Revealing the missing pieces of Westfield's puzzle

A lack of detailed information about Westfield's split into domestic and international segments has failed to inspire the market but the restructure makes sense.

Maybe it was just overwhelmed by the general sharemarket softness today, but the market’s response to Wednesday’s Westfield restructuring appears to be lukewarm at best.

The security prices for both Westfield Group and Westfield Retail Trust drifted down as the market absorbed the detail of the re-packaging of the two entities and $63 billion of assets into independent Australasian and international groups.

At the core of the less-than-enthusiastic response appears to be some cynicism as to why the Lowys would separate the business they are clearly very keen on – the international businesses that will be rebadged Westfield Corporation – from the Australasian assets on which their fortunes were built.

That’s despite the fact that the logic of the transaction is quite sound.

The Australasian business is essentially one that generates largely passive, low-risk and high-quality income flows from a mature portfolio of the region’s best shopping centres. It’s perfect for yield-driven investors with low tolerance for risk.

The international business, mainly centred on the US and UK, has much more of a higher-risk and more volatile development flavour to it. With Australia’s A-REIT sector no longer the cheap source of capital on which the Lowys built their international presence, internalising Westfield Retail’s management and combining its assets with Westfield Group’s to form Scentre Group is a rational move.

Apart from a general caution built on the market adage that one should always invest next to the entrepreneur rather than downstream, an element of the lacklustre response to the announcement could be the absence of important detail in the announcement. No doubt there will be a lot of detail in the scheme documentation and the independent expert’s report on the transactions.

An obvious missing piece of the Westfield jigsaw is the $1.9 billion reduction in Westfield Retail’s net tangible assets as it morphs into Scentre Group. The presentation yesterday showed net tangible per security falling from $3.47 to $2.81.

Half of that is easily accounted for. As part of the scheme, Westfield Retail securityholders will receive a $850 million capital return. They would also have to fund their share of the costs of implementing the restructure, which is estimated between about $150 million and several hundred million dollars.

The bulk of the rest of the missing asset backing probably relates to the internalisation of the trust’s management, currently provided by Westfield Group. Westfield hasn’t revealed the valuation of the management rights, but the core property management and corporate services agreements alone amounted to about $72 million last year. Westfield Group also collects development and design fees.

Presumably, if those fees were capitalised, they’d account for much of the missing value. That’s something the market will certainly take a closer look at once the detail becomes available.

There have also been some mutterings in the market about the apportionment of debt within the two entities.

Westfield Retail Trust’s borrowings will, when added to the debt within Westfield Group’s Australasian operations and once the capital return is taken into account, rise from $2.9 billion to $10.9 billion within the new enlarged Scentre Group. Westfield Group’s $12.1 billion of borrowings will be reduced to $6.5 billion within Westfield Corp.

Again, that makes sense. The low-risk profile of Scentre means it ought to be able to carry more debt, although the increase in gearing from the trust’s 21.5 per cent to Scentre’s 38.3 per cent is a big shift in balance sheet strategies.

Westfield Corp, with a big development pipeline and far more opportunities to expand, ought to have a far more conservative balance sheet.

While Westfield argues that the transaction should be evaluated in terms of its impact on earnings – it says the split will be immediately earnings accretive for both sets of securities (the leverage in Scentre presumably plays a part in that outcome) – the relative treatment of the two sets of securityholders will be the key focus of the institutional evaluation of the proposal once the detailed information becomes available.

A scheme of arrangement has a high threshold for approval, requiring 75 per cent of the securities voted in support of a proposal. Any kind of organised opposition tends to jeopardise the outcome of a scheme.

There is significant overlap at the big end of the Westfield Group and Westfield Retail Trust registers, so it is conceivable that at least some of the bigger institutions will be relatively indifferent to the way value has been apportioned.

Institutions with exposure only to Westfield Retail, and the significant retail investor presence on that register, are potentially a larger obstacle to the Lowy’s ambitions. They will be more cynical about the proposal given the Lowys’ obvious preference for the international business. There could be some pressure for some tinkering with the terms from those sources.

The family will still have a major ($600 million or so) interest in Scentre at the point at which the split occurs and Frank Lowy will be chairman of both the new entities. Today, at least, there is still some level of common interest.

The split is complex and the available details not as comprehensive as one might suspect. Westfield will have an interesting time negotiating with its lenders and the ratings agencies and will inevitably make the case to the securityholders in both existing entities in something other than broad brushstrokes.

Once the details are available, we’ll get a better sense of the fairness of the proposal and its impact on the two different sets of securityholders, as well as the prospects for its probable – but not guaranteed – success.