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What we like

Its assets are concentrated in London – a strong and more protected location than many other areas in the UK. Here there is local and foreign demand, whereas locations outside London have been struggling in light of a weak economy and a trend towards internet shopping. The redevelopment of Earls Court and Olympia into residential units could lead to a material upside revaluation relative to the current carrying asset value for these properties.


What we don’t like

The valuation implied by the share price suggests that the potential development upside in Earls Court and Olympia is already priced in. The local listing has more than doubled over the past 18 months, putting it at a 75% premium to net asset value (NAV), and it offers a mere 0.5% dividend yield. Given the redevelopment upside, a NAV premium is arguably justified but the question is how much of a premium is justified.

As per the table, we determine that the market is effectively valuing these redevelopment assets at 2.7 times carrying asset value, as determined by independent valuers (a 171% premium), which means the market is valuing these assets at close to £1 100/square foot (ft2) versus carrying value of £400/ft2.

Management believes that when developed these assets will be worth between £1 200 and £2 000/ft2. However, this will only be at completion – at least four years out – given the need to obtain planning permissions, demolish existing buildings, gain interest via pre-sales and actually build the units, all of which will also require a great deal of capital expenditure.

Thus an estimated net value of these assets today would be management’s valuation range discounted to today at a suitable discount rate to compensate for the risks associated with developments (delays in obtaining planning permissions, delays in demolishing and building, cost over-runs, poor pre-sales, not achieving target price discovery), less present value of capital expenditure needed. This translates into a net valuation range of £400 – £1 000/ft2 today. On this basis, the market’s implied valuation of £1 100/ft2 is excessive and we believe there is limited upside at current share price levels denominated in British pounds.

Further, the 50% or so depreciation in the rand versus British pound since early 2012 has been responsible for almost half the return SA investors have enjoyed on the local Capco listing. The exchange rate of about R15.50 per British pound at the time of going to press is now significantly above our estimated purchasing power parity (PPP) value, implying that the rand is now cheap against the pound and there’s implicit currency risk in Capco’s investment case at these levels.


Risks to the upside

The valuation could get a boost if price discovery on pre-sales of residential units in Earls Court and Olympia is significantly greater than even management’s upper end guidance of £2 000/ft2. But to put this into perspective, this equates to paying more than R340 000/m2 for an apartment, or R34 million for a 100 m2 apartment! The other major upside risk is that the rand continues to weaken materially relative to the pound, boosting the rand value of the investment further.


sim.sense’s bottom line

While the assets are in a good location and there is significant upside from redevelopments, in our view the market already appears to be pricing in even the best-case scenario laid out by management. As a result, there’s no buffer in the implied valuation to allow for the considerable risks inherent in property development. The rand/pound cross rate is now well above our estimated PPP and thus the odds are weighted towards the rand strengthening from here against the pound, which would detract from an SA investors’ total rand return.

Sanlam Life Insurance is a licensed financial service provider.
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