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Lippo group moves assets around to lighten balance sheet, monetise assets and raise fee income

Goola Warden
Goola Warden • 7 min read
Lippo group moves assets around to lighten balance sheet, monetise assets and raise fee income
SINGAPORE (Mar 15): Unitholders of Lippo Mall Indonesia Retail Trust (LMIRT) are preparing to dig deep into their pockets to finance the real estate investment trust’s proposed acquisition of Lippo Mall Puri for IDR3,700 billion ($354.7 million). Among
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SINGAPORE (Mar 15): Unitholders of Lippo Mall Indonesia Retail Trust (LMIRT) are preparing to dig deep into their pockets to finance the real estate investment trust’s proposed acquisition of Lippo Mall Puri for IDR3,700 billion ($354.7 million). Among its largest unitholders, Tong Jinquan holds 5.91%, or 168.94 million units.

In total, including the Value Added Tax of IDR370 billion, the Land and Building Acquisition Tax of IDR185 billion and professional and other fees and expenses of $12.1 million, the cost of acquiring Lippo Mall Puri is likely to be $420 million. Separately and subsequently, LMIRT is planning asset enhancement initiatives (AEIs) that will cost $10 million.

Lippo Karawaci, the Indonesian-listed parent and sponsor of LMIRT, had announced last November that it was planning to divest Lippo Mall Puri into LMIRT to lighten its debt-riddled balance sheet, following a downgrade to junk status by rating agencies such as Fitch Ratings. On March 12, the day LMIRT announced its acquisition, Lippo Karawaci laid out a recapitalisation plan.

The beleaguered Indonesian developer announced that it would raise US$1.01 billion ($1.37 billion) to recapitalise the company. The funding programme comprises US$730 million in proceeds from a rights issue underwritten by the Riady family as well as US$280 million in proceeds from the completion of its asset divestment plans.

Lippo Karawaci says the funding programme is set to “right-size its balance sheet through deleveraging and repayment of up to US$275 million of debt obligations; provide Lippo Karawaci with sufficient liquidity buffer to fund debt interest and REIT rental obligations through year-end 2020; and unlock shareholder value through investments in existing key projects”.

A second step by Lippo Karawaci is to divest assets into its REITs. Since Lippo Mall Puri is not sufficiently DPU (distribution per unit)-accretive, Lippo Karawaci has offered income support.

More income support

According to a statement by LMIRT’s manager, Lippo Mall Puri is still maturing in terms of shopper recognition, tenant performance and passing rents. Thus, Lippo Karawaci will provide income support with a guaranteed level of net property income (NPI) of IDR348 billion up to December 2019, increasing to IDR356 billion in December 2023. Together with the income support, Lippo Mall Puri is expected to generate an NPI yield of 9.41% — on a stabilised basis — which is higher than the NPI yield of the trust’s existing portfolio of 8.94% as at Dec 31.

LMIRT argues that the five-year income support would allow it to benefit from the additional stability of rental income and downside protection during the initial ramping-up period as the property continues to mature.

Undoubtedly, Lippo Mall Puri has had rave reviews from visitors. As at Dec 31, 2018, Lippo Mall Puri had an occupancy rate of 89.6%, higher than the industry average of 83.2% as at 3Q2018. Lippo Mall Puri’s 324 tenants include Cinema XXI, Matahari, Parkson and Time Zone, as well as international brands such as Adidas, Best Denki, H&M, Marks & Spencer, Uniqlo and Zara.

There is a ready catchment population, as the mall is part of St Moritz, an integrated mixed-use development that includes six apartment towers and an office-cum-five star hotel building. In addition, the mall is located within a 3km radius of high-rise private residential developments, townhouses, civic amenities, schools, hospitals, hotels, restaurants, offices and shopping centres. Also, the independent valuers say the target NPI in the vendor support agreement will be sustained by the underlying revenue of the property after the expiry of the vendor support period.

Notably, in FY2018, 25.8% of LMIRT’s gross revenue was contributed by Lippo Karawaci and related entities excluding underlying tenants of master lease areas. “Lippo Karawaci has already been falling behind on rental payments to LMIRT,” OCBC Credit Research says in an update. “The vendor support increases the exposure to Lippo Karawaci.”

In a results review last month, OCBC Credit Research pointed out that, if Lippo Karawaci and its related tenants were unable to meet rental obligations, the occupancy rate would plunge to 70%.

“Risks of tenants defaulting remain elevated, given the late payments and deteriorating industry trends. The occupancy rate has declined y-o-y to 92.9% (2017: 93.7%), though it improved q-o-q (3Q2018: 92.6%),” OCBC said last month.

LMIRT’s revenue fell 10.6% y-o-y in 4QFY2018 to $41 million, owing mainly to the weakening of the IDR against the SGD and expiry of master leases over the seven retail spaces. NPI fell a larger 14.5% y-o-y to $38.4 million, owing to income tax on land and buildings starting from Jan 2, 2018 and allowance for doubtful debts of $2.7 million.

The acquisition of Lippo Mall Puri exposes LMIRT to a single large tenant — its troubled sponsor. “The target NPI of Lippo Mall Puri in FY2020 is IDR350 billion, while the aggregate rental fees from related parties to the sponsor are IDR135.8 billion, representing 39% of the total NPI of Lippo Mall Puri. This will be mitigated, however, by a IDR70 billion ($6.65 million) deposit to support Lippo Karawaci’s obligation to LMIRT,” OCBC Credit Research says.

Dilutive acquisition with equity-raising

For FY2018, DPU was 2.05 cents, but this is likely to be diluted after the acquisition of Lippo Mall Puri (see table).

According to LMIRT’s Singapore Exchange announcement, the acquisition cost and the estimated cost of the AEIs of $430 million will be funded by a combination of debt and equity. For example, in the case of a 58.1% to 41.9% debt-to-equity funding ratio, about $250 million debt and 1.5 billion new units are likely to be issued to raise net proceeds of $180 million, for a total of $430 million.

In the case of a 34.9% to 65.1% debt-to-equity funding ratio, about $150 million debt and 2.4 billion new units are issued to raise net proceeds of $280 million, for a total of $430 million.

“Raising of equity through rights issue may be highly dilutive,” says OCBC Credit Research. Based on LMIRT’s illustration of funding the acquisition via 58.1% debt and 41.9% equity, 1.5 billion new units in LMIRT would need to be issued to raise $180 million, implying 12 cents a share, OCBC Credit Research points out. Currently, LMIRT has 2.86 billion outstanding shares with a market cap of $572 million at 20 cents a share. “If cost of equity is high relative to the cost of perpetuals, there may be relatively less incentive for LMIRT to redeem its perpetuals at the first call date,” OCBC Credit Research says.

In the rationale for the acquisition, LMIRT clearly indicates that it will enlarge its assets under management, which would inevitably benefit its sponsor. Despite the double-digit decline in NPI and 40% drop in DPU for FY2018, the REIT’s management fee fell just 7.4% to $11.6 million. The acquisition of Lippo Mall Puri will enable the sponsor to charge an acquisition fee and higher base fees.

First REIT investors concerned

Minority unitholders of First REIT are worried that they too will have to dig into their pockets for the REIT’s acquisition pipeline. On March 11, Soochow CSSD Capital Markets (SCCM) initiated coverage on OUE Lippo Healthcare with a “buy” recommendation. Among the reasons is the move by OUELH to an asset-light strategy. It could entail divesting its 12 Japanese nursing homes, which SCCM values at $293 million, to First REIT, which is sponsored by Lippo Karawaci and OUELH.

As at Dec 31, 2018, First REIT’s aggregate leverage was 35%. Assuming the nursing homes are acquired at $293 million, First REIT is likely to fund the purchase with a mix of equity and debt as most REITs prefer to keep leverage below 40%. “In this scenario, First REIT may need to raise $103 million in equity [for] a 35% equity and 65% debt ratio,” suggests Ezien Hoo, an analyst at OCBC Credit Research.

In addition to the Japanese nursing homes, First REIT’s other pipeline properties — Siloam Hospitals Balikpapan, Siloam Hospitals Bogor and Siloam Hospitals Bangka Belitung — have been completed, according to its FY2018 results presentation. A Myanmar hospital in which OUELH has a minor stake is also a pipeline property. Elsewhere, Lippo Karawaci has 34 operational hospitals under the Siloam Hospitals network across Indonesia, with potentially up to 50 operational hospitals by yearend, First REIT says. These hospitals could be injected into First REIT to lighten both OUELH’s and Lippo Karawaci’s balance sheets and garner higher fees for them from higher AUMs.

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