Apparently, they account for 10% of MDT's property rental...

Apparently, they account for 10% of MDT's property rental income.

2 competing views from top tier insto brokers (1st one says buy, 2nd one says avoid).

broker 1:

Concerns appear overdone…

. . . should serve as a catalyst for re-structure, highlighting value
We don’t usually comment on press speculation. However, we see speculation re: the Mervyn’s tenancy (10.5% of ABR) as a potential catalyst for further consideration of re-structure, releasing the hedge book value to pay down the problem debt facility subject to covenants. A cleaner structure would highlight the value in the RE, particularly combined with disclosure re LNT and Mervyn’s.

Double counting?
Mervyn’s was acquired by a private consortium from Target in 2004 as a turnaround play. Given the OpCo/PropCo structure and the current environment MDT’s share price had increasingly priced in some negative newsflow. We believe today’s sell off, based on press speculation, double counts the potential impact.

Potential Impact
We note the Mervyn’s portfolio was structured from the beginning to release real estate value in the event of tenant difficulty. If Mervyn’s are in difficulty, MDT’s position benefits from: a US$12.5m share of a letter of credit, cross defaulted tenancies and a complementary tenant in Kohl’s (rolling out 70 stores in 08). We estimate potential earnings impact of ~10%pa (avg), taking EPU yield to 33%!

Valuation unchanged. Downside to 39c if Mervyn’s portfolio worth zero!
Our valuation and price target is unchanged at 61c. We have provided downside sensitivities to highlight: zeroing the value of the Mervyn’s portfolio sees valuation reach 39c, while a more reasonable downside sensitivity (US$100psft and 50% of the letter of credit) would see valuation fall to 55c. Retain Buy.

broker 2 :

MDT: Nervy about Mervyn’s
The Wall Street Journal has speculated that Mervyn's LLC may be forced to file for bankruptcy protection after suppliers halted shipments to the retailer. Mervyn's is currently the number one tenant exposure in MDT's portfolio, comprising 10.6% of annual base rent (at end December 2007).
Mervyn's has not yet commented on the speculation. The New York Post reported that Mervyn's has been hard-hit by the housing crisis across the south-west, where it operates 175 stores. Fearing that a bankruptcy is looming, big suppliers, including Levi Strauss, have stopped shipping merchandise to Mervyn's in recent weeks, according to sources.
MDT commented yesterday that it has a $25m letter of credit over its Mervyn's rental exposure, equivalent to 9–10 months’ base rent, provided by a subsidiary of Deutsche. ! Interest cover was 2.3x at December 2007 (excluding unrealised gains and losses versus a covenant of >2.0x). We estimate that in order to breach the ICR covenant, MDT’s net property income would need to reduce by ~14.0% based on December 2007 results (equivalent to ~10.8% reduction in occupancy).
Our current forecasts for MDT assume a 300bp reduction in occupancy between December 2007 and June 2009. Occupancy had fallen 60bp over the March 2008 quarter. MDT also announced at the March quarterly update that Linens n’ Things was considering potential closure of two of its stores leased from MDT (covering less than 0.5% of MDT’s income). Based on our forecasts, each 1% fall in net property income equates to ~2% reduction in EPS.
We calculate that MDT can sustain approximately an 8% reduction in asset values (on December 2007 valuations), equivalent to a ~50bp expansion in cap rate, before breaching the lower threshold of gearing covenants. MDT's covenant gearing was 55.2% at 31 December 2007. The gearing covenant states that ’the Trust has six months to rectify if gearing goes above 60% but less than 65%’. A 16% reduction in asset values would take covenant gearing to the 65% level.
We remain concerned about MDT’s exposure to US durable goods retail, as well as its financial risk given high gearing, low ICR and the required sale of assets in a weak pricing environment. Furthermore MDT has $430m debt up for refinancing during FY09. Retain underperform.