A consortium’s decision to abandon its £2.9bn takeover bid for shopping centre landlord intu has sent waves through the retail investment industry.
Intu’s share price sank by 33% in opening trade after the consortium – comprising billionaire shareholder John Whittaker’s Peel Group, Olayan Group and Brookfield Property Group – scrapped the proposals.
The shopping centre landlord, which extended the deadline three times before the bid was withdrawn, blamed “the uncertainty around current macroeconomic conditions and the potential near-term volatility across markets” for the collapsed discussions.
“We suspected the process wasn’t running smoothly and we always thought it would be a tough sell to Brookfield shareholders,” noted analysts at Jefferies.
Consequently, it has left a question mark hanging over the future of the landlord.
David Brockton of Liberum says: “It clearly leaves intu in a challenging position. Its shopping centres are let off of high rents and valued at low yields, facing both cyclical and structural pressure.”
The landlord’s high loan-to-value (LTV) ratio in particular has raised red flags.
James Carswell of Peel Hunt warns LTV could rise from roughly 50% to up to 60% in the next few years. He estimated this would require it to either raise £2bn of fresh equity or sell around 40% of its assets in order to reduce LTV to 35%, a little above the sector average of 30%.
“They could do a combination of the two,” adds Carswell. “They could also run a higher leverage than 35%, in which case you would not need to sell, or raise, as much.”
What could intu do next?
Intu said it will substantially reduce its dividend to pay for its investment projects since raising capital through asset disposals remains “challenging”, starting with its final payout for 2018.
Brockton views this as a positive move that can provide “a degree of short-term headroom”.
“It shows they are mindful of the investment limitations that the business has, and the markets’ concern in respect to leverage,” he observes. “It perhaps also shows they are open to considering other means of securing more capital for the business.”
To facilitate its capital investment programme, intu said its strategy to manage its LTV ratio could involve further disposals and “other corporate initiatives”.
While it did not elaborate further, many have taken this to mean it could resort to an equity issue – or even that intu may seek another buyer.
However, the likelihood of the latter is low, especially since the collapsed talks marks the second time this year that a buyer has dropped plans to buy intu. In April, fellow shopping centre landlord Hammerson backed out of its £3.4bn bid.
Hemant Kotak, a managing director at Green Street Advisors, says: “You would be in the minority if you did not expect an equity placing or rights issue at this stage. As asset values get marked down, LTVs will shoot up so a capital call has to be on the cards to redress LTV to 50% or below.”
Alan Carter, managing director and analyst at Stifel, says that at one point they might have begun an equity raise; now, however, a rescue rights issue seems more likely.
“I don’t see what they can do. The company needs a capital reconstruction,” he adds. “This almost rivals Brexit as a complete shambles.”
Rental income prospects
The REIT has put on a brave face, asserting that while “market sentiment towards retail and retail property remains negative, intu is confident of its commercial prospects”.
Whittaker has also reiterated that Peel Group will remain a “long-term, strategic” shareholder, despite the aborted takeover. It owns around 26% of the group.
“Intu’s portfolio of super regional and prime city centre shopping centres is trading strongly and benefiting from the retailer store rationalisation process that is currently underway in the UK,” says Whittaker.
“Physical retail continues to play a key role in all successful multi-channel retailer sales strategies and intu’s national portfolio of centres enjoys some of the highest customer footfall in the country.”
However, several analysts are sceptical about the landlord’s rental income growth predictions, which it estimated to be in the range of 0-1%.
“Intu still haven’t acknowledged the full extent of the issues they face,” says Kotak. “Namely, there is sustained pressure on rents and that’s unlikely to go away any time soon. Management expect flat rents which doesn’t seem like the base case – it seems more hopeful than anything.”
Carter notes: “[Intu needs] to stop telling people everything is alright, and stop repeatedly referring to “negative sentiment”. It is not sentiment – it is a reality. There is nothing we have seen so far, post Black Friday and pre-Christmas, to suggest physical store sales are improving.”
Analysts at Jeffries say the deal “can’t have been helped” by Mike Ashley’s purported intention to close all of his stores at intu’s shopping centres, after it did not agree to proposed new terms on four House of Fraser locations.
Intu said the loss of theHouse of Fraser sites will cost it around 1% of next year’s rental income. However, this does not include the estimated loss of all of the brands owned by Sports Direct occupying space at its centres.
At any rate, it serves to highlight that demand from retail occupiers remains low, and that the negotiating power remains heavily weighted towards the tenants.
Wider valuation implications
In the same morning that the news broke, Hammerson shares fell by 7%. Share prices at Land Securities dropped by 4%, while British Land’s stock dropped by 2%.
Beyond this initial movement, the decision is broadly expected to have far-reaching implications for asset valuations at other landlords, all of which have stated aims to offload significant chunks from their retail portfolios.
“To me it is the nail in the coffin in terms of how the valuation industry has to look at these shopping centres,” says Carter.
“If intu says selling shopping centres is difficult because of an absence of buyers, it is inconceivable that valuers will just sit there and move yields out [by] five or 10 basis points. They will need to write down shopping centres significantly – there is nothing else they can do.”
Kotak agrees: “Valuers have been reluctant to mark down values but the question is, how can they not take this as evidence and look at the fact there are no buyers at the prices offered?
“No one believes the official valuations. If the valuers want to remain relevant they need to take a dose of reality and mark down much more aggressively.”
As long as true value remains an unknown, investor appetite is expected to shrink even more rapidly.
James Child, retail analyst at EG, says: “The latest purchase withdrawal of the intu estate will have repercussions for the rest of the UK shopping centre investment market.
“After what has already been one of the worst years in recent memory for investor confidence, the latest [retreat] will send prime retail values spiralling in the short term, and with Brexit on the horizon, appetite in the sector will continue [to] wane.”
The road ahead
There is no doubt that the failed takeover has thrown intu into a difficult position. To compound its troubles, the search to recruit a replacement for current chief executive David Fischel will likely have been put on hold during the bid process.
Whatever happens, it is clear that the new CEO will have their work cut out for them to reposition both intu’s assets and business structure.