British Land’s best assets – its liabilities

August 20, 2009

British Land is in a good position to take advantage of opportunities. We know because the chairman told us. Why then, is he supposed to be contemplating selling a stake in London office complex Broadgate to Blackstone?

Given how far prices have fallen, the timing looks odd, especially for a company that claims to be in a solid financial position. However, it may make more sense than it appears to. Bank lending and property markets are soft, but the peculiarities of Broadgate’s debt structure may make it worth while for both sides.

Broadgate, now over 20 years old, is showing its age and, at 2.2 billion pounds, is an uncomfortably big lump in British Land’s portfolio. Selling a stake would allow the company to reduce risk and diversify its business.

For a buyer, the attraction lies as much in the quality of Broadgate’s liabilities as those of its assets. The estate may need some work, but it has a state-of-the-art pre-credit crisis debt structure, which any buyer would inherit.

The complex carries 2 billion pounds of debt paying interest of 5 percent, a rate so low that if the loans were quoted, they would stand about 570 million pounds below par. This is equivalent to 61 pence a British Land share, about half of the mark to market gain of 119 pence that British Land recognises on its debt in its triple-net NAV figure.

The stock market may debate whether to recognise this gain, but a private equity firm like Blackstone would certainly value that cheap debt highly.

There is little current equity in Broadgate, and a half share might fetch only about 100 million pounds, but a leverage of about 10 times would produce a supercharged return if the buyer was prepared to wait for property prices to recover. The lack of any loan-to-value covenant in the debt reduces the risk of a breach if markets deteriorate further.

Even if prices take a while to rise, there is the cash flow benefit from the 5 percent cost of debt and the 7.8 percent yield, although the refurbishment costs would also need to be found. British Land’s balance sheet would be prettied up no end. The whole of the debt would disappear. The stock market would love that.

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