Suntec REIT: Downgrade to HOLD on valuation

Private placement to fund MBFC buy.
Suntec REIT recently closed the book of orders for its private placement to partly fund the acquisition of Marina Bay Financial Centre (MBFC) Phase 1. (Recall that Suntec REIT has proposed to acquire a one-third stake in MBFC Phase 1 from Cheung Kong Holdings Ltd and Hutchinson Whampoa Ltd. on an agreed property value of S$1,495.8m, which includes rental support of S$113.9m over a 60-month period from the completion date of the acquisition.) The private placement of 313m new units was 3.1 times oversubscribed, with the issue price per new unit fixed at S$1.37 following an accelerated book-building process. The trading of the new units on SGX-ST has commenced on 9 Dec 2010. The gross proceeds from the private placement amount to approximately S$428.8 million - 97.5% of it will be used to partially finance the acquisition, while 2.5% will be utilized to pay for advisory, underwriting, selling and management fee as well as other estimated fees and expenses.

Tight initial yields.
Suntec estimated that the FY11 net property income (NPI) for the MBFC acquisition to be around S$60.6m. This gives a fairly tight initial yield of 4% on the acquisition. The acquisition will, however, further enhances the income diversification of Suntec and reduce its reliance of income stream on any single property (~75.9% of total NPI of existing portfolio is currently derived from Suntec City). The MBFC acquisition will also act as the trend-setter for the emerging "Premium Grade A" office space that is debuting around Marina Bay area, on the back government's commitment to pump more than S$1b into infrastructure works to support Marina Bay's growth over the next 10-15 years.

Downgrade to HOLD.
While the effective interest rate of 3.12% per annum for the S$1,105m debt facility came in lower than expected, we see the need to increase our cost of equity from 6.0%to 8.2%, as we further finetune our CAPM assumptions to account for the slightly heightened risk aversion in the equity market. This in turn raises our WACC rate from 5.08% to 6.09% and lowers our fair value from S$1.63 to S$1.50. Hence we downgrade our rating to HOLD on valuation grounds, given that its estimated total return is less than 10%, even though we continue to like the trust for its high quality assets and exposure to the Marina Bay area.