Should Mirvac and Lend Lease wed?

Lend Lease and Mirvac are talking about a merger just as the world’s central banks, led by the US, are taking emergency action. This tells us there is a crisis. The sharemarkets are saying that the crisis will be solved and that there is no major downturn ahead.

I suspect the market is right but no one can be sure and those in the middle of the crisis are much more fearful. In preparing a road map to the future, both Lend Lease and Mirvac have to make a judgement on the long term.

During the 1970s, the chairman of Lend Lease, David Crawford, was a partner in a forerunner to KPMG and in the thick of nasty corporate problems. Lend Lease shareholders can be thankful for the wisdom of Crawford and chief executive Greg Clarke. At a time when there is very limited liquidity in the US and global commercial property debt markets, Lend Lease has only 14% gearing (net debt to shareholders funds plus debt)

If we are in for tougher times in the debt markets, this low gearing provides Lend Lease with potentially the opportunity of a lifetime. Lend Lease and Mirvac have announced that they are having discussions. Mirvac has more gearing than Lend Lease but is not high, and in 2006-07 it reduced gearing to 35.3%. However, a lot of the Mirvac assets do not produce cash flow for a long time and not until there is further investment which will depend on the debt markets.

Mirvac has prospered without Lend Lease but clearly in any extended period of tightness there are advantages in having all or part of the group as part of the wonderful Lend Lease balance sheet. And there are obvious operating synergies and scale that would make the combined group a global property powerhouse. But Crawford and Clarke need to ponder whether Mirvac or parts of Mirvac are really the opportunity of a lifetime.

Mirvac has wonderful assets but they are not on the market at knockdown prices. It really depends on whether Crawford and Clarke believe the current squeeze is a short-term or long-term phenomenon. If the central banks fail – this week the US Federal Reserve led a consortium of banks to pump billions of dollars into the banking system – then it would make sense to wait but that will be easier to determine in three to six months.

Last week I was able to give Eureka Report subscribers some advance warning of the problems facing Centro and its $26 billion shopping centre portfolio (See Centro faces tough times.) As it turned out the company issued a profit warning during the week.

The essence of Centro’s problem was that it had about $2 billion in short-term debt, which it had to refinance at higher interest rates. Centro has good property assets but if the squeeze on the US mortgage market lasts for, say, a year then it will seriously affect property values because there will be forced sales at lower prices.

Mirvac's balance sheet is dominated by an enormous residential land bank of more than $11 billion in undeveloped or partly developed residential land as part of its aim to ensure that it has a 10-year developmental pipeline. It puts the company in a unique position.

Residential land is not a traditional investment area for super funds but in 2005-06 Mirvac began forming unlisted property trusts to acquire its residential estates, which effectively brought forward part of Mirvac's profit on that land while it retained a big ongoing stake in the developments. In tighter conditions it will be harder to generate these sales.

In the US, Mirvac has a major stake in the Quadrant Group, a major provider of US property debt securities. Currently it has a portfolio of around $3 billion. Mirvac looks to this portfolio to generate wonderful growth in the future.

In theory Quadrant should be hit by the US mortgage crisis but Mirvac says it has no direct exposure to the US sub-prime mortgages and the meltdown is increasing the opportunities for the Quadrant joint-venture.

Mirvac chairman Sir James MacKenzie was very optimistic about Quadrant at the Mirvac annual meeting: "Credit quality within Quadrant's portfolio remains sound, and with more than $3 billion in funds under management, and not one loan is in default.”

“Quadrant is benefiting from increased returns due to widening spreads in the commercial mortgage-backed securities market, coupled with an increase in wholesale loan market volumes as investors seek quality”

Lend Lease and Mirvac can see the chance to have an unrivalled residential land and commercial development pipeline and a chance to use the crisis to be a much larger player in the US mortgage market. Lend lease has to decide whether to take some or all the opportunities that are available on the Mirvac table or wait for possible forced sellers of property related assets who will provide opportunities to move forward at much lower prices than exist today.

Whether those opportunities arise depends on whether the central banks are successful. But in terms of opportunities, Mirvac is a bird in the hand.

Source: Financial Shoebox