Analysis: Elliott Capital seeks to thwart Lone Star’s £700m Quintain takeover

Elliott Capital Advisors has thwarted Lone Star’s proposed £700m takeover of Quintain after the purchase of a 12.9% stake in the listed London residential property developer yesterday, seemingly in an 11th hour effort to either flush out a rival bidder or force the global private equity giant to increase its offer.

Elliott logoHedge fund Elliott Capital yesterday acquired 67.9m shares in five tranches at prices between 130.5 and 131.5 pence per share – virtually aligned to Lone Star’s offer price per share of 131p – through a contract for difference (CFD) purchase arrangement.

CFD share purchases are effectively a derivatives trade giving Elliott Capital full voting rights and dividend entitlement, without putting up the full capital of the underlying shares.

CFD purchases are a common hedge fund strategy and act like buying shares with leverage – if the share price in Quintain falls from the purchase price agreed by Elliott Capital, the hedge fund is liable for the difference.

Conversely, Elliott Capital’s upside would be magnified if Quintain’s share price rises beyond the purchase price, which would crystallise a bumper internal rate of return on the capital deployed.

Elliott Capital’s intervention coincided with Lone Star’s second offer extension by another week to 30 September. Lone Star has reduced its target to make its offer unconditional from 90% of the share capital of Quintain – which would have forced the remaining shareholders to sell to Lone Star under takeover rules – to 75%.

Yesterday, Quintain reported that Lone Star had reached 71.7%. Whether Elliott Capital’s move will make remaining shareholders pause and wait and see what happens, remains to be seen.

In its only public statement on the matter, Elliott Capital said: “Elliott believes that the offer substantially undervalues the company and confirms that it did not accept the offer.”

Beyond which, Elliott Capital declined to clarify its motives, leaving the floor open for logical speculation.

As a hedge fund, Elliott Capital is most likely looking for a fast a return on its capital with its accumulated stake designed to either:

  • flush out any rival bidders in the wings prepared to offer more than 131p per share; or
  • secure a higher offer price commensurate with the value Elliott Capital believes Quintain is worth.

Elliott Capital will not want the deal to collapse because Quintain’s share price could tumble back to around 100p, where it was before Lone Star’s offer.

If Lone Star reaches the 75% threshold, Quintain could be de-listed and run as a private company.

In this scenario, Elliott Capital could seek to broker a deal privately with Lone Star, sell its minority stake to a third party or remain as a minority shareholder in the private business. But as a hedge fund, Elliott Capital is unlikely to be primarily motivated by the prospect of being a long term investor in a Lone Star-managed London property developer.

As we do not know how Elliott Capital has arrived at the conclusion that Lone Star’s offer still undervalues Quintain, we can but speculate again.

Lone Star’s original offer reflected a 22.4% premium to Quintain’s closing share price the day prior to its public offer.

This willingness to pay a premium over equity markets for Quintain – whose share price had not traded above 110p per share at any point in the last 18 months, prior to the July 29 offer – revealed a mismatch between the net asset value of Quintain’s portfolio and the value equity markets attribute to the company through its share price.

This mismatch is explained, in part, by Quintain’s inability, under accounting rules, to book profits on pre-sold residential units in uncompleted residential blocks.

In its annual results in May, Quintain reported £42.6m in “unrecognised profits” from the sale or reservation of 90% of the 284 private homes in the Emerald Gardens scheme and 70% of 211 private homes in the Alto scheme. These unrealised profits are not factored into the current NAV and, arguably, were not priced in by equity markets in Quintain’s share price.

It is then easy to extrapolate the potential upside available to Lone Star when Quintain’s development pipeline is considered, against a supporting backdrop of a chronic housing shortfall in the Capital.

Over the four years to the end of 2018, Quintain plans to develop around 1,200 residential properties around Wembley. This will be scaled up to an annual development rate of 500 homes per year by 2019, as part of Quintain’s current target to deliver 5,000 homes in London’s generation-long undersupplied residential market.

Across the current 1,200-strong pipeline, 70% are planned for sale. Assuming an average sale price of £400k, this would equate to a £33.5m gross pre-tax profit from private home sales in Wembley, based on a 20% margin and assuming the Keystone JV remains in fact.

If Keystone is not re-invited into future schemes, and development pace can scale up to 500 per year, as Quintain has previously outlined, Lone Star’s room for upside expands further.

In addition, Lone Star could seek to accelerate the build out of the development pipeline – ironically through higher use of leverage which Quintain has spent years reducing – and attempt to secure a revised masterplan with increased density for The Eastern Lands scheme which, if secured, would result in an increase in land value.

All of which could substantially improve future trading prospects.

There is, perhaps, another mismatch.

The original differential – between Lone Star’s offer price and Quintain’s pre-offer share price – was between net asset value of Quintain’s portfolio and the value equity markets will accommodate.

The emergence of private capital removed those constraints by the willingness – in this yield-scarce environment – to price risk differently.

The second mismatch is between the price Lone Star has offered for the Quintain property portfolio and business and the potential end value from the pipeline of London residential developments over the long-term.

But of course pricing a property company on the end value of its development pipeline is a little harder to justify, given the time and money involved in realising that value as well as – in the case of Quintain – the uncertainty around securing planning permission for a revised Wembley masterplan.

About CoStar News

Finance Editor, CoStar News
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