The Reit thing to do?

Posted On Thursday, 14 June 2007 02:00 Published by eProp Commercial Property News
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Investec Property Group is being showered with praise for moving its external management of Growthpoint into the listed property fund

Norbert SasseThis improves income and readies SA's biggest fund for conversion to a real estate investment trust (Reit).

But it must be said that even in the face of this undoubtedly progressive transaction, the devil lies in the detail.

The transaction, whereby Growthpoint forked out about R1,6bn (plus R170m to its staff) to buy Investec and its empowerment partners out of the management contract, could have been better - that is, if it had been executed on a strictly arm's-length basis. But, given that Investec's own staff run Growthpoint, there will always be suspicion that it was not - which makes the case for internal management of property funds even more compelling.

Paul Duncan, an analyst at Catalyst fund managers, which owns 4% of Growthpoint, says: "We disagree with the price and the staff incentive mechanism. We feel that shareholders deserve a better deal. Let's say your manager says that from managing your portfolio it profits by R145m, which is excessive. And the contract has four years to run, but you can buy them out now for R1,58bn and issue new units to staff, at no cost, for a further R170m. How would you react? I'd certainly exhaust my alternatives before paying out 10,8 times the forecast pre tax income for a four-year contract. We feel very strongly about it and are considering our options."

Growthpoint CEO Norbert Sasse says the Investec management contract that was established with a 10-year duration clause had five more years to run.

Surely an independent fund manager negotiating with an independent property manager would have pointed out that it would not renew the contract when it ended, and offer to pay the manager his profit immediately?

Figures presented by Growthpoint show Investec budgeted to derive an operating profit of R145,7m/year from the management contract. Discounting the future income at 12,5%, Catalyst comes to a value of R700m, but Investec was paid R1,8bn.

How does one explain this premium, except to say it was Investec's last attempt at milking the Growthpoint cow?

As a way of justifying this hefty price tag, Investec makes a comparison of the 9,26% yield in this transaction against estimated yields of other independent property fund management businesses.

Madison, which manages three property funds with a combined market cap of about R24bn, commands a 6,7% forward yield. Allan Gray Management Company, which had assets under management of R5,5bn in February this year, was estimated to command a forward yield below 7,1%.

This analysis fails to mention the fact that the values in the Madison and Allan Gray management contracts include other complementary property services like property development, which were left out of the Growthpoint transaction, and international opportunities.

But Sasse defends the deal: "As soon as the proposal was mooted by Investec, a committee of independent directors was formed under deputy chairman Francois Marais. They received the proposal, researched and debated it exhaustively, got outside valuations and negotiated with Investec.

"The bulk of shareholders indicated their categoric support for both the concept and the price, and we have commitments from a large proportion of shareholders. We have followed 100% corporate governance.

"Besides, the quality of income we're buying is superior to that of Madison or Grayprop."

The FM was unable to make contact with Marais before going to press on Tuesday.

Investec CEO Stephen Koseff says Investec was selling a valuable infrastructure with 250 staff and all their skills, not just a management contract. "Where are you going to find those skills?" he asks. "We built significant value in Growthpoint from nothing with those skills over 15 years, and got it to the point where it can operate on its own."

Macquarie First South property analyst Leon Allison does not believe Growthpoint could have done a much better deal than they did with Investec.

"Investec are tough negotiators. And though Growthpoint could have started by saying it was going to cancel its contract, it also had to consider where it was going to get a skilled property and asset manager to replace Investec.

"The deal is yield-enhancing and good for the shareholders. Internal management is also a positive," adds Allison.

Investec did a sterling job in the bigger scheme of things. The bank is behind the phenomenal growth of Growthpoint from having nine properties worth R100m in 2001, into the largest listed property fund on the JSE, with 427 properties valued at more than R20bn and with a market capitalisation of R16,5bn.

The group says the board felt it should have its own management, and should conform with international Reit trends.

The transaction is to be settled through the issue of 98,3m new Growthpoint linked units at R16/unit, excluding distribution for the half-year to June 30.

That will give Investec a 13,4% interest in Growthpoint, up from 6,8%. It represents a big bonus for Investec, but it does nothing to improve the banker's reputation for greed.

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