Keppel DC REIT & M1’s NetCo deal – good or bad for investors?

I must say Keppel DC REIT and M1’s NetCo deal is probably the most unusual deal I have seen thus far.

• First, a REIT is investing in bonds instead of buying assets directly.
• Second, the deal is funded heavily by debt and the identities of the ‘external financiers’ were not disclosed.
• Third, it seems like the deal was structured for the benefit of Keppel Corp.

This is a curious case and I have more guesses than answers.

What is this NetCo deal?

M1 is selling its network assets (mobile, fixed and fibre assets) to a separate entity called “NetCo” for S$580m. Keppel DC REIT is buying S$88.7m worth of bonds and S$1m worth of preference shares issued by NetCo. This is a small amount, compared to the S$493m external borrowings made by NetCo.

M1 will continue to be the sole and exclusive user of NetCo’s assets. M1 is also responsible for maintaining and repairing the network and receive a monthly service fee in return. The agreement lasts for a period of 15 years.

Essentially, this is a sale-and-leaseback scheme.

Is this good for Keppel DC REIT?

This is a decent deal for the short term but…

i) Buying bonds instead of assets?

You might have noticed that Keppel DC REIT is not buying the assets or a stake in NetCo. Instead, it is buying the bonds and preference shares.

This is unusual for a REIT.

Moreover, NetCo is not a data centre but an owner of a telecom infrastructure. Earlier this year, Keppel DC REIT had expanded their mandate to include digital assets rather than remaining a pure play for data centres, in order to fit this deal in.

The NetCo bonds are paying an interest of 9.17% per annum. It looks rather high but may be appropriate considering the lease is short and depreciation is high for telecom infrastructure. The bond tenure is 15 years, in line with the agreement period between NetCo and M1.

ii) Taxes and its impact on DPU

Another tricky issue is that these bonds may not qualify for the tax exclusion which REITs usually enjoy. Keppel DC REIT is in the midst of applying with the Monetary Authority of Singapore (MAS) to get these bonds as Qualifying Project Debt Securities (QPDS) to avoid paying the corporate tax on the interest income.

If the QPDS application is successful, the Distribution Per Unit (DPU) accretion will be 3.8%.

If the QPDS application is unsuccessful, the DPU accretion will be around 3.1%.

Either way, it is a DPU accretive investment and good for unitholders on this end.

But this comes with a price.

iii) Loss of (potential) price premium

I believe the expansion of the mandate has cost Keppel DC REIT its data centre premium. It could have commanded higher price multiples if it remained as a pure play data centre REIT.

I suspect the data centre space is much harder to compete nowadays, considering more players are coming in. And in Singapore, there are no new data centres allowed to be built at the moment. The demand for data centre acquisition is high while the supply is limited. Thus, expanding the mandate can help Keppel DC REIT continue to grow outside the data centre space.

This is a decent deal for the short term but Keppel DC REIT would have to focus on data centre growth in the long run.

Keppel Corp – the biggest winner!

In short, Keppel Corp is the biggest beneficiary of this deal. They are the main actor while Keppel DC REIT is in a supporting role.

Keppel Corp owns about 80% stake in M1 and the selling of M1 assets to NetCo has lightened its balance sheet. This is part of the 2030 vision of running an asset-light business model and the jettisoning of assets have begun – selling M1’s network assets to NetCo and Keppel Offshore and Marine to Sembcorp Marine.

This is the art of financial engineering – you get to shape the perception of a stock.

We saw this gameplay with CapitaLand’s restructuring, whereby the asset-heavy business was privatised and the asset-light real estate investment management business remains listed. The latter is a more desirable business and you can see that the share price has performed well after the restructuring.

The next best thing is that the entire CapitaLand empire didn’t change at all (it is just organised differently) and the ultimate control of the CapitaLand empire remained with the same management and the biggest shareholder. Magic.

The same can be said for Keppel Corp. The goal of being an asset-light business would improve its perceived value. This deal doesn’t really affect their day-to-day operations. M1 continues to use, maintain and repair the network assets even though they were sold to NetCo. M1 (and indirectly Keppel) get cash from the sale without losing control.

There’s no change to the book value or net tangible assets (NTA) of Keppel Corp in this deal.

The magic happens in the details. M1 is a subsidiary of Keppel Corp and the former’s fixed assets are consolidated in the latter’s balance sheet. With the sale of the assets to NetCo, the fixed assets will reduce and the cash will go up. The quality of the assets has improved as a result. The deal was done at book value and hence, Keppel’s NTA doesn’t change after the deal.

NetCo is NOT a subsidiary of Keppel Corp and hence its liabilities are not consolidated in Keppel’s financial statements. Yet, M1 still owns 100% ordinary shares of NetCo. It is quite brilliant actually – a sale-and-leaseback structured as a divestment deal.

It is all about perception and it was a success. Keppel Corp share price went up after this deal was officially underway:

I expect more mergers and acquisitions as well as restructuring activities coming from Keppel Corp in the next 9 years.

But…who are the external financiers?

This is the elephant in the room – who are generous enough to lend 85% of the asset value to a special purpose vehicle, NetCo?

And considering Keppel DC REIT’s bonds equivalent to 15% of the value, the deal was 100% done in debt!

This is my own suspicion and I can be wrong. I think the likeliest financier would be Temasek, considering that it has a stake in all the parties involved.

M1’s assets alone probably wouldn’t have been sufficient to form a separate business trust. Few investors fancy telco assets these days. These assets continue to be a drag on Keppel performance and the lacklustre offshore business has been giving Keppel a lot of headaches too. Keppel is keen to sell some assets to improve its metrics. Temasek is often the buyer of last resort for this case.

The identity of the financier/s has not been disclosed, so it is anyone’s guess.

Good for now

This is a perception shifting deal and it has worked thus far for Keppel Corp. Keppel DC REIT has a decent deal with a high 9.17% annual interest rate for the next 15 years.

Many of our blue chip companies are underperforming and there is pressure to rejuvenate them. It is no easy task because some businesses are affected by global trends and you can’t turnaround a business in weeks or months especially it is being disrupted. Restructuring and shifting perception would be the easiest and quickest way.

There will be a sea of change coming to Singapore Inc and this is just the start.