017 their acquisition of Rock Square in Guangzhou for RMB 3,361m or S$688.9m.
The acquisition will be in conjunction with their parent company CapitaLand. CRCT will take a 51% majority stake in the joint venture while CapitaLand will take 49%.
One year after buying Galleria in Chengdu and just 4 months after selling CapitaMall Anzhen, CRCT is doing another deal.
Here’s a few things to know about the transaction.
[Also read: Review of CapitaLand REITs]
The Mall is in a strategic location in Tier 1 Guangzhou. According to their slides, Guangzhou had GDP growth of 8.2%, above the nation’s average of 6.7%.
Retail sales for consumer goods grew 9% in 2016 and the urban disposable income per capita grew 9% to RMB 50,941.
Guangzhou ranks 4th among China’s top 20 cities in terms of the number of high-income consumers and disposable income per capita is expected to double over the next 15 years.
Rock square is is the Haizhu district, which is the second most populous district in the city with more than 1.6 million people.
The commercial district is well known for it being the home to the Creative Industry Zone, Sun Yat-sen University and the Guangzhou’s landmark Canton Tower.
Dominant mall and great accessibility
Rock square is one of the largest malls in Haizhu district and has a population of 800,000 within a 3km radius.
The mall is served by multiple ground entrances with direct connection to Shayuan Station and Guangzhou-Foshan line.
At 96.4% committed occupancy as at 30 June 2017, the mall has a patronage of 24 million footfall in 2016.
Post acquisition metrics
After the acquisition, CRCT’s tier 1 exposure will rise by 6%.
Present portfolio valuation of RMB 11,800m will rise to RMB 15,141m.
Tier 1’s proportion of the portfolio valuation will rise from 71.6% to 77.9% while tier 2 and 3 will fall from 22.8% to 17.8% and 5.6% to 4.3% respectively.
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At this stage of the cycle, increasing exposure to Tier 1 cities would make CRCT’s portfolio more resilient.
CRCT’s portfolio valuation will rise by 28% which is a hefty amount, and that is why CRCT joined their parent CapitaLand in this acquisition.
Shortly after selling CapitaMall Anzhen which was on a master lease basis, CRCT has recycled their capital into a higher potential mall.
The land use right expiry has also been lengthened, with CapitaMall Anzhen having a land use right expiry of between 2034 to 2042, to Rock Square with a land use right expiry of 2045.
There is also an improvement on DPU and gearing after the acquisition.
DPU rises from 10.05 cents for FY 2016 to 10.16 cents after the acquisition on a pro-forma basis.
Gearing falls from 35.4% to 33.9%, bringing it even lower than the average REIT gearing level.
After the Rock Square acquisition, CRCT will have an increased debt heardroom of S$569, giving it financial flexibility for future growth.
[Also read: CapitaLand opens largest mall in Suzhou]
Gearing was reduced by the equity fund raising.
NAV is stable at S$1.6 before and after the acquisition.
Investment window to capture upside
CRCT intends to capture upside provided by expiring leases which are due mainly between 2018 and 2020.
By gross rental income, a total of 28+12+13%, or 53% of space will be rolling in 2018 to 2020.
By net lettable area, the figure is 15+8+9%, or 32%.
If rents in Guangzhou continue to rise, CRCT will be able to tap on this window to lock in higher rents.
This would flow through the company and ultimately into the hands of unitholders.
CRCT has made a strategic move by divesting their master-leased mall which I reckon provides a 2-4% annual increase, into one that has the potential to cause revenue to grow by more than 5%.
In the same breath, the rents may suffer if the overall market turns down. This stability is something which the master leased Anzhen mall could provide.
As is typical for many malls these days, a large portion of the space in Rock Square is taken up by F&B tenants.
The next largest taker of space are fashion & accessory tenants.
[Also read: 10 things to look out for in Chinese REITs]
Notable tenants include Uniqlo, Zara, Gong Cha, Watsons and anchor tenant Aeon.
Nothing really to shout about regarding their tenants, as most of these tenants should be found in large regional shopping malls.
Based on CRCT’s slides, the Rock Square acquisition is executed on a 50% LTV basis.
50% of the acquisition consideration is from borrowings, while 22% are from equity fund raising proceeds and 28% from cash, likely from the CapitaMall Anzhen sale.
The funding requirements are in Singapore dollars, with the purchase consideration being S$351.3m. S$1.8m will go to acquisition related costs like due diligence and legal fees while CRCT will stand to take home S$3.5m as acquisition fee.
As with many non-China domiciled companies, they face an issue of trapped cash.
CRCT will be using onshore cash in China to fund the purchase.
In the acquisition announcement, there is a salient terms section which relates to an entrustment loan.
[Also read: Singapore residential yields at historical lows]
CRCT will essentially be porcuring a two year entrustment loan of RMB 476.8m to prepay the principal amount of the onshore loan.
This entrustment loan bears an interest rate of 3.045% per annum, resulting in RMB 14.5m of interest payments per year, or RMB 29m (approx S$5.9m) over the tenure of the loan.
Pro Forma financial effects
One thing that stands out is the increase in DPU and decrease in gearing after the acquisition.
It is difficult for many REITs to achieve both with an acquisition.
Gearing usually rises after an acquisition because of the loan taken.
In Rock Square’s case, the decline in gearing is most likely because of the 28% of purchase price being paid in onshore cash.
This helps CRCT reduce the amount of money that needs to be raised either by an equity fund raising or debt.
Looking at the numbers, the mall must have been trading at a very very tight yield. This is to be expected for China Tier 1 malls, especially in the South.
The amount of distributable income rises by S$6.8m (S$93.6m minus S$86.7). Since this is the distributable amount, we need to work backwards to get the gross revenue of the mall.
We know that in between the gross revenue and distributable income line are items such as property manager fees, onshore loan interest payments, corporate income tax (25% of taxable income), statutory reserve (10% of taxable income less corporate income tax, applicable in China), withholding tax (10% on amounts to be distributed offshore), offshore interest payments, trustee fees and REIT manager fees.
It would therefore be reasonable to think that gross revenue be about S$9-10m. From these, the above items are deducted to arrive at a distributable amount of S$6.8.
This is a very rough gauge but that is how the income from the property level flows to Singapore then to unitholders.
If gross revenue is S$9m, and purchase consideration is S$351.3m (based on CRCT’s 51% share), the property level yield would work out to be about 2.6%, and this is using gross revenue as the numerator. If net property income were used, I believe the yield would be lower.
Low as Singapore residential yields are, it’s still higher than Rock Square!
For CRCT to buy a mall at such a low yield, have DPU accretion and a reduction in gearing, it is certainly impressive.
In conclusion, the Rock Square is a strategic move by CRCT to expand using the Sponsor CapitaLand’s network.
The acquisition will enhance the portfolio quality and increase exposure to high-growth Tier 1 city. This is good for the REIT.
Nothing to argue about regarding the locational and intrinsic qualities of the mall given it is a dominant mall in the area.
It is quite a feat also to see gearing fall after the acquisition.
Most importantly, there is no DPU dilution, with it rising from 10.05 cents to 10.16 cents after the acquisition.