LONDON -- This month's bid by the British Telecommunications PLC Pension Scheme and GE Capital Real Estate for U.K. property company MEPC has been broadly welcomed as a savvy move.
Not only were the BT plan and GE Capital able to snap up attractive real estate at bargain-basement prices, they also set in motion a long-needed restructuring of publicly listed property holding companies.
Both GE Capital Real Estate, the commercial real estate division of General Electric Capital Corp., and the 30 billion ($45 billion) BT fund -- the U.K.'s largest pension plan -- had noticed MEPC earlier this year. Because of its status as an "old economy" stock, MEPC's share price was trading at a discount of between 25% and 30% to net asset value.
Hard to swallow
In fact, MEPC officials had sounded out GE about a possible deal. But with a market capitalization of 1.9 billion, MEPC looked like a difficult deal for one buyer to digest on its own.
So earlier this month, GE and the BT fund jointly bid 1.9 billion for MEPC, the U.K.'s third largest publicly held property company.
The sheer size of the deal, valuing the company at 3.5 billion including net debt, took the U.K. investment market by surprise and is expected to trigger similar bids for other property companies.
But whether another U.K. pension plan will have the financial weight or the initiative to pull off a similar deal is unclear.
U.K. pension plans are willing buyers of property, seeing real estate as a slightly more tax efficient investment than equity, said Gerald Blundell, European director for LaSalle Investment Management, London. But many U.K. pension plans are quite conservative and might not be willing to invest in a vehicle using debt to increase returns on property investments, one of the main reasons for the BT/GE Capital bid for MEPC.
The genesis of the deal goes back to the beginning of this year, when the BT fund's internal property investment team, responsible for the plan's 2.6 billion worth of property investments, was trying to understand why listed U.K. property companies had been performing poorly while direct property holdings had been doing well.
Despite good commercial property prices and healthy rental returns, most listed property holding companies were trading at the time at an average 28% discount to their net asset value.
The managers of the BT fund's property assets had been discussing the nature of this anomaly with officials at GE Capital Real Estate since the beginning of the year, said Alastair Ross Goobey, chief executive officer of BT's investment manager, Hermes Investment Management Ltd., London.
And while scouting around for tasty-looking property investments during the first few months of this year, both Hermes and GE Capital independently had considered MEPC an interesting opportunity.
The firm's management was whittling down its investment portfolio to focus on a few high-rent business parks in greater London. But the "old economy" label was hurting MEPC's share price.
While existing investors were heading for the exits, both the BT fund and GE Capital were getting extremely interested.
Meanwhile, behind the scenes at MEPC, Chief Executive Officer Jamie Dundas and Finance Director Stephen East were quietly scouting around for partners with deep pockets to help restructure their company.
"We decided to look through all the options open to us for how to deliver shareholder value," said Mr. East.
According to a senior property analyst, one issue of particular concern to MEPC was that a large portion of its debt was fixed at a high rate of interest over a relatively long period. MEPC was looking for a deal that would pay off that long-term debt and replace it with borrowings secured at lower interest rates.
MEPC already had been working with GE Capital on a number of joint ventures, and the question of how to restructure the British company to deliver shareholder value began to crop up in conversations between the two firms' management teams in early April, said Mr. East.
GE Capital was "an obvious counterparty to talk to, see what sort of offer they would make. We knew they were interested in property, and we knew they were interested in size," he added.
And around the same time, GE Capital officials decided they would be interested in making a play for MEPC, said Charles Alexander president of GE Capital (Europe), London.
"The discussion evolved first with MEPC, then we brought in Hermes. The sheer size of the transaction meant we wanted to share the risks with a partner on an equal footing. Hermes has a long history of involvement in the U.K. property sector," said Mr. Alexander.
BT Pension Scheme and Hermes executives were more than willing to accept GE Capital's suggestion in April to team up and make a joint bid for MEPC, take it private, revamp the financing and sweat the assets to improve investment returns.
"MEPC have a very attractive property portfolio, a good management team, and the deal gives us the ability to introduce leverage to our property investment portfolio," said Mr. Ross Goobey.
Under the terms of the deal, Leconport Estates, London, an unlimited liability company and a joint venture between BT Pension Scheme and GE Capital, will purchase the issued share capital of MEPC and delist the company from the London Stock Exchange.
The BT Pension Scheme's share of Leconport will be worth 950 million, but will only slightly increase the fund's exposure to property, which at the end of last year accounted for almost 10% of total assets.
By taking MEPC private, its management will be given more flexibility to restructure the capital base of the company than would be the case if it remained a public company.
Both Mr. Alexander and Mr. Ross Goobey want to make more efficient use of debt financing to improve internal rates of return on the underlying investments in MEPC.
"Research shows that (unleveraged) returns on property will be somewhere between 10% and 11% over the next few years," said Mr. Ross Goobey. Included in the deal is an incentive package for MEPC management that creates a bonus pool designed to encourage an internal rate of return exceeding 15%.
The bid was accepted by the management board of MEPC and, pending shareholder approval, is expected to take effect by September.