SPECIAL REPORT: Blackstone goes walkabout

Blackstone’s expected acquisition of Valad Property Group next month would be the New York giant’s first meaningful foray into Australian real estate. PERE Magazine June 2011 issue.

It was a matter of when, not if, The Blackstone Group’s relentless ambition to dominate the planet’s private equity real estate universe would see it set its sights on Australia.

That moment became official on 29 April, when troubled real estate investment and fund management business Valad Property Group announced it had reached an agreement with the New York-based private equity and real estate juggernaut to sell all its stapled securities in a deal valued at A$806 million (€601.7 million; $1.06 billion).

Short of a rejection by shareholders at a scheduled vote early next month, Blackstone will pay A$1.80 per share, equal to A$208 million, for the company and assume A$598 million of its liabilities. For that money, it absorbs into its global portfolio of $26.5 billion in fee-earning assets under management a portfolio of Australian properties with a total value of approximately A$600 million. In addition, Blackstone assumes a further A$300 million of co-investments across Valad’s mostly European funds, which owned real estate valued at A$8.1 billion as of June 2010.

Even if the deal were not to happen, [Blackstone] would still be in a relatively favourable position as any alternative bidder would need to repay the bonds at face value, enabling Blackstone to capture value anyway
Unnamed source

Having already bought the US division of one Australian credit crunch casualty, Centro Property Group, Blackstone is poised to consume another in a deal that will inherit it a meaningful amount of Australian real estate for the first time. Until now, Blackstone’s exposure to Australian property was limited to a single hotel previously acquired as part of a wider portfolio. The purchase of Valad enables it to add offices, retail and industrial properties across Australia and New Zealand.

Though no formality, Blackstone’s offer for Valad is expected to be approved as it represents a 56 percent premium to the firm’s closing share price of A$1.16 on 27 April. Hedge fund manager Orbis Australia is just one investor that stands to benefit, having bought 21.8 million shares in Valad since the global financial crisis. Its shares were worth A$25 million when trading was suspended prior to the announcement of Blackstone’s offer and were worth A$39.2 million shortly afterwards.

Still, there will be unhappy investors too. Valad’s stock price rebounded only marginally after collapsing 99 percent from its five-year height of A$35 in 2007 – a time when its assets under management stood at a more impressive A$17 billion. With the company’s zenith (and arguably its nadir) behind it, Valad’s future now lies firmly in the hands of Blackstone.

Even in the unlikely event that shareholders reject the offer, Blackstone already has purchased $185 million of convertible bonds secured against the Sydney-based firm from US retail REIT Kimco Realty for $165 million. One source said: “Even if the deal were not to happen, [Blackstone] would still be in a relatively favourable position as any alternative bidder would need to repay the bonds at face value, enabling Blackstone to capture value anyway.”

A nod from shareholders, however, is expected, and Blackstone already is determining how it will move the company forward. PERE understands that, at press time, Chris Heady, the Hong Kong-based senior managing director that led the investment, and his team had commenced a strategic review to determine the future of the 290-staff Valad and its two major components, namely the Australian property portfolio and the European real estate investment management division. That review is expected to last about a month.
In the meantime, market commentators are speculating about the firm’s future. “It’s too early [for Blackstone] to think about what happens to the actual business,” said one source familiar with the deal. “But [Valad] will have various contractual obligations and relationships that they will need to continue servicing.”

B makes the grade

The acquisition of Valad is expected to be one of the final outlays by Blackstone Real Estate Partners VI, which closed on $10.9 billion in February 2007. Blackstone would not comment about the investment prior to obtaining shareholder consent, but PERE has learned that, contrary to certain commentator beliefs, the deal was not driven by a focus on Valad’s European investment management business.

One source said: “If you look at the Valad business, the bulk of the value lies with the Australian properties owned on its balance sheet.” He described the European funds business as “a relatively small component of the value of the company but a lot of its AUM,” although it does include various Valad co-investments that range between zero percent and 20 percent across its funds.

Establishing a meaningful presence in Australia is at the heart of this investment. As well as complementing its November takeover of the Asia real estate platform of Bank of America Merrill Lynch, which saw it assume more than $2 billion in assets under management across the Asia-Pacific region, Blackstone’s strategy is understood to centre around a cyclical approach to Australia’s B-grade property market, which it believes has yet to rebound from a decline in valuation following the global financial crisis.

A source familiar with the firm said: “Australia’s prime property has almost re-priced back to levels seen before the financial crisis, but a lot of the B properties are yet to recover. So, cyclically, they are buying assets at a pretty good time.”

According to the latest research by Richard Ellis, prime office yields in Australia’s central business districts, for example, tightened by 0.15 percent during the fourth quarter of 2010 alone to 7.58 percent – the lowest seen since September 2009. Valad’s portfolio, which includes offices but also retail and industrial properties, has seen its collective yield go out but not yet retract significantly.

Confident of improving economic fundamentals and its ability to add value, Blackstone is said to be sure that yields will rebound. “The book value of [Valad’s] real estate at its peak was operating at about 7.2 percent. Today, that book value is about 8.7 percent, so you’ve seen cap rates widen by 150 basis points, giving a reflection of how values have declined,” the source said.

While acknowledging the theory behind Blackstone’s charge, another source said: “Dealing the Australian portfolio may deliver upside [to Blackstone] but will be hard work and comes with risk.” He added that retaining as much of Valad’s Australian team, currently led by interim chief executive officer Clem Salwin, who was hired at the start of the year from UBS Real Estate, would be an important factor in Blackstone’s ability to work value from the assets.

Dealing the Australian portfolio may deliver upside [to Blackstone] but will be hard work and comes with riskpe Quote Here
Unnamed source


Within the Australian portfolio are some properties partially-owned by Valad or Valad entities that would need conjoined thinking with its various joint venture partners. One example is Sydney’s Gold Fields House at 1 Alfred Street, an office building purchased in 2006 with Valad balance sheet money (21 percent), equity from its Australian V Plus fund (39 percent) and capital from Dutch pension fund investor Algemene Pensioen Groep, also an investor in the V Plus fund. The future of the property, valued last October at A$290 million, will need consensus from all parties, as would certain others.

Questions in Europe

According to PERE’s sources, Martyn McCarthy, Valad’s chief executive officer for Europe, is expected to remain with the firm despite his part in the failed management buyout of the European division in March, which resulted in the resignation of the company’s former managing director Peter Hurley one month later. According to The Australian newspaper, however, McCarthy may find his division still subject to suitors, including former Valad executive Kevin McCabe.

McCabe, a British property entrepreneur, sold his $2 billion fund management business Scarborough to Valad in June 2007, furnishing it with a European portfolio then valued at A$10.2 billion and comprising 89 properties owned outright, 14 funds and a property services platform. Although he joined Valad’s board as part of the sale, he resigned from his position little more than two years later. Hurley’s future involvement in anything Valad also is questionable as the same newspaper reported he had sold his Sydney home amid speculation he plans to relocate to Europe “to start afresh.”

Regardless of what moves are made by other parties around Valad in Europe, Blackstone’s chief concern with will be the Australian business. As PERE’s source said: “The European business has a good reputation as a far-reaching platform but, when Blackstone makes an investment, it focuses on the area of greatest value.” That value resides down under