Frasers Commercial Trust - Impending equity/asset injection

Prior to the impending refinancing of its S$550mn in debt due in July 2009, Frasers Commercial Trust (FCOT) opted to revalue its portfolio booking a net revaluation deficit of S$143.6mn. With the revaluation deficit (FCOT’s revised book value is now at S$0.79/unit), gearing rose to 0.58x at end-1Q09. On our numbers, gearing is likely to increase further given the likelihood of further asset revaluation deficits as market asset values fall. According to JLL, since the market peak, capital values have fallen 27.6%, although further downside risks remain, given the slide in rents. Recent transaction and valuation evidence in Singapore suggests that office values are down by around 35% since the peak. In May 2009, Anson House was reportedly sold for S$85mn (equivalent to S$1,100/psf) down from S$129.5mn (S$1,701/psf) achieved in 4Q07, a fall of 34.4%. Similarly, Parakou Building was recently sold for a reported S$81.4mn (equivalent to S$1,280/psf) down from the S$128mn achieved in 2Q07, equating to a fall of 36.4%. While FCOT has booked revaluation deficits on its Singapore properties, ie, its Keypoint office building at S$294mn (equivalent to S$941/psf) versus its acquisition price of S$370mn in 4Q07 (S$1,186/psf), a fall of 20.5%, the write-downs to date may still not be enough. On our numbers, we expect FCOT to book a further revaluation deficit of S$247mn, pushing gearing to 0.73x. While technically not in breach of the Monetary Authority of Singapore’s (MAS) guidelines (as the rise in gearing is driven by the deterioration of the asset base rather than an increase in gross borrowings), refinancing of its current debt, in our view, will be dependent on addressing gearing concerns.

While FCOT is looking to divest assets — notably Cosmos Plaza and its interest in AWPF — at best, we estimate FCOT will raise S$85mn, from this disposal, which would only modestly bring gearing down to 0.56x (vs 0.62x projected for end FY09). We believe the REIT will need to do more; consequently, we believe a rights issue or asset injection from the parent is likely.

On our numbers, FCOT will need to raise S$440mn to address the dual issue of declining asset valuations and rising gearing. As an alternative to a straight capital raising it is possible that parent Fraser and Neave (F&N) could inject assets from its own portfolio, potentially the original seed assets it intended for its own sponsored REIT. The subject assets that F&N originally intended to inject into a standalone REIT were Alexandra Point, Alexandra Technopark and Valley Point (office and retail), with an estimated value of around S$600mn. Assuming two of the three assets are injected at a value of around S$440mn, FCOT REIT’s gearing could potentially fall from 0.62x to 0.40x. The offset to this would be a dilutive equity issuance. On our numbers, this would be dilutive by about S$0.19/unit (assuming stock was issued at a modest discount to the current share price), with FCOT markedly increasing its stake in the REIT from a current 22%. It seems plausible that a combined asset injection and rights issue will be proposed, checking the parent’s stake (Fraser & Neave) to below 50%. While technically the scenario would trigger a general offer (GO), we believe FNN would seek a GO waiver prior to the execution of the transaction.

We have revisited our earnings numbers and have marginally cut our DPU forecasts for FY09-FY11 by 2-5% to reflect expectations of higher vacancy in the group’s Singapore portfolio given the greater-than-expected contraction in net demand in 1Q09. Not withstanding the changes to our occupancy assumptions, we have rolled forward our intrinsic NAV to FY10 with our new value S$0.48/unit (vs S$0.47/unit), with the lift driven by higher translated values from the REIT’s Australian and Japanese assets, in spite of more conservative cap rate assumptions for the group’s Australian assets.

While our core NAV is not adjusted significantly, our valuation methodology incorporates the potential for dilutive capital raising to check gearing at 0.40x. On our numbers, as discussed above, we see FCOT having to make a further asset writedown of S$247mn as discussed earlier, which could drive gearing to 0.73x, higher than the MAS’ limit of 0.60x. Note: a REIT is not considered to be in breach of the 60% gearing limit if it is attributable to depreciation in the value of the REIT’s assets. We assume that FCOT will need to raise additional equity of around S$440mn to keep gearing below 0.40x. We now assume that this equity will be raised at S$0.22/unit, a modest discount to the current unit price (vs S$0.17/unit previously, which was the unit price at the time) so the theoretical capital raising would have a lower dilutive impact than we had previously adjusted for, ie, S$0.19/unit (vs S$0.23/unit previously) resulting in our price target being raised to S$0.29/unit (from S$0.24). We have highlighted in previous notes that FCOT faces a number of issues, with the deteriorating office market compounded by translation losses and higher funding costs. While FY09F looks challenging, expectations of a resolution of refinancing issues (in part supported by parent Fraser & Neave as discussed above) should provide a much needed catalyst for re-rating of the stock and we retain our BUY rating.

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