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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

Precinct Properties New Zealand / Equity Bottom-Up

<h2>Precinct Properties AFFO Boost from Management Internalisation</h2>
Precinct Properties (PCT) has announced that it has reached an agreement with its manager, AMP Huami Management Limited (AHML), to terminate its management contract and become an internally-managed vehicle as of 1 April 2021. The net cost to PCT is expected to be NZ$145m, resulting in expected cost savings of NZ$14.6m per annum, translating to 6.0% AFFO accretion on a pro-forma basis. Despite this solid lift in the earnings profile there was no update to FY21 DPS guidance of 6.5cps. We are positive on PCTs decision to internalise given&nbsp;it&nbsp;provides an attractive avenue to deploy capital in a low yield/return environment (cost saving represent a 6.8% yield on the gross cost to terminate the management agreement or a 10.1% yield on the net cost) while also improving the governance structure of the vehicle.
Key points
<ul>
<li>Net cost of NZ$145m contingent on favourable tax ruling: PCT will pay AHML NZ$215m, or NZ$145m once incorporating the expected tax benefit of the transaction and cancellation of NZ$10m of development fees. While the tax benefit is yet to be granted, other internalisations have been tax deductible and this aligns with the tax advice that PCT has received from KPMG.</li>
<li>A fall in MER boosts AFFO: The internalisation is expected to reduce PCT’s management expense ratio (MER) from 0.74% to 0.31% (one of the lowest in the sector), and boost AFFO by +6.0% on a per share, pro-forma basis. The payment will be debt funded by a new NZ$250m 5-year bank facility. Committed gearing lifts to 36% post-internalisation, 1 Queen St commitment, and a further NZ$90m divestment. PCT targets gearing of &lt;37.5%, as such any further portfolio activity will likely require further asset sales or additional equity.</li>
<li>Director discretion: Under its previous structure AHML had discretion to appoint two directors to the board, however with an internally-managed structure, PCT shareholders gain full discretion (with &gt;15% shareholding required for a board seat). In our view, the structure also improves governance with better alignment of director and shareholder interests.</li>
<li>Opting for internal: Under an internally-managed structure, LPVs directly employ staff to carry out the various property and asset management functions. All employee costs are recognised as corporate overhead (outside of on-site staff such as shopping centre employees who can be directly attributed to assets). As a result, the property management and leasing functions for internally managed vehicles are effectively recognised as a corporate expense and not a direct property expense (to the extent these are not outsourced).</li>
</ul>
Rohan Koreman-Smit&nbsp; Senior Analyst, Equities
<figure class="editor-figure mceNonEditable"><img src="https://mail.google.com/mail/u/0?ui=2&amp;ik=f57c39853c&amp;attid=0.1&amp;permmsgid=msg-f:1695515054490858053&amp;th=1787adf576413245&amp;view=fimg&amp;sz=s0-l75-ft&amp;attbid=ANGjdJ-GNJhKtog5tkZ3hsmXX2sl8ToUGPp1UBNJ4Q8sZx53yMpGKlkwO3SV5XxoYaMNbT3w8rLDAZpkS6WTRaHIuoQX1ps3zBXlI_gke3T1SK0ltU_LUTPdvvIq3n8&amp;disp=emb" class="editor-image img-responsive"></figure>
 P: +64 9 368 0085 | TF: 0800 367 227&nbsp; Level 23, Lumley Centre, 88 Shortland Street, Auckland

Precinct Properties AFFO Boost from Management Internalisation
Precinct Properties (PCT) has announced that it has reached an agreement with its manager, AMP Huami Management Limited (AHML), to terminate its management contract and become an internally-managed vehicle as of 1 April 2021. The net cost to PCT is expected to be NZ$145m, resulting in expected cost savings of NZ$14.6m per annum, translating to 6.0% AFFO accretion on a pro-forma basis. Despite this solid lift in the earnings profile there was no update to FY21 DPS guidance of 6.5cps. We are positive on PCTs decision to internalise given&nbsp;it&nbsp;provides an attractive avenue to deploy capital in a low yield/return environment (cost saving represent a 6.8% yield on the gross cost to terminate the management agreement or a 10.1% yield on the net cost) while also improving the governance structure of the vehicle.
Key points

Net cost of NZ$145m contingent on favourable tax ruling: PCT will pay AHML NZ$215m, or NZ$145m once incorporating the expected tax benefit of the transaction and cancellation of NZ$10m of development fees. While the tax benefit is yet to be granted, other internalisations have been tax deductible and this aligns with the tax advice that PCT has received from KPMG.
A fall in MER boosts AFFO: The internalisation is expected to reduce PCT’s management expense ratio (MER) from 0.74% to 0.31% (one of the lowest in the sector), and boost AFFO by +6.0% on a per share, pro-forma basis. The payment will be debt funded by a new NZ$250m 5-year bank facility. Committed gearing lifts to 36% post-internalisation, 1 Queen St commitment, and a further NZ$90m divestment. PCT targets gearing of &lt;37.5%, as such any further portfolio activity will likely require further asset sales or additional equity.
Director discretion: Under its previous structure AHML had discretion to appoint two directors to the board, however with an internally-managed structure, PCT shareholders gain full discretion (with &gt;15% shareholding required for a board seat). In our view, the structure also improves governance with better alignment of director and shareholder interests.
Opting for internal: Under an internally-managed structure, LPVs directly employ staff to carry out the various property and asset management functions. All employee costs are recognised as corporate overhead (outside of on-site staff such as shopping centre employees who can be directly attributed to assets). As a result, the property management and leasing functions for internally managed vehicles are effectively recognised as a corporate expense and not a direct property expense (to the extent these are not outsourced).

Rohan Koreman-Smit&nbsp; Senior Analyst, Equities

 P: +64 9 368 0085 | TF: 0800 367 227&nbsp; Level 23, Lumley Centre, 88 Shortland Street, Auckland

Precinct Properties: AFFO Boost from Management Internalisation