Will Lowy's tinkering placate Westfield investors?

It’s not often that Frank Lowy has blinked under pressure from investors, but last evening’s tinkering with the terms of the proposed restructuring of the Westfield property empire is an indication of both the level of opposition to the deal and his own determination to get it across the line.

The Lowys had been adamant that the terms of the restructuring, which will see Westfield’s Australasian operations merged with the Westfield Retail Trust to form the new Scentre Group, were fair and wouldn’t be changed.

There was significant investor discontent, however, not with the strategy under-pinning the proposal but with the terms. A particular point of contention was the value attributed to Westfield Group’s operating platform in Australasia and the consequent decrease in asset backing and increase in gearing that WRT securityholders would experience.

Given that Westfield has been continuously testing the level of investor support for the proposal, it would appear reasonable to assume that the change to the terms announced late yesterday were in response to concerns that the proposal could be voted down at the WRT scheme meeting later this month.

The revised terms don’t alter the merger ratio, which will still see WRT security holders owning 51.4 per cent of Scentre and Westfield securityholders 48.6 per cent.

What the Lowys and WRT have done, however, is to reduce the amount of debt being transferred into Scentre with the Westfield Group assets by $300 million, from $7.1 billion to $6.8bn.

That reduces Scentre’s gearing from 38.4 per cent to 37.3 per cent, increases its net tangible asset backing from $2.82 per security to $2.88 and improves its pro forma funds from operations from 21.5 cents per security to 21.75 cents.

While the gearing ratio is outside the proposed target range for Scentre of between 30 per cent and 35 per cent, it doesn’t reflect the value of the operating platform, which has been estimated by the independent experts hired by Westfield Group and WRT at between $2.8 billion and $3.5 billion.

While the change -- funded by the recent $1.1bn of funds released by Westfield Group’s recent sale of three regional shopping centres in the UK -- is relatively modest, the gesture towards the concerns of WRT investors may be sufficient to reduce the level of opposition to the merger and get it across the line.

There has never been any significant questioning of the strategic logic that underpins the restructuring and the carving up of the Westfield empire into two discrete businesses: one Australasian with a predominantly passive income focus and the other a more development-oriented international vehicle with a very different risk profile.

With Frank Lowy saying that the adjusted merger terms are final, the fate of the proposal now hinges on whether critics of its terms will be appeased by the modest reduction in gearing and modest increase in accretion to WRT securityholders’ free funds from operations.

If there remains sufficient investor opposition to vote down the scheme, the Lowys do have some options.

The obvious one is to retain the status quo. However, it would also be possible for Westfield Group to simply spin out its Australasian business, with its co-ownership of WRT’s retail centres as well as its management and development activities into a competing vehicle. That would be messy, particularly for WRT security holders.

This morning’s sharemarket response to last night’s announcement, which saw WRT units edge up marginally but Westfield Group securities slip, would suggest that the market believes the odds on the merger being voted down have lengthened.