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Champion REIT （2778，HK）Successful acquisition, bullish prospect

Friday, June 13, 2008

8004

Champion REIT(2778)

Recommendation on 13 June 2008
Recommendation	Buy
Price on Recommendation Date	$3.600
Target Price	$4.770

Weekly Special - 002050 Sanhua

Summary

On May 28, through right offerings, issuance for convertible bonds and bank loans, Champion Real Estate Investment Trust (Champion REIT or Company) successfully financed HK$ 7.63 billion for acquisition on Langham Place shopping mall and office building, which is owned by the Companys holding shareholder, Great Eagle Holding Limited (Great Eagle).Discounted right offerings, profit dilution will impose bearish atmosphere for stock price in short-term, while long-term competitiveness for REITs will be promoted. We give Champion REIT “Buy” rate, 12-month target price at HK$ 4.77, 33 % premium increase than current price.

Composite finance acquisition on Langham Place

Composite finance will back up Champion REIT procuring Langham Place shopping mall and office building from Great Eagle at price of HK$ 12.5 billion (see Table 1). The acquisition involves Langham Place shopping mall and office building, with area totals 1.94 million square feet. Acquisition price for retail part is approximately at HK$ 12,519/square feet, for office building, the price is HK$ 6,815/square feet. Total acquisition is 11.8% discount by estimated price of HK$ 14.1 billion. This acquisition will not include the Langham Hotel and the already sold forth-story for the office building.

Table 1 Financing structure

Source: Companys announcement

We think driving factors for Great Eagle launching this acquisition are: Firstly, Great Eagle can arbitrage at high level when market booming, to improve assets situation. After the acquisition, Great Eagles shareholding ratio will remain the same as 48.7%.While Great Eagle added HK$ 7 billion more cashes, which can be used to reduce debt ratio, distribute dividend or develop hotel business. Secondly, to enhance Champion REITs assets scale. Champion REIT is Great Eagles key platform for commercial properties. Through merger of Langham Place, market value for Champion REIT will add 53% to HK$ 4.18 billion, which may vary income resources, and effectively improve REITs assets structure.

Champion REIT allocated sale for new share discounted at HK$ 3.6, which is a main factor for stock price sharp drop after relisting. At the end of 2006, Champion REIT once allocated sale for 50 million new shares at price of HK$ 5.1, and premium ratio was as high as 36%.While worry about this new share allocation sale, profit dilution lead into underselling for investors.

Table 2: Assets structure change （HK$ 1 billion）

Source: Companys announcement

25% convertible bond premium ratio highlights convertible bonds as the market focus. We think there is evident willingness for Champion REIT to finance through equity, while possibility for bond converting into equity will be larger. Therefore, we estimate that the in the coming year, stock price for Champion REIT will quite potentially fluctuate within range of HK$ 4-5.

Furthermore, after the completion of this acquisition, Champion REIT plans to cancel partial of two existing financial projects, namely three-year interest swap contract, and Great Eagle to give up 20% dividend acquisition of Champion Eagle in 2008.This measure will enable Champion REITs financial structure clear and transparent.

Post-inflation era, REITs will be aspired

The keep rising inflation rate in Hong Kong continually imposing direct and serve negative effect on REITs yield. DBS Vickers forecasts inflation rate for Hong Kong will reach up to 5%, while our estimation is the average dividend yield for REITs in Hong Kong will be 6% in 2008, so investors actual annual yield will only be 1%.We believe high inflation environment caused underselling is the main factor for Hong Kong REITs mediocre performance in recent half year.

Since September 2007, in order to avoid economic recession, the Fed has lowered interest rates to a total of 325 basis points. U.S. exports, retail and other economic indexes in April were improved, and U.S. economys climbing out of slump was in sight, while inflation problem is threatening the weak U.S. economy from time to time. April CPI for U.S. was 3.9%, core CPI was 2.3%, higher than expected 2-2.2%.We think in late half of 2008, the Fed may shift the focus to price stability, and interest rising possibility before 2009 is higher.

Figure 1: Hong Kong Composite Price Index unit: %

Source: www.gov.hk

Figure 2: Hong Kong and US interest rates comparison

Source: HKMA, and FED

Owing to implementation of the related exchange rate system and local higher level inflation in Hong Kong, it is most likely that Hong Kong may get into the cycle of interest rate increase before 2009.Prior to the incremental cycle, REITs will be more likely to be favored by investors. Firstly, assets flow from high risk asset into low risk, stable return fixed income security; Secondly, current average rent for REITs affiliated properties is lower than market price, with long-term contract guarantee, therefore, REITs yield will grow steadily.

According to our estimation, in late half of 2008, inflation for Hong Kong will remain at high level, with further rising momentum; assets price will increase, while operation pressure for entity will increase. Rent price for REITs affiliated properties were improved in various degrees (relating to proportion for renewal customers), net assets value discount for REITs was reduced (except from The Link Real Estate Investment Trust, whose long-term will be premium transaction), meanwhile, price was recovering gradually. Along with clarification for expectation on government regulation on inflation, good-quality REITs will be aspired ardently by market.

Risk

The potentially keep increasing inflation may reduce the real rate of return for REITs in the same pace, and weaken the investment confidence of share holders, resulting in underselling. Such systemic risk is worth of investors paying close attention.

Valuation

Based the above situations, we calculate that interim 2009 NAV per share for Champion REIT will be HK$ 6.36, and we give 25% discount, 12-month target price at HK$ 4.77, an increase of 33% than current price. We give Champion REIT “Buy” rating.

Author

Champion REIT （2778，HK）Successful acquisition, bullish prospect

Summary

Composite finance acquisition on Langham Place

Post-inflation era, REITs will be aspired

Risk

Valuation

Financial Data:

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