At first glance, Iluma, with its deserted ground floor and empty shop units, seems an unlikely fit for CapitaMall Trust, which has acquired the mall for $295 million. Yet, Simon Ho, CEO of CMT’s manager, is confident he can quickly extract value from the 17th mall in its portfolio and make it as lively as Bugis Junction across the street, which CMT also owns.

Iluma sits on a 60-year leasehold site, which is connected by a bridge to Bugis Junction. It has an NLA (net lettable area) of 185,190 sq ft. The purchase price works out to $1,593 psf, 18% below Bugis Junction’s book value of $1,933 psf as at Dec 31, 2010.
 

 

Occupancy at Iluma is 83.7%, compared with close to 100% for most of the other malls in CMT’s portfolio, and its property yield, at 3.8%, is way below CMT’s portfolio property yield of 5.75% to 5.8%. To make matters more difficult for Ho, 60% of the mall’s gross floor area (GFA) has been earmarked for entertainment, a sector that commands lower rents than retail.

 

But Ho sees “synergies” with Bugis Junction, or “BJ”, as he calls it. The latter, which sits atop Bugis MRT, sees 3.2 million people walking through it every month, but Iluma gets barely a third of that traffic. So, what makes Ho think he can do a better job than Jacks International, the seller of Iluma?

 

“The vacancy is 16.3%, so we can go inside and start leasing immediately,” says Ho. “Of this, 10.6%, or two thirds, of the space is on Levels One and Two — prime space,” he adds. However, 10% of Iluma’s NLA is up for renewal this year, of which 71% is on Level One. Next year, another 40% is up for renewal. “A lot of people will get worried, but we’re okay. We can find upside immediately,” he says.

 

Ho also wants to increase NLA efficiency, which refers to the ratio of NLA to GFA. “That’s where we want to extract value,” he says. The NLA efficiency of CMT’s portfolio is 68%, but the NLA efficiency of Iluma is just 63%. While GFA of a building is fixed, NLA is not. Extra NLA can be squeezed, say, from a corridor that is 5m wide, Ho explains.

 

What about the requirement to set aside 60% of GFA for entertainment? Ho says 30,000 sq ft is taken up by an eight-screen multiplex operated by a unit belonging to the vendor. Another 10,000 sq ft will be used as either a black box or experimental theatre that will comprise a flexible singlespace performance area with at least 400 seats and a single-space exhibition area measuring at least 4,306 sq ft. This space already makes up 23% of NLA and is being leased back to the vendor, with rentals for the cinema pegged at $5 psf.

 

Ho says entertainment is broadly defined by URA and includes karaoke suites and themed restaurants.

To be sure, CMT, a unit of CapitaLand, Southeast Asia’s largest developer, has long perfected the art of extracting value from malls. In the past two years, asset enhancement initiatives (AEIs) have expanded NLA in Basements One and Two of Raffles City by 36.4% to 61,024 sq ft, from 44, 739 sq ft, with gross rentals for the two basements projected to increase 32.6% to $14.2 million, from $10.7 million. The capital expenditure was $33.2 million and the return on investment (ROI) is 8%. Elsewhere, at Jurong Entertainment Centre, which is being turned into JCube, NLA is projected to increase to 35,751 sq ft, from 5,985 sq ft, by 1Q2012. The ROI on the capital expenditure of $200.3 million is projected at 8%.

 

But there have been near misses. One asset that CMT has been struggling with is The Atrium@Orchard, acquired just before the financial crisis in 2008 for $839.8 million. As at Dec 31 last year, Atrium was valued at just $590 million. Even then, the worst of the downdraft for the acquisition is over. AEI started in January this year. CMT plans to raise the retail portion of Atrium to 126,982 sq ft of NLA, from just 16,318 sq ft, while reducing office NLA by 35% to 357,806 sq ft by 3Q2012. The project will cost $150 million and CMT is projecting an ROI of 10.4%, and incremental net property income (NPI) of $15.61 million.

 

With rental renewals, NLA efficiencies, and operational efficiency, Iluma is unlikely to take as long as Atrium for distribution per unit (DPU)-accretion. “We won’t have to wait three to four years to get the upside; it will be accretive,” says Ho, who expects the lift in revenue and NPI to be almost immediate. More importantly, Bugis Junction, which is fully occupied and has a waiting list of tenants, could also be integrated with Iluma as one mega mall, a trend CMT appears to be moving towards. “If you look at BJ, the space we have for [marketing and communications] is very small and there isn’t even enough space for promotional events,” Ho says.

 

He knows something has to be done quickly to raise Iluma’s profile and popularity with shoppers, though. “The operation team on the ground needs to execute it and move fast. This is where I’ve put in my A-team,” Ho declares, adding that the team includes managers responsible for successful malls such as Raffles City, Bugis Junction and IMM.

 

“The integration of Iluma with BJ is not something that will scare them. We have a team that can hit the ground running,” he says. The combined NLA of Bugis Junction and Iluma would be 606,000 sq ft, Ho points out. That is about the same size as the joint Plaza Singapura- Atrium mall and slightly smaller than ION Orchard, which belongs to CMT’s immediate sponsor, CapitaMalls Asia.

 

To be sure, the Bugis area is also quite an established shopping district. “The demand is there,” Ho insists, reiterating that more than three million people walk through Bugis Junction every month. “We must make sure they cross the bridge.” 

 

Even then, many analysts have retained their “sell” and “neutral” calls on CMT. Only Citi Research has upgraded it to a “buy” recommendation from a “neutral”. “CMT has fallen 7% YTD and underperformed the Straits Times Index, which has declined 6% over the same period. We upgrade the stock from a ‘hold’ to a ‘buy/low risk’, but maintain our price target of $2. The acquisition of Illuma would increase DPU by 1%, based on our estimates, given its low financing cost of 2%,” Citi says in a recent report.

 

In January, CMT announced a 5.9% increase in NPI to $390.1 million for FY2010. Distributable income was $294.8 million, up 4.6% y-o-y. In 2010, the trust distributed 9.24 cents, giving a yield of 5%. Consensus estimates of 10 cents DPU for this year gives a forward yield of 5.4%. The trust’s average cost of debt last year was 3.7%. Since then, it has announced it raised $300 million through two-year retail bonds priced at 2%.

 

Analysts say blended cost of debt makes the Iluma purchase barely accretive. “The purchase at an NPI yield of 3.8% does not look yield-accretive to the portfolio NPI yield of 5.6% or the trading yield of 5.3%,” notes Vikrant Pandey, property analyst at UOB Kay Hian. “We do not see the acquisition contributing significantly to CMT’s current portfolio currently as the mall is still a secondary mall in the Bugis area. We anticipate that the potential acquisition of ION Orchard will be a better fit to CMT’s portfolio.” ION, completed and opened in 2009, was developed by CapitaMalls Asia and Sun Hung Kai Development.

 

Although Pandey has a “sell” recommendation on CMT, he sees a case for acquiring Iluma. “There is significant potential for asset enhancement, as the property is 84%-occupied and there are potential synergies to link the mall with Bugis Junction, creating a seamless shopping experience with a total NLA of over 600,000 sq ft, equivalent to that of ION Orchard.”

 

Joy Wang, REIT analyst at JP Morgan, has a “neutral” rating on CMT. In a recent report, she says, “While the entry yield for Iluma is only 3.8%, not quite accretive compared with CMT’s current WACC [weighted average cost of capital] of 4.4%, the acquisition could offer a strong growth opportunity. We estimate that if CMT’s management is able to bring the occupancy level to 100%, from the current 84%, and passing rents to about $11.50 psf, from the current $8.70 psf, the trust would be able to achieve an unlevered project [internal rate of return] of at least 10%, to be realised in the next three years,” she says. (See table for valuation of REITs with a retail component.)

 

{jcomments on}