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Lendlease deal huge but FVE unchanged

Lex Hall  |  19 Jul 2019Text size  Decrease  Increase  |  
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Morningstar has applauded Lendlease's historic development deal with Google but has left its fair value estimate for the Australian property giant unchanged as it had expected improvement.

The $21 billion deal is a positive step for Lendlease (ASX: LLC), says Morningstar director of equity research Adam Fleck, who has retained his fair value estimate of $15.20.

The news had an immediate effect on Lendlease’s share price, which has fallen 30 per cent over the past year linked to concerns in its engineering and construction services business.

The share price jumped 4.75 per cent to $14.76 as the market welcomed the tie-up – the biggest in Lendlease’s 61-year history, which is expected to begin in 2021.

Under the deal, Lendlease will help Google develop 15 million square feet of residential, retail, hospitality and community space across three neighbourhoods in the San Francisco Bay Area.

Google headquarters

Lendlease will help Google develop 15 million square feet of residential, retail, hospitality and community space across the San Francisco Bay area

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Google will set up office space within the planned mixed communities in Jose, Sunnyvale and Mountain View.

The mixed-use communities projects will be developed during the next 10 to 15 years.

Lendlease is currently finishing the construction of Google's new UK headquarters in London.

Fleck says the deal could give Lendlease a more than $200 million annual boost in earnings, and signals a positive step in the company’s bid to move past recent cost blowouts and delays in engineering and construction.

“The multiyear development includes affordable housing for rent and sale, along with collocated retail and hospitality offerings.

“At a 15 per cent margin – our assumption for the long-term profitability of Lendlease’s US development pipeline – we estimate the contract could add more than $200 million of EBITDA annually for the 10- to 15-year agreement.  

“Nonetheless, we already included a sizable step up in development revenue in our projections and combined with lumpiness in project timing and uncertainty over eventual funding, we maintain our $15.20 fair value estimate.”

At 4pm on Friday, Lendlease was with fair value range, trading at $15.02, up 1.69 per cent.

Boost to US development pipeline

The deal more than triples the US development pipeline to $28.9 million from $7.9 billion currently. This puts the region nearly on par with Australia and Europe.

“The deal reflects Lendlease’s push to grow its development segment, build scale in the US, increase vertical integration, and increase residential exposure within its investment decision,” Fleck says.

He notes that large, multi-year deals can mean uncertainty in total end value, but in this case, “the $21 billion looks about right.”

He also flags some expected “lumpiness to the eventual earnings stream”, given the large-scale nature of multi-family residential construction.

Lendlease is likely to commit minimal capital investment to this project, Fleck says, and will partner with others – pension funds and sovereign wealth funds – to provide capital and avoid owning land because it is capital-intensive and fails to generate revenue over long periods.

“While this structure improves returns on invested capital, it can lead to a slimmer portion of earnings flowing to Lendlease.”

Bulls say

  • The Lendlease pipeline of major projects has expanded, but most are in an early phase of delivery, meaning the group has yet to reap full benefits from its vertically integrated businesses.
  • A strong balance sheet, with gearing under 10%, and good access to third-party capital from its funds management platform mean that Lendlease likely benefits from a development-funding cost that is lower than those of most competitors.
  • With government balance sheets increasingly strained, the public sector will return to private-public partnership models to fund long-term infrastructure. Lendlease is well positioned to participate in this growth because of its expanding footprint and capable

Bears say

  • With about 20% of EBITDA derived from construction and engineering services, a substantial portion of group operating earnings is nonrecurring. As such, a steady stream of work needs to be secured to maintain earnings. This is looking more challenging, given constraints on the government budget, corporate constraints, and falling commodity prices.
  • Earnings in recent years have been propped up by rising asset values and central bank cutting interest rates. A return to more neutral interest rate settings will hurt earnings, as asset values will decline and borrowing costs will increase materially.
  • Lendlease maintains a significant amount of capital in development projects. With property prices elevated across the globe, Lendlease has high exposure to a slump in residential and commercial property prices.


is senior editor for Morningstar Australia

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