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Brokers Upbeat Over REA Move On iProperty

Australia | Nov 03 2015

This story features REA GROUP LIMITED. For more info SHARE ANALYSIS: REA

-Familiarity de-risks proposition
-But material growth is required
-Initially dilutive to REA EPS


By Eva Brocklehurst

Online real estate classified market players are consolidating, with REA Group ((REA)) signalling an intention to acquire iProperty ((IPP)), a company in which it already holds a 22.7% stake. iProperty owns portals in Malaysia, Hong Kong, Thailand, Indonesia and Singapore.

The initial cash consideration will range from $430-500m, UBS calculates, funded by $480m in new debt and cash. iProperty is expected to enjoy revenue growth at a compound rate of 30% in FY15-18 with growth drivers being rising internet and smartphone penetration, migration of advertising spending online and product innovation.

Risks centre on the extent to which advertising spending migrates online and competition from other players in the sphere. The merger will dilute earnings by around 3.0% in FY17, the broker estimates. In tandem, UBS also lifts REA Group's Australian forecasts, expecting 20% revenue growth in FY17, ex merger impacts.

So, how will the deal be progressed? For the shares it does not yet own REA Group is offering $4.00 cash or $1.20 cash plus 0.7 shares in an unlisted entity, which will hold a 10.7-20.0% indirect interest in iProperty. This will enable iProperty shareholders to retain exposure to its growth for two years. Put options will be attached to the shares and exercisable in 2017/18, with REA Group retaining a call option in 2018 in the event the puts are not exercised.

The familiarity with iProperty may de-risk the acquisition somewhat, in JP Morgan's view, but material growth is required to justify the price paid, at around 29 times the last 12 months revenue, given iProperty is currently breaking even. The broker likes the exposure to the Asian real estate classifieds market. Nevertheless, while REA Group has a strong track record and the intellectual property to succeed, it is unclear as to whether Asia's move to online will evolve the same way as it has in Australia.

Credit Suisse was not surprised by the bid and considers the price is worth paying. The offer is 14% above the broker's base case valuation of iProperty but still below the $5.70 a share bull case valuation. REA Group is familiar with the company so the transaction is a manageable risk in the context of its market cap, Credit Suisse asserts.

The move is also considered timely, as domestic growth is re-accelerating. A strategic expansion in Asia makes sense to many brokers too, as there is some customer overlap and the market opportunity is sizeable with digital penetration at an early stage. Moreover, iProperty is number one in four out of the five markets in which it operates.

Credit Suisse envisages potential synergies if REA Group shifts some of its IT development spending to lower-cost Asian markets. Little probability is assigned to a competing bid, given REA Group's blocking stake and the rationale in combining the two businesses.

A similar view is held by Deutsche Bank, given the significant longer term growth potential of iProperty. REA Group will fund the acquisition through a combination of cash and new debt and the broker believes the debt/earnings ratio will remain undemanding. That said, Deutsche Bank considers it unlikely the company will pursue other acquisitions in the near term. The downside risk, in the broker's opinion, lies with a severe downturn in the the property market.

The development is positive, in Macquarie's assessment, as it provides REA Group with another driver outside its core operations and there is scope to leverage products an experience into a wider market. The transition to online from print in Asia lags Australia and there may be opportunities down the track for REA Group to strengthen its position in the region. Macquarie envisages limited synergies up front, mostly in terms of corporate and shared development costs.

Morgan Stanley believes this was a decision REA Group had to make – whether to expand internationally in a meaningful way, or remain a domestic oriented business, highly profitable, but with slowing growth prospects as the industry matures. While aware of the higher risk profile, the broker believes the acquisition makes strategic an financial sense and expects it to be accretive in three years time.

FNArena's database contains five Buy ratings for REA Group and three Hold. The consensus target is $48.03, suggesting 1.8% downside to the last share price. Targets range from $41.40 (JP Morgan) to $53.50 (Credit Suisse). There is one Buy rating and two Hold for iProperty on the database with the consensus target of $3.95 signalling 2.7% upside to the last share price.

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