February 2, 2017
Milestone Apartments REIT
From "low" to "moderate" – evaluating offer sensitivities; Shifting to Outperform
Our view: On Jan-19, Milestone Apartments REIT ("MST") agreed to a US$16.15/unit all-cash privatization offer from Starwood Capital Group ("Starwood"). We initially ascribed a "low" probability to a higher offer. Sensing somewhat greater investor discontent than anticipated, we've shifted our probability assessment to "moderate". Herein we examine valuation sensitivities. We reiterate our $22 target on MST's units, but due to risk-weighted return expectations, our rating shifts to Outperform.
Key points:
Squaring-off some key numbers... – MST’s transaction press release cited the deal as having a $2.85B EV and an implied value/suite of $120,000. Our analysis squares-off precisely with these figures (see Exhibits 2 and 3).
...But not all – MST’s transaction press release also cited an implied cap rate of 5.8% based upon the US$16.15/unit offer price. Our forecast and valuation model derives a slightly higher 5.9%-6.0% implied cap rate, thus suggesting the offer price slightly less robust (see Exhibit 3).
Modest portfolio premium – Amassing a 24,000 unit portfolio (78 communities across 16 markets) is a difficult, but do-able exercise for an experienced apartment investor. Outside of the capital investment, this sort of endeavor takes time, effort, and, it includes transaction costs. As such, we believe unitholders should be paid a portfolio premium for an en-bloc portfolio sale. We estimate the Starwood offer equates to a ~10% premium over pro-forma IFRS equity and ~5% over gross asset value (Exhibit 4). We view these premiums as being at the low-end of the acceptable range.
But seemingly no platform premium – MST is a fully internalized REIT, having in-house integrated asset management and property management functions. MST’s chairman describes this platform, which includes people (~1,200), systems, offices and processes as “state of the art”. As Starwood is acquiring this platform, we believe it sees value (perhaps the MST platform can help drive performance across the ~67,000 multi-res units that Starwood already has under management). While the offer seemingly includes a ~5% portfolio premium (as per above), we see no evidence of platform-value consideration.
Price improvements of +US$0.50/unit to +US$2/unit don't yield a major change in key valuation metrics – Valuation sensitivities (Exhibit 5) illustrate that for every $0.50/unit of price improvement, the implied cap rate changes by a scant 9-10bps and the average implied value/suite rises by $1,500-$2,000. Hence, price improvements of US$0.50/unit to US$2/ unit don’t move the needle that much.
Rating shifted to Outperform from Top Pick; $22 target maintained