Investa bid sparks a bonfire

The $6.6 billion bid for Investa has lit a fire under Australian listed property trusts. But leading analysts are “bewildered” by the price offered for the mid-sized ASX listed trust by US-based Morgan Stanley Real Estate. Does the offer represent fair value for its assets or is it symptomatic of a sector careering out of control?

The announcement last Thursday May 31, of Morgan Stanley Real Estate’s $6.6 billion takeover of Investa came as a surprise to no one. A wave of consolidation in the Australian listed property sector has long been forecast.

The offer represents a 14% premium to the closing price of $2.69 on May 30 and a 56% premium to the value of Investa's net tangible assets as of December 31. As soon as the offer was unveiled, the price of Investa and a string of Australian LPTs soared.

As traders speculate, two sectoral reports from high profile broking houses have emerged, identifying likely takeover targets. A note from Merrill Lynch published on June 5 names CFS Retail, Multiplex, Lend Lease, DB RREEF, Mirvac, APN/UKA European Retail Trust and Commonwealth Office. A separate note from Goldman Sachs JBWere names Multiplex, Macquarie DDR Trust, Reckson New York Property Trust and Tishman Speyer Office Fund.

A question many analysts have been asking is 'Why now?’ In January 2006, Investa was trading for $2 and the then chief executive, Chris O'Donnell, left the company to chase opportunities in Dubai not long after. With the chairman John Arthur assuming the role of caretaker CEO by April, analysts wonder why the bid did not come sooner.

Between that last announcement and May 2007, the stock ran up another 27.5%, which is about average for the sector in Australia. Separately it was delivering investors a yield of about 5%. Investa has returned more than 20% to investors for three years running. The former Westpac property trust is a good performer.

But the Morgan Stanley Real Estate offer more accurately reflects the mood of the LPT (or REIT) sector globally. The initial deal that triggered the latest global rush of activity in listed property was the sale of billionaire US businessman Sam Zell’s Equity Office Property Trust to private equity group Blackstone for $US36 billion.

There are two ways a group like Blackstone or Morgan Stanley will commonly generate a return. The first is if the portfolio is “under-rented” – the current rental income is lower than the market rate. This was one of the main drivers behind the Equity Office takeover.

Stephen Hayes, managing director of Perennial Real Estate Investments, says: “Investa’s buildings aren’t badly managed, they are very well let. It’s not like they [Morgan Stanley] can come in with their foreign expertise and add anything at all.”

Alternatively, it's possible that Morgan Stanley Real Estate really believes in Australian office as an asset class. The $6.6 billion offer represents a 5.4–5.5% cap rate (yields relative to property value). Rates above 5% usually represent fully valued property.

'Beyond' our expectations

In considering the cap rate, a new report from Goldman Sachs JB Were on the Investa deal states: “The offer was beyond our expectations, and certainly represents one of the biggest premiums ever paid for the acquisition of an Australian REIT.”

This is not to suggest that Morgan Stanley Real Estate is inexperienced in the sector. It has been in the global market since 1969. Moreover, it has dealt previously with Australian companies: Morgan Stanley Real Estate had the foresight to pick up Lend Lease’s US REIT business at the fire sale price of $300 million in 2003.

John Snowden, head of property securities at Colonial First State, says: “Some overseas companies like Morgan Stanley have a much lower cost of capital and can afford to pay a higher price. If you look at their track record in places like Asia they have made hundreds of millions out of canny property investments.”

Most industry insiders are highly sceptical of a rival bid emerging. In cases like these a $20 million break fee wouldn’t necessarily dissuade a serious competitor but the exorbitant cap rate might. Another aspect of the deal that might prove a turn-off is the Clarendon business. This is Investa's residential property development business, which is exposed predominantly to NSW. It’s a highly competitive, low-margin business in perhaps the most depressed property market in Australia.

Takeover expert Tom Elliott, of MM&E Capital, suggests it might be premature to rule out a counter-bid. “It’s not impossible that someone else could buy in,” he told Eureka Report. “Right now you can buy the stock at a 1% premium to the bid, so you’re paying 3¢ over the $3.08 a share bid. That’s probably not a bad risk/return trade-off on what I expect would be a 50:50 chance of someone else coming into the bidding process.

Meanwhile, the rest of LPT sector continues to move forward in leaps and bounds. In the few trading days since the announcement, Charter Hall had gained 11.2%, Commonwealth Office Property gained 11.5%, Mirvac gained 12.4% and DB RREEF gained 11%.

Last year there was a record $4.6 trillion worth of takeover deals announced globally. These is little doubt that this activity will continue and that listed property will play a starring role as the story unfolds. But seemingly sky-high valuations set a dangerous precedent for future acquisitions when forecasts for capital gains are below 10-year bond yields.

nHow LPT share prices have moved
	ASX	Mkt Cap ($m)	Share price May-30	Share price Jun-05	Increase (%)
APN/UKA European Property Trust	AEZ	709	$1.28	$1.35	5.08
Babcock & Brown Japan	BJT	944	$1.88	$1.92	1.86
Commonwealth Office Property	CPA	2,813	$1.57	$1.75	11.46
CFS Retail	CFS	4,965	$2.32	$2.32	0.00
Charter Hall	CHC	1,159	$2.77	$3.08	11.19
DB RREEF	DRT	5,857	$1.83	$2.03	10.93
ING Office	IOF	2,198	$1.72	$1.80	4.96
Investa	IPG	4,683	$2.69	$3.09	14.87
Lend Lease	LLC	7,781	$19.82	$19.32	(2.52)
Mirvac	MGR	5,995	$5.25	$5.90	12.38
Multiplex	MXG	4,111	$4.75	$4.94	4.00
Macquarie DDR	MDT	1,185	$1.25	$1.26	1.20
Reckson New York	RNY	313	$1.17	$1.20	2.56
Tishman Speyer Office Fund	TSO	926	$2.61	$2.73	4.60