A takeover bid was one of the great hopes to revive the slumbering Shaftesbury share price. The proposed merger with London West End peer Capital & Counties seems unlikely to catalyse a re-rating in the shares or invite future approaches for the enlarged Shaftesbury Capital. A clean break rather than an all-share merger would be far more desirable for Shaftesbury shareholders.
Under the terms of the deal, Shaftesbury shareholders would receive 3.356 new Capital & Counties shares for each Shaftesbury share they hold. Ownership of the new company would be split 53/47 between Shaftesbury and Capco.
The economics of the deal, structured as a takeover of Shaftesbury owing to Capco’s existing 25 per cent stake in the company, are hardly alluring for the former’s shareholders. The exchange ratio implies a value of 509p for Shaftesbury, the brokerage Stifel calculates, a 13 per cent discount to the real estate investment trust’s share price the day prior to the terms being announced last week.
Admittedly, that ratio also values Shaftesbury’s net tangible assets (NTA) at 695p a share, a 2 per cent premium to the group’s asset value at the end of March, but below the level that analysts have forecast the assets to have reached by the end of September.
So what is the point of the proposed tie-up? Scale, naturally, has benefits, not least in sharing the operating cost burden over a larger number of properties and potentially providing easier access to credit.
Shaftesbury Capital’s portfolio would total 675 buildings, leased to 2,000 occupiers and valued at £5 billion. But for Shaftesbury, whose operating costs as a standalone business were spread over a larger portfolio than Capco, the costs associated with the tie-up will mean the deal is dilutive to earnings over the first two years, at least.
Cutting loose that earnings drag will require the enlarged company to hit an annual cost-savings target of £12 million, which both management teams reckon could be delivered two years after any deal completes. Those savings will come from pretty pedestrian sources, including removing duplicate boards and third-party adviser costs. That figure is hardly compelling in itself. Synergies look “low and expensive to achieve, immediately nullifying their impact”, reckons Alex Savvides, a fund manager at JO Hambro Capital Management, which has a 1.5 per cent stake in Shaftesbury.
He’s got a point. There will be a £11.4 million cost to achieve those savings in the first place and rampant inflation another complicating factor. Then there is the risk of higher debt costs. Holders of bonds issued by Shaftesbury will have the right to redeem the bonds if the deal completes. If all holders of Shaftesbury’s mortgage bonds exercised the put right, this would require the new company to fund £575 million in redemptions plus any interest accrued.
A new debt facility is already in place to cover that eventuality, but any draw down on that, or restructuring of the bonds, would mean higher financing costs for the new Shaftesbury Capital.
Unspectacular potential savings aside, what else is on the table? For Shaftesbury shareholders, not a lot. For Capco shareholders there is the chance to gain exposure to a more diverse mix of assets by location and use, at least. Retail, a sector where rents have been driven lower by traders battling against online competition, accounts for almost half of Capco’s portfolio, with hospitality and leisure accounting for just over a quarter, all located in Covent Garden.
For Shaftesbury, whose properties have a broader footprint across London’s West End, including Soho and Chinatown, exposure to those sectors is still weighty but account for just under two-thirds combined.
A bias towards retail and leisure meant that a collapse in footfall and pandemic trading restrictions hammered rents and property values for both landlords over the past two years. Tenants more able to pay rent and a recovery in demand resulted in estimated rental values returning to growth during the second half of last year.
However, there is a reason shares in both companies still trade at discounts versus their respective net asset values. A tight reliance by their retail and leisure tenants on consumer spending, set to be squeezed further in the months ahead, is one. For Capco, a 32 per cent discount, versus Shaftesbury’s 18 per cent, is the symptom of a greater bias towards retail, shorter track record and the lingering effects of the since-sold package of Earl’s Court assets, which weighed heavily on the company’s NAV amid a weakening London residential property market.
The discounts attached to the real estate investment trusts’ share prices pre-date the pandemic. So, too, does a patchy performance in terms of rental and property value growth. In 2019, the value of Capco’s portfolio declined by 1.7 per cent, after adjusting for the sale of the Earl’s Court assets, the culmination of a slowdown in the rate of growth recorded for the Covent Garden assets in each of the previous three years. For Shaftesbury, the same trend was in train, culminating in a 0.2 per cent decline in the value of the portfolio in 2019.
The fundamental question for shareholders is exactly how combining companies at the mercy of the challenged retail and leisure sectors is going to result in a sustainable lift in rental and property value growth. The answer isn’t obvious. Short-term pandemic recovery aside, neither is what will help close the gap between the share price of Shaftesbury Capital and the enlarged company’s net asset value.
If increased scale brings with it an increased level of “protection” against takeover, as Stifel’s John Cahill suggests, that muscle might not necessarily work to shareholders’ advantage. At least it might have brought with it a meaty premium for Shaftesbury shareholders, without it there seems little to excite shareholders.
ADVICE Hold Shaftesbury and Capital & Counties
WHY The wide discounts attached to the shares after the recent sell-off leaves the shares justifiably cheap
