Sizing up EPF and PNB’s purchase of Battersea assets

This article first appeared in The Edge Malaysia Weekly, on January 29, 2018 - February 04, 2018.
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THE Employees Provident Fund (EPF) and Permodalan Nasional Bhd (PNB) took the public by surprise when they announced on Jan 18 that they were buying the commercial assets in Phase 2 of the Battersea Power Station development in the UK for £1.6 billion (RM8.8 billion).

The property transaction is dubbed the most expensive to date in the UK.

Given the huge sum involved, the investment has been justifiably criticised. General public perception is that it is a “bailout”, particularly after news emerged of a cost overrun at the seven-phase project, which has a potential gross development value of £9 billion.

The EPF has a 20% stake in Battersea Project Holding Co Ltd, the joint-venture company that is undertaking the redevelopment of the Battersea Power Station, while S P Setia Bhd and Sime Darby Property Bhd (SD Property) hold 40% each. PNB is the controlling shareholder of S P Setia and SD Property.

To clear the air, the EPF and PNB issued a joint statement a day after the announcement was made.

“The EPF and PNB are steadfast and committed to uphold the trust of the two institutions’ members and unit holders respectively, as well as the Malaysian public, and any inferences that investment decisions are made for any other reason than for the benefit of the people are completely false and malicious,” the statement read.

The fact that the parties involved in the deal are all related actors in the same play has made the situation a little sticky, Kenanga Investment Bank head of equities research Sarah Lim Fern Chieh tells The Edge.

She believes a more objective way of assessing the deal is to view it as if the parties involved are not related. “If I am S P Setia or [SD Property] and I am selling to a third party, does the deal meet my overall objectives? And on the flip side, if I am in the EPF or PNB’s shoes and I am buying these assets from a third party, is it at a fair acquisition price?”

In her opinion, it is a fair deal for all the parties involved.

For S P Setia and SD Property, the fresh investment provides the opportunity to offload the assets to meet funding requirements without having to resort to a cash call, she says.

“In the UK, they do not practise progressive billings when it comes to payment collection from buyers, which means that property developers can only collect the payments due when the project is completed.

“Thus, developments in the UK are very cash flow-intensive and when you have a project with many phases, the payment collected from one project needs to be redeployed for the next one.

“For example, for the Battersea project, money collected from the completion of Phase 1 needs to be redeployed to subsequent phases, and in the case of the commercial component, if the developers had chosen to keep it, quite a bit of their capital would have been tied up and they would probably have had to come back to the shareholders with a cash call.

“Also keeping chunks of investment properties is not appropriate for the developers’ business model at this juncture.”

Lim explains that due to the nature of payment terms in the UK, it would be more optimal for the developers to keep investment properties only towards the later stages of the project.

On the cost overrun, she opines that the project’s high cost is understandable, given that a sizeable portion of the original design structure had to be maintained in Phase 2, which involves the redevelopment of the iconic power station and its four chimneys.

“From what I understand, it is not as simple as the developer just bulldozing the place. It is a heritage site, so there are strict procedures to follow. The project needs to be redone part by part.

“Also, a lot of specialised work is needed. For example, the bricks used for the project need to come from the original source, any asbestos has to be carefully removed, and the redevelopment of the heritage building has to meet structural integrity standards, all of which make it an exorbitant affair. This is the main reason why, as reported in the foreign media, the project’s margin had dropped from 20% to 8.2%,” she says.

However, Lim points out that on the whole, considering all the components of the Battersea project, its pre-tax profit margin is still more than 20%.

“It should be noted that when Battersea was acquired [in 2012], [the ringgit was stronger against the pound sterling] and land cost was low as all the pre-approvals had been obtained. The pre-tax profit margin was guided at around 16% back then.

“Today, even with the incorporation of the expensive Phase 2, its pre-tax margin is more than 20%. So, what we are trying to illustrate here is that Phase 2 — the commercial component — is just one part of this huge project,” she says.

 

Pricey deal

In their statement, the EPF and PNB said the deal was non-binding and that its terms were subject to further due diligence and negotiations. This means the £1.6 billion is just an indicative price.

Analysts say the pricing of the whole deal at this juncture is too preliminary for comment.

Hong Leong Investment Bank Research analyst Lee Meng Horng says the indicative price of the commercial assets works out to more than £1,500 psf based on the size of the area of 1.02 million sq ft and proposed purchase price of £1.6 billion.

“If you look at Phase 1 of the project (residential), it was going for about £1,000 psf, Phase 2 (residential) for £2,300 psf and Phase 3a for £1,600 psf. For now, these are the comparisons that can be made,” he adds.

MIDF Research analyst Jessica Low Jze Tieng says the £1,500 psf price tag for the Phase 2 commercial portion is 50% more than the Phase 1 residential portion’s £1,000 psf.

“Phase 2 comprises office and retail space. On top of it, there are quality tenants like Apple Inc, so we think the price is reasonable,” she says.

Apple Inc has taken up 470,000 sq ft of the office space — almost half of Phase 2 — for its new UK head office.

Kenanga’s Lim opines that from the EPF’s perspective, it would be getting a very lucrative tenant in Apple. “Apple has signed a 16-year lease and the rental rate implies a close to 4% to 5% yield,” she says, adding that an acquisition price that implies a lower than 4% to 5% yield would not be a right move as it would not be fair to PNB and the EPF, and their respective unit holders and contributors.

At the end of the day, with PNB and the EPF already stakeholders in the redevelopment project, can the £1.6 billion purchase be considered a bailout? Or is the duo making the investment to ensure that the project progresses and generates returns on their investment?

 

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