MCT-MNACT Merger Under Active Scrutiny
Investors are overly worried about Festival Walk. Hong Kong’s retail sales and restaurant receipts picked up in 2H21 and will be boosted by the reopening of border with Mainland China. There are many precedents and the land lease for Festival Walk is likely to be extended by 50 years upon expiry on 30 Jun 47. MCT’s merger with MNACT, if completed, is accretive to pro forma 1HFY22 DPU by 7.5% (scrip) to 8.9% (scrip and cash). Maintain BUY. Target price: S$2.48.
WHAT’S NEW
• Festival Walk a dominant mall in Kowloon. A lot of the controversies surrounding the proposed merger between Mapletree Commercial Trust (MCT) and Mapletree North Asia Trust (MNACT) lie in the pessimism over outlook for Festival Walk. The property comprises a seven-storey retail mall and a four-storey office tower. It is linked to the Kowloon Tong MRT station, which is an interchange station for the East Rail Line that takes passengers to New Territories and the Shenzhen border. It is in close proximity to two renowned universities, City University of Hong Kong and Hong Kong Baptist University. Thus, shopper
traffic was high at 41.3m in FY19.
• Revival at Festival Walk after three horrible years. Hong Kong’s economy has weathered street protests in 2019 and the COVID-19 pandemic in 2020 and 2021. We believe Festival Walk has started to turnaround after two consecutive years of negative rental reversion (FY20: +8%, FY21: -21% and 9MFY22: -32%).
a) Domestic consumption has started to normalise. Hong Kong has chalked up 11 consecutive months of yoy growth in retail sales since Feb 21 with pick-up aided by economic recovery and the government’s HK$36b electronic consumption voucher scheme. Retail sales increased 6.2% yoy in Dec 21. The recovery in restaurant receipts was even more impressive at 29.1% yoy.
b) Imminent reopening of border with Mainland China. Cross-border travel between Hong Kong has resumed in a small way through the Come2HK scheme for visitors from Mainland China (initially restricted to just the Guangdong Province) and Macau, which commenced in Sep 21 with a daily quota of 2,000. Travellers do not need to undergo quarantine in Hong Kong but have to serve two weeks of quarantine when they return to Mainland China.
The reopening of border with Mainland China on a quarantine-free basis is expected to commence with a small pilot programme and the daily quota was initially set at 3,000. The reopening is expected to commence once the Omicron variant outbreak in neighbouring Guangdong Province has subsided. The 10 land checkpoints are expected to be fully opened and the daily quota substantially expanded by Jun 22.
c) Land lease to be extended by 50 years upon expiry in 2047. Articles 120-123 of Basic Law provide the legal basis for renewal of land leases in Hong Kong. Based on a policy statement announced in Jul 97, new leases of land would be granted a term of 50 years subject to payment of annual land rent equivalent to 3% of the annual rent value of the property. There are many precedents for extension of land leases, the most notable being the extension of land lease for Pok Fu Lam Gardens by 50 years until 2056 in mid-06. Under the current land lease extension policy, leasees need to apply for “conditions of regrant” two years before the expiry of land leases.
Many investors are unduly worried that Festival Walk has only 25 years left on its land use right expiring on 30 Jun 47. We understand valuers usually value properties in Hong Kong as freehold properties given that land leases are renewable upon expiry.
STOCK IMPACT
• Heads I win – Opportune timing to acquire Festival Walk. Many investors have an overly pessimistic view on the outlook for Festival Walk. In the near term, Festival Walk has to weather Hong Kong’s stringent zero-tolerance policy to control COVID-19. However, the imminent reopening of border with Mainland China would bring reprieve as Mainland visitors accounted for about 25.3% of retail sales in Hong Kong before the COVID-19 pandemic. Like many other properties in Hong Kong, land lease for Festival Walk is likely to be extended for 50 years upon expiry on 30 Jun 47.
• Tails you lose – MNACT unitholders may vote against the merger. There is a new air of activism in the Singapore stock market. Proxy advisors Institutional Shareholder Services and Glass Lewis have questioned the deal process and unfavourable offer and have advised unitholders to vote against the merger between ESR REIT and ARA LOGOS Logistics Trust. Similarly, activist fund manager Quarz Capital has also complained about the unattractive offer from MCT, which undervalues MNACT at a discount to NAV per unit of S$1.225. If the deal is aborted, MCT’s unit price could recover back above S$2.00.
• The test of fire. MCT and MNACT would hold their EGMs in mid-April.
EARNINGS REVISION/RISK
• We maintain our existing DPU forecast for MCT on a standalone basis.
VALUATION/RECOMMENDATION
• MCT has underperformed. Unit price for MCT has corrected 9% since the proposed merger between MCT and MNACT was announced on 31 Dec 21. Unit price for MNACT has dropped by a smaller 1.8%. On a relative basis, MCT has underperformed by 5.5%, while MNACT has outperformed by 1.7% relative to the FTSE all-share S-REIT index.
• Maintain BUY. Our target price of S$2.48 is based on DDM (cost of equity: 5.75%, terminal growth: 1.8%).
SHARE PRICE CATALYST
• DPU and NAV accretion from the merger with MNACT.
• MCT has five properties located in the HarbourFront area, which accounted for 91.5% of its AUM in aggregate. It will benefit immensely from the development of the Greater Southern Waterfront and rejuvenation of Sentosa Island and Pulau Brani.