Westfield: Today’s the day for an unfair deal

Nathan Bell explains why you should vote differently depending on which side of the transaction you're on.

The Westfield empire, combining Westfield Group and Westfield Retail Trust, is today set to restructure for the third time in a decade. But as the proposal requires 75% of the companies' 200,000 shareholders to approve the deal – and just under half getting a decidedly shorter straw – consent is no sure thing.

Back in 2004, the Lowy family orchestrated the merger of Westfield Holdings, Westfield Trust and Westfield America Trust into Westfield Group. Then, in 2010, the properties in Australia and New Zealand were spun off into Westfield Retail Trust.

Now, the Lowys are at it again with the aim of creating two geographically independent Westfields that will each develop, own and manage their own shopping centres. The restructure will ‘generate greater long-term growth and value for both Westfield Group and WRT investors' as chairman Frank Lowy put it.

There’s certainly some merit to both companies taking control of their development pipelines and management. The benefits that accrue to Westfield Group shareholders by reducing debt and allowing management to focus on the robust international operations are clear cut. But what do Westfield Retail Trust shareholders have to gain?

The Australian operations are likely to find revenue growth hard to come by as previous aggressive rent increases bite into tenants' profits, just as they face increasing online competition. This could be why the Lowy family and Westfield Group are so keen to separate the Australian management business.

If the deal is approved, Westfield Group shareholders will receive one share in the new internationally focused Westfield Corporation, as well as 1.246 shares in the Australian focused Scentre Group for each security of Westfield Group held.

Westfield Retail Trust shareholders will receive 0.918 shares in Scentre and a cash payment of 0.2853 cents for each Westfield Retail Trust security held. This would result in Westfield Retail Trust shareholders owning 51.4% of Scentre and Westfield Group shareholders owning 48.6%.

The Lowy family will come away with 8.4% of Westfield Corporation, equal to their existing ownership stake in Westfield Group. They will also wind up with 4.1% of Scentre and Frank Lowy will chair both boards.

Wait a minute. The Lowy family abandoned Westfield Retail Trust in March last year by selling its entire $664m stake at $3.09 per share. Now it’s asking Westfield Retail Trust shareholders to put up 68% of the assets to receive 51% of Scentre’s stock. How is that fair?

The original proposal included the transfer of $7.1bn of debt from Westfield Group to Scentre. As a sweetener, the proposal has since been amended to transfer only $6.8bn. It’s a step in the right direction but it still nearly doubles the debt burden for Westfield Retail Trust shareholders, with total debt as a proportion of assets increasing from 21% to 37%.

What the Lowys propose is to transform Westfield Retail Trust from a landlord of high-quality shopping centres with little debt to a leveraged property developer and manager. All in the name of ‘forecast earnings accretion’.

Under the new deal, Scentre's funds from operations are expected to be about 21.75 cents per security, 6.6% higher than Westfield Retail Trust’s 2014 guidance of 20.4 cents. The distribution is likely to be $0.1985 per share, for a forecast yield of 6.2%.

Shareholders of both Westfield Group and Westfield Retail Trust will have their chance to vote today. Should the restructure be approved, the new companies are expected to list separately around June.

It’s probably no surprise that the ‘independent experts’, paid $1.7m for their opinion, found the deal fair. However, we think the proposal still favours Westfield Group shareholders.

Splitting off the slow-growing Australian management business to focus on the robust international operations is a smart move for Westfield Group. Furthermore, Westfield Corporation's $4bn development pipeline will be twice the size of Scentre's, making for better growth prospects. We recommend Westfield Group shareholders vote yes.

For many Westfield Retail Trust shareholders, however, the pure ownership of Australian shopping centres, without the added operating risk of a management company, is all they really want. Under the proposed restructure, net tangible assets will fall from $3.47 per share to $2.88 and, while earnings will be enhanced in the short term, growth over the long term is less assured.

The new proposal would improve Scentre's balance sheet, relative to the original plan, but the inherent unfairness of the split remains. We recommend Westfield Retail Trust shareholders vote against the proposal.

Disclosure: Intelligent Investor staff own securities in Westfield Group and Westfield Retail Trust. 

Nathan Bell is Research Director of Intelligent Investor Share Advisor (AFSL 282288). Unlock all of Share Advisor’s stock research and buy recommendations by taking out a 15-day free membership.

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