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Morningstar | Lendlease’s Google Deal is Massive but our Unchanged AUD 15.20 FVE Factored in Big Improvement

No-moat Lendlease’s AUD 21 billion development agreement with Google in the greater San Francisco area is a positive step. It signals a desire to move past its recent struggles with cost over-runs and timing delays in engineering and construction. The multiyear development includes affordable housing for rent and sale, along with colocated retail and hospitality offerings. At a 15% margin--our assumption for the long-term profitability of Lendlease’s U.S. development pipeline--we estimate the contract could add more than AUD 200 million of EBITDA annually over the 10- to 15- year agreement, nearly 15% of our long-term profit forecast. 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 AUD 15.20 fair value estimate. Following recent solid performance, shares now screen as fairly valued.

The deal tracks Lendlease’s intentions to grow its development segment, build scale in the U.S., increase vertical integration, and increase residential exposure within its investment division. The contract more than triples the U.S. development pipeline to AUD 28.9 million from AUD 7.9 billion currently, putting the region nearly on-par with Australia and Europe. It takes the consolidated total to nearly AUD 100 billion. However, we expect some lumpiness to the eventual earnings stream, given the large-scale nature of multifamily residential construction.

Lendlease is likely to commit minimal capital investment to this project. Per other recent deals, such as the Barangaroo office precinct in Sydney, the firm is likely to partner with others to provide capital, and avoid owning land--which is highly capital-intensive without revenue generation for long periods. While this structure improves returns on invested capital, it can lead to a slimmer potion of earnings flowing to Lendlease.

Large, multiyear deals can be subject to uncertainty in the total end value, but we think the AUD 21 billion (USD 15 billion) here looks about right. Lendlease and Google plan to develop as many as 15,000 homes over the course of the agreement, with a focus on more affordable housing--a real challenge in the supply-constrained San Francisco bay area. Based on current average affordable home prices in the region between USD 500,000 and USD 1.3 million per unit, this implies around USD 13.5 billion in total value, at the midpoint, with the remaining USD 1.5 billion consisting of retail and other supporting property types.