Isetan (Singapore) Ltd (SGX: I15) has seen its share price surge 38% this year. Rumours have been swirling that the Japanese departmental store operator in Singapore will be able to cash out on its 26% stake in Wisma Atria. Starhill Global Real Estate Investment Trust (SGX: P40U) announced that it has sent a non-binding letter of intent to Isetan.
An article on Business Times also said that sources close to the matter believe that the REIT is willing to pay more than S$290.7 million, the fair value of Isetan’s stake in Wisma Atria. Amidst all the buzz around the two companies, I did a bit of research to find out if should investors consider picking Isetan shares now?
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Massive injection of cash
If the deal does go through, Isetan would receive a massive injection of cash. As of 30 June 2019, Isetan had S$38.1 million in cash and no debt. Even after the rise in its share price, Isetan has a market cap of just S$216.6 million.
In comparison, the sale of its stake in Wisma Atria will give it a cash injection of S$290.7 million. That alone is more than the company’s entire market capitalisation currently.
Together, with its current net cash position, the sale would result in Isetan ending up with S$328.8 million in net cash balance, which is around 51.8% more than its current market capitalisation.
Isetan’s investment in Wisma Atria has gone under the radar for years. Due to conservative accounting policies, the fair value of its stake was not reflected in its balance sheet. The group records its investment property at cost and deducts accumulated depreciation and impairment loss. Depreciation on leasehold land and buildings are calculated on a straight-line basis over a life of 50 years. As such, its investment properties are only valued at S$28.2 million on its balance sheet. This is a far cry from the greater than S$290.7 million that Starhill Global REIT is reportedly willing to pay for Isetan’s 26% stake in Wisma Atria.
If the deal does go through, Isetan will report a profit equal to the difference between the carrying value of the property and the disposal proceeds. This would result in a one-off profit of $262.5 million, which is also more than the company’s entire market cap.
On the surface, Isetan looks to be massively undervalued once you consider the fair value of its stake in Wisma Atria. Isetan will also be able to reward shareholders through a special dividend if the sale of its stake in Wisma Atria proceeds. However, as with any investment, there are important risks to appreciate.
The main risk is if the sale does not go through. Isetan will be stuck with its stake in Wisma Atria and will have to contend with its annual rental income. Investors who were anticipating a sale might also give up on the company as there might not be a catalyst to drive its share price higher. If there is a mass exodus of its stock, its shares could fall dramatically in the short-term, even though it trades below what I believe is its fair value.
My Foolish take
Although I’m aware of the risks involved, I believe the possible returns should a sale go through far outweighs the downside risk.
A sale could result in Isetan’s share price skyrocketing another 50% (to the value of its net cash) or the company could easily pay out the bulk of its proceeds from the sale as dividends, resulting in a massive paycheck for shareholders.
On top of that, it seems that the sale of Isetan’s stake in Wisma Atria to Starhill Global REIT will be beneficial to both parties. For Isetan, it will unlock value for shareholders, while Starhill Global REIT will be able to consolidate its interest in the prime Orchard Road property. As such, I’m hoping that, despite the uncertainty around the sale, it would eventually get done.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn’t own shares in any companies mentioned.