Keppel DC REIT - CIMB Research 2017-09-25: Market Not Fully Reflecting Latest Acquisition

Keppel DC REIT - CIMB Research 2017-09-25: Market Not Fully Reflecting Latest Acquisition KEPPEL DC REIT AJBU.SI

Keppel DC REIT - Market Not Fully Reflecting Latest Acquisition

  • Incorporating the acquisition of B10, we raise our F17F-19F DPU by 0.1-4.6%. We believe that the market has not fully reflected Keppel DC REIT (KDCREIT)’s latest acquisition.
  • Strategically, we view that Ireland could be a beneficiary of Brexit. Assuming 7.5% NPI yield and funding cost of 1.6%, the acquisition is immediately accretive.
  • We believe KDCREIT is close to achieving its S$2bn AUM target by 2018. It needs to acquire S$200m worth of third-party assets from now to 2018.
  • On the back of the increase in our DPU estimates and rolling forward of our DDM-valuation, we raise our Target Price and upgrade KDCREIT to an Add.
  • If we were to factor in a S$2bn AUM by end-2018, we could derive a DDM-based TP of S$1.40, implying potential unit price upside of 7.7%.

Raising FY17F-19F DPU by 0.1-4.6% 

Acquisition of B10 Data Centre 

  • KDCREIT completed the acquisition of B10 Data Centre (DC), its second DC in Dublin, Ireland on 13 Sep 2017. The agreed value of this asset is €66m (c.S$101.3m). This compares to independent valuation of €67.3m (c.S$103.3m), which includes the 999-year leasehold interest of the property. Adjusting for the indebtedness and net working capital for B10, warranty and indemnity insurance policies payable, a potential €0.6m tax payable and c.€1m for client racks expansion amount (which we have elaborated on below), the cash consideration for B10 is €58.5m (c.S$89.8m).
  • Unlike the other overseas acquisitions thus far, the acquisition of B10 is based on a colocation lease structure (not shell & core or fully fitted). In part, this is because KDCREIT has an on-the-ground operational team in Ireland to manage the facility. On the other hand, similar to most of the REIT’s other overseas transactions, B10 was also an off-market deal.
  • B10 has a long WALE (weighted average lease expiry) of 11 years and is 87.3% leased to four tenants from the internet enterprise, IT services as well as telecommunications sectors. The facility is located within the Ballycoolin Business and Technology Park in Dublin, c.12km from the Dublin city centre. B10 started operations in 2013 and offers c.25,200 sq ft of NLA (net lettable area).
  • Strategically, we view that Ireland could emerge as one of the leading financial centres in Europe for banking and financial services companies looking to relocate from the UK, post-Brexit. In addition, the EU General Data Protection Regulation could mean two-way data migration between the UK and EU; and Ireland could be one of the beneficiaries of higher DC demand, given the emergence of hyper-scale and large-scale DC players around Dublin.

Some T&Cs to take note of 

  • The manager has guided initial NPI yield for B10 to be mid-7%. It also stated that incorporating the acquisition, pro-forma FY16 DPU would increase by 6%.
  • We note that the NPI yield guidance is based on full occupancy of the asset (currently 87.3%), which has been reflected in the cash consideration. The cash consideration for B10 has been reduced by c.€1m (client racks expansion amount). This amount can be viewed as a form of income top-up (instead of an increase in the numerator, there is a decrease in the denominator in the calculation of NPI yield).
  • Accordingly, if the existing client were to expand its space requirements in B10, KDCREIT would have to return to the vendor a payment equivalent to the operating income attributable to the increase in take-up space. The payment is capped at c. €1m.
  • Hence, this also implies that there is some visibility that the vacancy in B10 could be filled by a client’s expansion requirement in the near-future.
  • In addition, we note that should B10 be able to receive additional power of 2.0MVA by end-2018, KDCREIT would pay the vendor €4m for a further 2.0MVA of power or a pro-rated amount between 1.8MVA and 2.0MVA.
  • Should B10 receive this additional power, it could also spell the need for further capex to upgrade the facility’s UPS (uninterruptible power system). At the same time, the upsized capacity means that B10 could take on additional clients or accommodate existing clients’ expansionary plans.

Outlining our assumptions 

  • Factoring in the acquisition, we raise our FY17F-19F DPU by 0.1-4.6%. We also took the opportunity to temper our expectations for Dublin 1, which is expected to undergo AEI (to improve power efficiency) in 4Q17. We now expect Dublin 1’s occupancy to hover at the c.55% range for some time. We had previously expected 10% pts improvement in occupancy for both FY17F and FY18F.
  • We outline our assumptions behind the accretive acquisition of B10.
    • We assume initial NPI yield of 7.5% and 90% NPI margin.
    • We expect B10 to be fully occupied by 2018.
    • The acquisition would be fully funded by 5-year €-debt. We assume borrowing cost of 1.6%. We estimate KDCREIT’s aggregate leverage to increase to 34.2% by end-17 (end-2Q17: 27.7%).
    • We factor in effective withholding tax of 12%.
    • 1% acquisition fee payable in cash to the manager.

Setting our sights to S$2bn AUM by 2018 

Close to achieving its target; needs to acquire S$200m worth of third-party assets 

  • With the acquisition of B10, KDCREIT’s AUM (assets under management) has increased to S$1.53bn with aggregate NLA of c.917k sq ft across 13 DCs. Including the completion of maincubes DC in 2018 (we have conservatively factored in contribution from 4Q18 onwards and 30:70 debt:equity funding for the forward purchase), KDCREIT’s AUM would be c.S$1.66bn. This means that to achieve its S$2bn AUM target by 2018, KDCREIT would need to acquire about S$340m worth of assets from now to 2018.
  • Sponsor Keppel Telecommunications & Transportation (KPTT) currently has one DC (Almere 2) on its balance sheet. Almere 2 is adjacent to KDCREIT’s Almere 1 in the Netherlands. Almere 2 was completed in 2015, with NLA of 118k sq ft. We believe that the asset could stabilise in 2018 and would be ready for acquisition. Assuming a valuation of S$1,163 psf (in line with the valuation of Almere 1), we estimate the potential price tag of Almere 2 to be c.S$140m. Hence, this implies that KDCREIT is close to achieving its target, and needs to acquire third-party assets worth around S$200m from now to 2018 to meet its target. 
  • The REIT continues to look at North Asia (Seoul, Tokyo, Beijing, Shanghai, Hong Kong, Taipei) and Europe (the Nordic countries, Poland, Luxembourg, France, Italy and Germany) for acquisition opportunities.

Other buying opportunities from the Keppel group but assets would not be ready by 2018 

  • Aside from the sponsor, we note that there are other buying opportunities from the Keppel group. However, we believe that these assets would not be ready for acquisition by 2018. Namely, sponsor KPTT and the Alpha Data Centre Fund (private equity fund managed by Keppel Capital) jointly acquired a DC in Frankfurt for €76m (c.S$116.8m) at end-2016. It was then reported that the DC was partially occupied and has committed c.25% of space to a global financial institution. 
  • Additionally, KPTT recently injected Keppel DC Singapore 4 (SGP 4) into Alpha Data Centre Fund for S$170m. SGP 4 is in close proximity to KDCREIT’s DCs (SGP 2 and SGP 3). Featuring over 182k sq ft of gross floor area over five floors, SGP 4 achieved temporary occupation permit (TOP) in mid-2017 and has achieved over 25% commitment.
  • We note that the key difference between Alpha Data Centre Fund and KDCREIT is that Alpha invests in both greenfield and brownfield assets while the REIT invests in stabilised assets only. Once Alpha DC Fund’s assets stabilise, KDCREIT could be a natural buyer for these assets.

Valuation and Recommendation 

Upgrade to Add with higher TP 

  • On the back of the increase in our DPU estimates and rolling forward of our DDM-valuation, we raise our target price from S$1.28 to S$1.36.
  • We acknowledge that KDCREIT’s YTD unit price performance (+10%) has relatively underperformed the FSTREI (+13%). We believe that valuations being relatively full is the reason behind its flattish unit price performance so far this year. 
  • Nevertheless, we note that its unit price post-acquisition of B10 has remained range-bound. While the lack of granularity could be a factor, we believe that, on paper "numbers", the market has not fully reflected KDCREIT’s latest acquisition of B10.
  • Projecting total returns of 10.5% (4.7% unit price upside + FY18 dividend yield of 5.8%), we upgrade KDCREIT from Hold to Add. 
  • Apart from the “sexy” data centre story, we expect KDCREIT’s hitherto inorganic expansion to drive a 3- year DPU CAGR of 8% through FY19F. In addition, DPU growth profile could be further elevated should the trust achieve S$2bn AUM by end-2018.

What could our TP be if we factor in S$2bn AUM by end-2018 

  • We currently do not take into account the potential acquisitions in our target price.
  • If we were to factor in a S$2bn AUM by end-2018, and assuming average NPI yields of 7-7.5% for the additional S$340m worth of acquisitions, we could derive a DDM based-TP of S$1.40, implying potential unit price upside of 7.7%.
  • Other key assumptions behind the S$2bn AUM target: 
    • We assume the additional S$340m worth of acquisitions would be funded by one-third debt and two-third equity. This would allow KDCREIT to maintain its aggregate leverage in the low 30s.
    • We assume 2.5% cost of borrowings for the additional acquisitions. We assume new equity to be issued at S$1.25/unit.

YEO Zhi Bin CIMB Research | LOCK Mun Yee CIMB Research | http://research.itradecimb.com/ 2017-09-25
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