Mergers and acquisitions in the listed real estate sector are traditionally few and far between.
However, there has been a torrent of activity in the past few weeks, with Hammerson buying intu, Unibail-Rodamco buying Westfield and now Brookfield looking to take private serviced office provider IWG.
For company chief executives, investors and advisers, a culmination of factors have led them to believe that mega deals, usually nothing more than a pipedream, might all of a sudden be conceivable.
“In the real estate sector, the vast majority of deals involving public companies are recommended – i.e. both sides want the deal to happen,” says Patrick Long, head of UK real estate at Lazard.
“There are different reasons companies might explore a combination, such as a divergence in share price performance between two companies with similar assets, or succession issues, or a founder shareholder looking to exit.”
The NAV mirage
Since the UK’s vote to leave the European Union, much of the listed real estate sector has traded at a significant discount to NAV – in other words, the total value of the shares of a company are less than the book value of a company’s portfolio, minus its debt.
Therefore, in theory, a company could be bought for one price and its assets subsequently sold at a higher price.
The old adage goes that this is actually something of a mirage.
Once a bid is made for a company the discount disappears as shares surge due to the buyer’s interest and a defensive valuation is put up, with the seller insisting on a bid that matches the new, inflated NAV.
But this argument may be starting to weaken, as some companies have been trading at substantial discounts for 18 months.
“In the early 2000s, property shares were trading at a persistent discount, because the sector was out of favour. Many listed companies were taken private at a material premium to their share price but at a discount to the realisable value of their underlying assets,” recalls Long.
“However, even if a public company is trading at a substantial discount to NAV, it does not necessarily mean that an offer at a conventional bid premium of say 30% will be successful, as the target may argue that its assets are worth at least NAV,” he adds.
Private equity push
In the current global low-return environment, investors are increasingly having to be inventive to achieve their target returns.
The flood of equity into real estate funds searching for yield, the availability of cheap debt, and lack of alternative higher yielding sectors can be considered both an argument for and against M&A deals.
The deluge of cash has prompted some private equity players such as Blackstone and Brookfield, which have the expertise to pull off such deals, to raise core or core-plus money that could allow them to bid more aggressively for listed companies than they would be able to with opportunistic equity.
Listed companies typically also take a highly conservative view on debt, and it would be possible for bidders to leverage up much more aggressively when considering deals.
“Given the price that will be needed to be paid to take most companies private, it makes it hard for most opportunistic private equity investors to do so and make their appropriate returns,” says Rishi Bhuchar, co-head of EMEA real estate, gaming, lodging and leisure investment banking at Deutsche Bank.
What is likely to stop some deals happening is shareholders holding out for a full price. With interest rates remaining low, there being very few IPOs of scale and multi asset-class managers allocating more money to real estate, and not less, investors don’t necessarily want their money back as they have limited options as to where to invest it.”
“However, with some firms now raising core-plus funds that would be able to deal with the complexity, it is possible that they could team up with some of their overseas LPs [limited partners] to do so.”
But the current appetite for real estate globally makes it all the more difficult to get a bid accepted.
“What is likely to stop some deals happening is shareholders holding out for a full price. With interest rates remaining low, there being very few IPOs of scale and multi asset-class managers allocating more money to real estate, and not less, investors don’t necessarily want their money back as they have limited options as to where to invest it,” Bhuchar says.
One way to square this circle somewhat is to undertake merger deals where no, or limited, cash changes hands and money goes back in investors’ pockets.
“The share-for-share deals, like with Hammerson and intu, where businesses are trading at a discount, are easier to do as shareholders can still enjoy a potential upside later on rather than companies selling out entirely at deflated price,” says Andy Pyle, UK head of real estate at KPMG.
Sector advantages
In some sectors such consolidation is a clear advantage, as illustrated by the two recent major retail deals.
“The benefits of scale are more obvious in sectors like logistics and retail where there is much more tenant overlap than in the office sector, for example,” says Long.
Over and above this there are also general economies of scale arguments around centralising back-office functions as well as some management while, broadly, the larger a company is the better terms it can negotiate with lenders.
It can also increase its profile and following among investors.
However, some companies have become smaller, shrinking their market caps and making them relatively more accessible to bidders.
The likes of British Land and Great Portland Estates have been selling off assets substantially above book value, returning cash to shareholders and taking a disciplined approach to the hot market in London.
“Companies have always looked to sell where they can, profitability and at a significant premium to development costs of assets and above book value. What seems to be a little different this time is they do not appear to see the same level of opportunity to reinvest,” says one senior adviser.
Listed sector M&A deals are notoriously difficult to pull off – with combining and satisfying management teams often the trickiest task – and the most likely scenario for 2018 is that there will be only a small handful. But alongside the possibility of there being somewhat greater clarity over the direction of Brexit, there are strong arguments than for some years to say that it is more likely now that monumental transactions may occur.
Fantasy M&A – what deals might happen?
The big beasts – British Land and Landsec
For years a deal for one of the UK’s two largest property companies has seemed out of reach, but with the weight of cash in the sector it is now at least a reasonable mental exercise.
British Land has a £6.7bn market cap and a 26.9% loan-to-value ratio. Say the company could be bought for £8bn – a 20% premium – with leverage of 50%, it would take £4bn of equity.
It may sound a big number, but considering Logicor was bought for €12bn (£10.6bn) by CIC last summer it is not ridiculous to think that a club of two or three investors could find the cash.
To stretch the hypotheticals further, both companies have potential options over merging and demerging.
In light of the Hammerson/intu and Westfield/Unibail mergers, it could be argued that having as big a critical mass of retail as possible is an advantage – or at least being a sector purist.
Could either or both companies demerge their offices and retail businesses? If they were willing, could the offices and retail elements of each company be combined?
It would certainly be a neat way of making sure there were enough posts for all management to be kept happy.
Capital & Counties
For many market experts, the general consensus on CapCo is “something’s gotta give”.
The company fundamentally has two assets – its super prime Covent Garden estate, WC2, and its more problematic giant residential redevelopment project in Earls Court, SW5.
In order to bring Earls Court forward in the tough London residential market, it appears likely that CapCo will have to bring in new equity one way or another and it may need to be a more opportunistic or value-add style of investor to make such a big call.
Covent Garden sits in almost complete contrast, as a mature collection of coveted world-class retail with a diversified income stream that would be hugely attractive to a major pension fund.
A joint venture between a private equity firm and a sovereign wealth fund would be a perfect combination to make an approach and split the assets.
Shaftesbury
Hong Kong investor and owner of the Langham Estate, Sammy Tak Lee, has long held ambitions to make a move for Shaftesbury and its esteemed collection of West End villages.
At the end of last year he held more than 25% of the company and in 2015 went as far as to make a low-ball, try-it-lucky 888p bid for the company that was rejected out of hand.
Those close to Shaftesbury have questioned whether Lee has the resources to make a true takeover offer
on his own.
But with the floods of capital that have headed to London in the past year from Hong Kong he may find many willing helpers back home.
The London office specialists – Derwent London and Great Portland Estates
There is a cruel irony in the fact that the two businesses that are perhaps the most universally praised in the listed property sector were the ones that saw their share prices most badly hit following the EU referendum.
Raising cash at a discount is uneconomical and, even if they did, finding the right opportunities at present when the market is so aggressive is difficult.
This has led them to sell assets at strong prices but, in doing so, making them that bit more accessible as targets.
The argument for consolidation is not as strong between two office specialists as it might be in retail or industrial because there is less of a crossover in tenants, but it would create a company that would have even greater relevance to investors.
While there are no signs that Derwent chief John Burns is about to retire, at 73 he is no spring chicken. A management team with Burns in the chairman position and GPE chief executive Toby Courtauld at the helm would be something of a dream team.
Empiric Student Property
Empiric was the worst performing property share of 2017, delivering a -7.2% total return, and has been in a state of flux.
In November 2017 its bosses waived their bonuses due to “financial and operational inefficiencies” and the following month co-founder and chief executive Paul Hadaway was handed his notice by the board.
The company has assets in cities and towns across the country that might be considered to be approaching oversupply, and its portfolio is relatively inefficient due to the proliferation of studio flats.
However, given the seemingly insatiable deluge of capital pouring into the student market, it is being touted amongst experts as an obvious takeover target.
Workspace
While not strictly a flexible office operator, Workspace’s model is pretty close to one and it has been a pioneer in the UK of managing a large portfolio with a diversified income stream from SMEs.
The WeWork phenomenon and Brookfield’s approach for IWG make it look even more attractive.
British Land has started its own serviced office brand, Storey, and Workspace – both its portfolio and its expertise – could be integrated into a more traditional office landlord.
It may be valued more highly as a standalone business though, and would likely need the support of major shareholder and former hedge fund manger Nicholas Roditi.
The last mile phenomenon – Hansteen and Mucklow
The once mucky world of light industrial estates is now considered hot property as firms look to reinvent them into valuable last mile logistics hubs.
Blackstone and M7 took out Hansteen’s portfolio in continental Europe last year, leaving only the UK portfolio. With how aggressively their Onyx venture is agglomerating the sector, they could come back for more.
It would also be a neat exit for Hansteen founders and joint chief executives Ian Watson and Morgan Jones.
West Midlands-based A&J Mucklow’s portfolio is similarly in vogue, and its £325m market cap would be relatively bite-sized if the Mucklow family, which still collectively own a major shareholding, could be convinced to sell.
Even more logistics mega-mergers?
2017 was the year of the mega logistics deal, with the sales of Logicor and Gazeley, and there could be more to come.
Londonmetric is steadily moving towards becoming a pure logistics company and there would be some logic to any deal between it, Tritax or SEGRO.
With the growth of e-commerce, like in retail, there is an increasing overlap of tenants across regions, and forging relationships with them of a larger scale and having a broader overview of trends and data would be beneficial.
To send feedback, e-mail david.hatcher@egi.co.uk or tweet @hatcherdavid or @estatesgazette
