• The proposed acquisition of T Tower will extend Keppel REIT’s footprint into South Korea, a third market in addition to Singapore and Australia.
• Seoul offers a deep office market with attractive demand-supply dynamics. The transacted price is attractive with NPI yield at 4.7%, and is expected to lead to immediate yield-accretion of 2.5% based on a pro-forma 2018 DPU.
• Maintain BUY with target price raised to S$1.37.

What’s New

• Keppel REIT (SGX:K71U) announced the proposed acquisition of T Tower in Seoul at an agreed value of ₩252.6b (S$301.4m). After taking into account attributable share of adjusted net liabilities, Keppel REIT’s purchase consideration for a 99.38% stake is ₩129.6b (S$154.6m).
• The proposed acquisition will be funded by debt, split between a ₩-denominated loan with interest rate at sub-3% and proceeds from issuance of S$200m 1.90% convertible bonds.
• The acquisition is expected to complete in 2Q19.

Stock Impact

Entry into third market brings new growth and diversification.

• The transaction will diversify Keppel REIT’s S$8.4b prime commercial portfolio beyond Singapore (82.4%) and Australia (14%), into South Korea (3.6%), a third market for potential DPU-accretive acquisitions. The transaction will raise the freehold portion of Keppel REIT’s portfolio to 20.6% (+5.7ppt), and portfolio committed occupancy to 98.8% (+0.1ppt).
• Portfolio WALE will remain long at 5.5 years, while lease expiry remains well spread out.
• Owning assets across Singapore, Australia, and South Korea enhances income stability, due to the different stages of the property cycles in the respective markets.

Attractive transacted price; expected to be immediately yield-accretive.

• With an NPI yield of 4.7%, the T Tower acquisition is expected to boost pro-forma 2018 DPU by 2.5% to 5.70 S cents, based on debt financing. Transacted price is also attractive, which is at a 2.5% discount to an independent valuation by Cushman & Wakefield (C&W).

Acquisition cost of 141.1b (S$168.3m) funded by debt.

• The debt funding mix comprises ₩-denominated loan and proceeds from the issuance of convertible bonds. Post-acquisition, gearing would increase from 35.7% to 38.1%, but would still be below the regulatory limit of 45%.
• The acquisition cost will comprise a purchase consideration of ₩129.6b (S$154.6m), acquisition fee payable to manager of ₩2.5b (S$3m), and other professional and transaction fees of ₩9.0b (S$10.7m). The purchase consideration of ₩129.6b (S$154.6m) has taken into account the attributable share (99.38% stake) of the adjusted net liabilities of ₩123.0b (S$146.8m).

Freehold, 28-storey Grade A office located in Seoul’s CBD with NLA of 228,000sf.

• T Tower is located within a 5-mins walk from Seoul Station (major railway station with linkages to Incheon International Airport and various South Korean cities) and well-served by other rail, subway and bus networks. The strong connectivity has helped attract multinational and national companies with regional presence.
• The site also enjoys diverse amenities, F&B outlets, and is close to key retail districts, such as Myeong-dong and Namdaemun.

Capitalising on Seoul’s deep office market.

• The outlook for Seoul’s office market appears robust, with office investments reaching a historical high in 2018 amid ample liquidity and positive investment sentiment. Grade A office buildings are expected to be in high demand across the three key business districts (Central Business District, Gangnam Business District, and Yeouido Business District) in Seoul, on the back of healthy leasing demand and limited supply, according to C&W.
• CBD vacancy is expected to peak at 16% in 2020 (and then decline to 13% in 2022), according to C&W. CBD’s new supply is expected to increase in the next two years, but will be muted subsequently. CBD’s demand is expected to remain resilient over the subsequent years given its strong connectivity and with the CBD being a preference among international conglomerates and notable national companies to locate their headquarters.

Building fully-leased with reputable tenants.

• T Tower is 100% leased to 11 well-known national and international tenants, with the tenant mix predominantly in the technology, media and telecommunications (TMT) (19.8%), manufacturing and distribution (29.6%) and services (33.2%) sectors.
• Some notable tenants include Philips Korea, LG Electronics, and SK Communications. The property has a WALE of 2.8 years (by NLA) as at 1Q19, and most of the leases have fixed annual rental escalations of 3%.

Leveraging on sponsor’s on-the-ground experience in South Korea.

• The sponsor, through Keppel Capital, has managed close to S$3b of assets (GFA of 5.2m sf) since 2004, which includes CBD commercial offices, like Seoul Square, Jongno Tower, Pacific Tower, and Center Place.
• Keppel REIT would be able to leverage on sponsor’s strength in South Korea to source for further growth opportunities in the Seoul office market.

Earnings Revision / Risk

• We raised our 2019-21 DPU forecasts by 1.4-2.2%, factoring in new contributions from the T Tower acquisition.

Valuation / Recommendation

• Maintain BUY with a raised target price of S$1.37. Our valuation is based on DDM (required rate of return: 6.25%, terminal growth: 2.0%).

Share Price Catalyst

• Higher office rentals and positive newsflow on leasing activities.
• More accretive acquisitions in Singapore, Australia, and South Korea

Source: UOB Kay Hian Research - 24 Apr 2019