Keppel DC REIT’s proposed investment in M1’s Netco bonds and preference shares

Keppel DC REIT (SGX: AJBU) has decided to expand its investment mandate to diversify away from being a pure data centre REIT. 

Last week, the REIT announced it would enter into a bond subscription deed and a subscription and shareholders’ agreement to purchase S$88.7 million worth of bonds and S$1 million worth of preference shares respectively in NetCo. 

The move is certainly unusual – REITs typically purchase physical real estate instead of financial assets. Therefore, we will delve into the key facts of this proposed investment and consider if it is beneficial to that investors of Keppel DC REIT. 

Forming of NetCo

M1 is Singapore’s first digital network operator, providing a suite of communications services, including mobile, fixed line and fibre offering, to over two million customers. It is owned by both Keppel Corporation Limited (SGX:BN4) and Singapore Press Holdings Limited (SGX:T39) after being privatised back in September 2018. 

(Source: Company presentation slides) 

As part of the arrangement, M1 will incorporate a wholly-owned subsidiary known as NetCo that will acquire the network assets of M1 for S$580 million, or the assets’ net book value, through an asset transfer agreement. 

The two parties will also enter into a 15-years network services agreement, where M1 and its mobile virtual operators will use NetCo’s network capacity, while the telco, M1, handles the day-to-day operations and maintenance of the network assets as well as the capex works. 

NetCo will seek financing for S$493 million while selling bonds worth S$88.7 million to Keppel DC REIT at a coupon rate of 9.17% per annum. In addition, NetCo will also issue S$1 million worth of preference shares to Keppel DC REIT’s wholly-owned subsidiary. 

The set-up is to unlock the value of M1’s network assets and is part of Keppel group’s asset monetisation strategy and asset-light business model under its Vision 2030. 

Is the investment beneficial to Keppel DC REIT?  

We can consider the deal from several aspects:-

1. DPU accretive investment

Unitholders will enjoy a higher distribution per unit (DPU) from this acquisition. 

Using the fiscal year 2020’s (FY2020) DPU of S$0.0917 as a base, the DPU is expected to increase by 3.8% to S$0.09519 post acquisition.

The pre-requisite for the 3.8% DPU increase is that the bonds are classified by the Monetary Authority of Singapore (MAS) as qualifying project debt securities (QPDS). 

Assuming the QDPS is not approved, the bonds will not qualify for tax exclusion, and the REIT will have to pay corporate income tax on the interest income earned.  

Under the second scenario, the DPU will fall slightly to S$0.09457, but is still 3.1% higher than the FY2020’s DPU.

Meanwhile the net asset value per unit of the REIT will remain constant at S$1.19. 

Aggregate leverage however will increase from 36.7% to 38.0% post acquisition, but it is still much lower than the 50.0% threshold set by the MAS. 

2. Stable and long-term cash flow

The acquisition will provide a long-term stable source of income of S$11 million per annum comprising the payment of both principal and interest over 15 years.

The REIT will also not be assuming any operational management risks as M1 will perform the day-to-day operations and maintenance of, as well as perform the capex works for the network assets. 

But investors have to be mindful that the REIT is not buying the assets or a stake in NetCo. Instead, it is purchasing financial assets in bonds and preference shares. Therefore, NetCo’s (or in turn, M1’s) ability to service and repay the principal and interest payments will be crucial. 

3. Strong growth platform

Once completed, the REIT’s assets under management will increase by 2.7% to $S3.3 billion. 

The enlarged portfolio will create a stronger platform for acquisition growth, providing the REIT with better access to capital and debt markets for future deals. 

However, one could argue that the expansion of the mandate and the subsequent investment in NetCo has cost Keppel DC REIT its data centre premium. 

Shares of the REIT have declined 15.0% this year, and analysts and market observers had attributed the drop to its diversification from purely data centre properties which are in high demand due to growth in data creation and data storage needs. 

In summary

Overall, unitholders of Keppel DC REIT should not feel too disappointed with the NetCo investment as the positives still outweigh the negatives. This is a short-term deal, and the financial investment appears to be DPU accretive to investors. 

Nevertheless, it is understandable that most investors would prefer that the REIT to keep its focus on data centre acquisitions – there does not seem to be much synergy in the acquisition of M1 bonds and preference share and its current portfolio of data centres assets. 

Ultimately what unitholders look forward to are sustained increases in DPU that will bump up their passive income flow. Therefore, Keppel DC REIT’s recent announcement of two other data centre acquisitions in the past three months, one each in China and Netherlands, would certainly be music to the ears of most investors.  

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