Wednesday, May 21, 2014

Analyzing Quill Capita Trust's purchase of Platinum Sentral

Disclaimer: The information I got on this deal is from online articles which may or may not be up to date. I also make a lot of assumptions on this deal which could result in my analysis being off the mark. I’m also not an investment banker or corporate finance lawyer, so my understanding of the deal could be wrong. There may also be errors in my calculations. This is not a recommendation to buy or sell Quill Capita Trust. I’m analyzing this deal because I get high doing stuff like this.

Hey, how are you guys doing? It’s time for another article by the Greedy Dragon BITCHES!!! Today I will be talking about a recent property acquisition made by Quill Capita Trust, a Malaysian office REIT. Quill is to double its asset size with this property acquisition. I was meaning to discuss this deal for quite some time now as I get a buzz analyzing deals, but I guess I got side-tracked by Bar Refaeli’s photos on Facebook or something. According to this article in The Star, Quill entered into a deal to buy Platinum Sentral for Ringgit Malaysia (RM) 750 million from MRCB. The property consists five blocks of four to seven-storey commercial buildings located in Kuala Lumpur. Most of Platinum Sentral’s net lettable area (NLA) is used as office space, but some of the NLA is used for retail space as well.

Quill will pay for Platinum Sentral with a combination of stock and cash. Quill will issue 206.25 million units at RM1.28 per unit, so RM 264 million of the RM 750 million total purchase consideration will be in stock. The effective price paid for the property is actually lower than RM 750 million. This is the case as the current market price of Quill’s units (RM 1.14 per unit) is lower than the pricing of the units that will be issued to MRCB. According to my calculations, the effective purchase consideration for Platinum Sentral is RM 721.12 million.

According to this article on The Edge, Platinum Sentral’s office space is fully occupied while its retail space is 77% occupied. Considering that the retail space only makes up about 11.8% of the property’s NLA, I would say that the occupancy rate is satisfactory. Based on the average rental per square foot (psf) figures I got from this press release from Malaysian Rating Corporation, Platinum Sentral would have a rental yield of 6.64%. The press release was in August, 2013, so I guess the rental psf figures should still be more or less relevant. To get a rough idea of how much it costs to operate the property, I will use Tower REIT as a benchmark as all its properties are located in Kuala Lumpur. In 2013, Tower REIT had a net operating income margin of 69.17%. So, applying Tower REIT’s net operating income margin to Platinum Sentral’s gross rental yield, the property would have a net operating income yield of 4.59%. If you include other income such as income from the property’s car park, then the yield should be higher. Overall, I think that the rental yield is acceptable as the property is in a good location and the buildings are quite new.

Note: My calculation of net operating income may differ from how it’s conventionally calculated, please ask me for my formula if you’re interested.

Now, Quill plans to raise the balance RM 486 million cash for the deal by raising debt and issuing more units. Quill plans to place between 55 million and 85 million new units of Quill Capita Trust to institutional investors at a price that will be determined later. In this article we will assume that 70 million (the midpoint) new units will be issued at Today’s price. So, including the 206.25 million new units that will be issued to MRCB, 43.67% of Platinum Sentral’s effective cost will be funded by equity. I believe that Quill did not use too much leverage as according to Quill’s press release dated April, 2014, it only has a current gearing level of approximately 36%.  

If the assumptions I made about the equity raising exercise turns out to be true, then Quill will need to raise RM 406.195 million in debt. According to this press release from Quill dated April, 2014, its cost of debt was 4.3% per annum for quarter 1, 2014. I will assume that the debt raised will cost 4.3% per annum and be in the form of a balloon loan where principal is not amortized periodically but paid off in a lump sum at the end of the loan. So, after deducting the interest cost from Platinum Sentral’s net operating income yield discussed earlier, the property will have a return on equity (ROE) of 4.96%. I guess the ROE is alright for a property investment as I haven’t factored in other income such as income from the property’s car park. This definitely isn’t on the level of deals made by Warren Buffett. But for an income investor, it probably will turn out to be ok over the long-term. I personally won’t buy office properties now as the KL office market seems soft and there’s a chance that you can add properties to the portfolio at lower valuations if you wait a bit. But Quill’s management is much more experienced than me (I don’t even own my own house) and they have more and better information than me. So, of course they’re in a better position to make a decision.

On the surface the deal seems ok. However, I can’t come up with a conclusion as to whether or not I think the deal creates value without knowing stuff like:

1) provisions for rental increments in the agreements with tenants 2) the impact of increases in property assessment taxes if any 3) the cost of the new debt that will be raised for the deal and what percentage of the new debt will be fixed rate debt 4) the price of the new units will be issued to institutional investors 5) up to date info for net property income   

This is probably the longest article I wrote in a long while. I hope you guys liked it. Thank you for reading. Take care and stay rational.

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