CORE-B.ST - Corem Property Group

[alwaysinvert]

Share price: 18.80

Common shares outstanding (0.60 SEK dividend last year): 343194505

Preferred shares outstanding (20 SEK annual dividend): 3600000

 

Real estate portfolio: 13.6B

Stock portfolio: 4.6b

Total interest-bearing debt:  10.4B 

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Alright, bear with me for the boring sum of the parts exercise for the first few paragraphs. I promise DRAMA, I promise DEALMAKING and I promise CATALYSTS.

 

Some numbers and facts

 

Corem is a Swedish real estate company with a mid-sized logistics portfolio and some stock holdings in other real estate companies, namely, at current market prices, 2.7B in Klövern (office), 1.6B in Castellum (office and logistics) and 250M in Entra (offices in Norway). It is controlled by real estate mogul Rutger Arnhult.

 

Corem’s own properties are on the books for 13.6B at a 5.7% yield. However, judging by a recent reference sale of logistics properties in Castellum, this could more accurately be market valued at 120% of book, should they opt to sell it all in a package deal.

 

In the summer of 2019, Corem themselves sold a minor city-focused portfolio of 4.2B at a yield of 5% to Blackstone. Corem’s remaining portfolio is centered around major cities (with Stockholm being more than half). This fall, Wihlborgs sold 1.4B worth of logistics to Blackstone at a 30% premium to book. The appetite for logistics deals in Sweden seems almost boundless.

In addition to yields falling precipitously in recent years, there is a sizable portfolio premium on these assets, especially when they are geographically clustered. For big foreign capital it is not worth to buy these objects individually, but it is very attractive to buy in bulk. As an alternative measure of this, listed Swedish logistics “pure play” giants Sagax and Catena both trade at huge premiums to book.

 

For Corem, latest reported EPRA NAV is 20.37 per share. Adjusted to market prices for shareholdings NAV would be 22.70. Additionally, adjusted down to a yield on par with the recent Castellum sale to Blackrock it would put NAV at 30.6. The preferred share can be viewed conservatively as debt or just as an annual drag of 0.21 SEK on the NAV. I will leave that judgement up to the reader.

 

But what is unique here?

 

Ok, so now we have taken a brief overview of the numbers. And I realize that I may have lost most readers – another real estate play at a discount. Those are a dime a dozen, and this is not even screaming cheap at a quick glance.

 

But what if I tell you that there is a bid of 18.60 on this company from the controlling shareholder? I will try to explain all the dynamics behind why there could be fireworks here.

The bid is a mandatory bid, triggered by the purchase of 5% of the shares from the third largest holder of stock. Number 2 is Arnhult’s brother, putting the two of them together at 70% of the shares. Him and his brother do not count as related parties (as opposed to a spouse or child), but I’m working under the crazy assumption that they are relatively aligned with each other.

 

Arnhult’s publicly stated intent is not to take the company private, rather he thought the shares were offered to him at an attractive price. The mandatory bid was just a necessary by-product of the purchase. While I am sure that he wouldn’t mind grabbing more shares at the price, I think this is a truthful statement. Covenants on Corem’s listed bonds prohibit a takeover by a non-public company, something which would also make an outright MBO more cumbersome. Additionally, that defeats the most compelling logic behind M&A in the sector – size and access to better financing terms.

 

The bid will not succeed in getting above 90%. I would be extremely surprised to see it get more than a few percent acceptance, since the market has swallowed huge amounts of stock just above the bid level in recent days.

 

Arnhult – a consolidator in waiting?

 

At this point a further presentation of Rutger Arnhult is warranted. Warren Buffett aficionados may be familiar with the name Gurdon Wattles, a businessman who pioneered cross shareholdings across numerous undervalued companies. It was a cheap way to get control of cash flows and direct them to buying other cheap assets and taking control over them in turn. This inspired Buffett’s early post-partnership career and allowed him to get control over among other companies like Blue Chip Stock, See’s Candies, Wesco and Berkshire Hathaway. Ultimately, this arrangement got him entangled in an SEC investigation due to nothing but the sheer complexity of it all and Buffett started slowly folding it all into the Berkshire that we know today.

 

Arnhult’s modus operandi is similar. But of course, in true real estate fashion there is also an added benefit of healthy doses of leverage, both private and at the public company level. His companies have been highly geared historically, but the leverage has moved down significantly in recent years.

 

Via his private holding company, M2 Holding, and Corem he gained control of Klövern in 2012 in a boardroom coup. Klövern has since both attempted and completed several mergers. Arnhult and his brother together control 45% of the stock and Arnhult is the CEO of Klövern.

 

Arnhult is certainly not a stranger to making plays for big mergers. He wanted to combine Corem and Sagax a decade ago but got rebuffed.  Nevertheless, he held on to his roughly 10% stake in Sagax and has been rewarded with one of the very best performing stocks over the last 10 years. A couple of years later he took a stake in Diös, wanting to find a way to merge it with Klövern. No solution was found, and Arnhult exited soon after at a profit. Instead, he went on to fold a couple of smaller public players into Klövern.

 

Since 2017, Arnhult has steadily built a stake in the far larger Castellum, also partly via Corem and partly privately, reaching control of 18% of the shares today. At the next AGM in the spring, it looks like he will be voted in as chairman and take control of the company, despite protestations of the former chairwoman and possibly other board members. Concurrently, Arnhult will leave as chairman of Corem and CEO of Klövern.

 

The finance press is, in a diplomatic wording, mildly skeptical of Arnhult’s activities. Lately, he has been embroiled in a ruckus in, as the exiting chairwoman of Castellum accuses him of having a conflict of interest due to his financial interests in “competing” companies. In the last few months there has been even more scrutiny of his cross shareholdings and the presumed misalignment between him and outside shareholders. The fact that his companies tend to trade cheaper than peers – despite good historic performance – has even been dubbed the “Rutger discount”.

 

Castellum, the big elephant

 

Meanwhile, Castellum – one of the largest real estate companies in Sweden – has been engaged in a bidding war for a takeover of the third holding in Corem’s stock portfolio, Entra. After getting bested on their offer, Arnhult, signalled battle over.

 

As far as I can tell, Castellum could still in theory come back over the top, since an EGM has already approved of share dilution for this purpose. A merger might dilute Arnhult enough so that he doesn’t have the votes necessary in the spring anymore. As a defensive manoeuvre from an entrenched management, this might make sense. But it would be highly unusual and may only delay the inevitable. I put this down as a relatively low probability.

Arnhult’s ascension to the chairmanship in Castellum could be the beginning of his pivot from the cross-shareholding strategy to a consolidation and scale strategy. Much like Buffett was prompted by outside forces to change from his “wattling” days, the evolving financing terms in the Nordic real estate market has made both Klövern and Corem in some sense sub-scale.

 

Arnhult has historically used high gearing with mostly bank loans and preferred shares as a sizable amount of the equity. Bank loans are now substantially inferior – and harder to obtain – than bonds. And the market appetite for preferred issues is not the same as in years prior.  So, the name of the game is to play the bond market. But to have entrance into the bond market on good terms you need a Moody’s Investment Grade rating. Neither Klövern nor Corem has this, nor are they close to obtaining it. But Castellum does.

 

Klövern, the problem child

 

When Klövern refinanced a bond during the summer, Arnhult complained about having to pay 100 bps more than comparable companies. A giant handicap in the RE world where cost of capital is everything.

 

In the fall, Klövern executed a capital raise via rights offering. This may have been prompted by the banks as a term for extending loans during the spring, giving Arnhult some leeway to delay the raise beyond the immediate covid crash. It could also be a pre-alignment of the capital structure with Castellum, avoiding the need for a refinancing in February 2021 on unfavourable terms and simplifying a coming merger by not having Klövern quite so aggressively geared.

 

Klövern after the capital raise has a 50% LTV with an added preferred share. Castellum is in the low 40s with no preferred issue. Castellum needs to be at 45% long-term to maintain their IG rating, so there is clear room for a deal.

 

Klövern is not ideally situated in the current environment and has a couple of office developments in NYC on top of that. However, on a relative basis Klövern’s valuation makes little sense. It is currently the statistically cheapest company in the sector on the entire Stockholm exchange. It even trades at a higher discount to NAV than hospitality pure play Pandox (22% vs 17%).

I think an all-share merger between Castellum and Klövern at 100% of NAV is a good fit for all involved. Klövern shareholders get out of a perennially discounted stock, Castellum achieves more size relatively cheaply, can refinance Klövern’s bonds on way better terms and gets some more geographical diversification which makes tapping the deeper Eurobond market more logical. Arnhult’s expressed preference for developments over bidding on properties on auction in the current environment also makes much more sense to drive under the large umbrella of Castellum with way cheaper capital.

 

When asked about the possibility of a merger between Castelum and Klövern recently, Arnhult responded: “Under the right circumstances where all shareholders in all companies would gain equally, I wouldn’t be opposed”.

 

Corem, the safest play

 

But what about Corem? While Klövern might be first in line for a merger, Corem is a beneficiary of any structural changes with either Castellum, Klövern or Corem itself. It has great real estate assets but are kind of stuck at their current size, a long way away from achieving IG rating with relatively expensive financing for their portfolio risk level. Their assets are much more valuable to a larger player. The current arrangement just doesn’t make long-term sense.

 

They could sell their properties portfolio at top dollar and turn themselves into an investment vehicle. Or they could be folded into Castellum further down the line. I believe less in the MBO route, but it is also possible. Their own RE is low-risk and non-replicable as a portfolio. It is cheap on a break-up basis and in total has the largest exposure to my thesis of Arnhult pivoting his strategy.

Arnhult also loves the stock. He made big buybacks beginning in March 2020 (!) at above 20 SEK on average. And now there is an 18.60 mandatory bid being launched after him privately buying almost 5% of the stock. He has never triggered a mandatory bid before despite being close to or over 30% in Klövern and Corem for many years. Make no mistake: he thinks it’s a complete steal at these prices.

 

The mandatory bid runs until February 26. As these things go, some shareholders realize that they want to take the opportunity to liquidate an otherwise hard-to-move position. Thus, the shares have been locked in a trading range just above the 18.60 level ever since news of the incoming bid was announced. Since then, Klövern has moved up substantially in price (and Corem has locked in some unrealized gains from the capital raise). The logistics peers have also had good performance and the Castellum logistics portfolio sale further confirmed the hidden values in Corem.

 

[realassetsvalue]

I have thought this was a quite interesting idea (thank you for highlighting it) and have been doing some work on the portfolio. What do you think about the bid for Klovern announced today? I think the logic you laid out in your post makes sense - i.e. Corem too small on its own to make long-term sense - but are you surprised that Corem is the consolidating vehicle rather than Castellum?

Appreciate your perspective if you have any thoughts!

[alwaysinvert]

I have thought this was a quite interesting idea (thank you for highlighting it) and have been doing some work on the portfolio. What do you think about the bid for Klovern announced today? I think the logic you laid out in your post makes sense - i.e. Corem too small on its own to make long-term sense - but are you surprised that Corem is the consolidating vehicle rather than Castellum?

Appreciate your perspective if you have any thoughts!

There have been rumours on this combination going back a decade. However since it never happened before, the entities were pure plays in logistics and office respectively and most importantly Arnhult had a larger holding in Corem than in Klövern, I didn't consider it likely since he would have to pay with discounted shares from the Corem side. Castellum on the other hand could pay with both better valued shares and cash, owing to their solid balance sheet. That was my reasoning.

The market seems to agree that Corem is giving up some value on its side. On the other hand it neatly solves a "political" problem that Arnhult would have in taking over Klövern with Castellum at this stage, in which he would have been raked over the coals in the media for his bias.

That said, I fundamentally like the deal - I would have liked almost any movement from the status quo and this is fine, especially since it happened fast.

I also think that the market is underestimating the changes to LTV from taking Klövern in-house and getting credited with its assets 100%. Additionally, the preferred to D conversion is extremely significant from a ratings perspective, as Moody's views D shares as 100% equity capital. Consequently, an IG rating while not imminent is probably decently close.

Ultimately, I think that this entity will be combined with Castellum down the line. Maybe the sentiment for office space has to start thawing a bit before that happens, but I would not be surprised at all if it occurred in 1-2 years.

I have no idea how the market thinks that this combined entity deserves the same discount to NAV as Klövern had last week. Makes no sense whatsoever.

[alwaysinvert]

I will by the way warn anybody looking to arb this that the merger ratio will not be dividend adjusted. Corem pays 0.65 and Klövern pays 0.13 before the merger will be finalized. It has been trading with no deal spread pretty much all day.

[realassetsvalue]

Thanks for your thoughts. I thought I'd share the portfolio sale comps that I pulled together starting with the transactions you highlighted and adding a few other recent ones I could find relatively quickly. I'm not Euro enough to think in Sq m so I think in sq ft but by my math, at SEK 18.50 a share, Corem trades at an implied 5% cap rate, SEK 1,270 PSF and ~5% discount to their external portfolio valuation... 

As is clear from the portfolio sales by listed groups (and as you raised in the initial post) those external valuations are very conservative. Case in point, Castellum's sales to Blackstone have been at 15% - 20% premiums to book value.

The Castellum portfolio sales have been at SEK 1,360 PSF, 6% rental value yield and ~4.5% cap rate. Based on those metrics, Corem's portfolio would be undervalued on an unlevered basis by 7%, 9% and 17% respectively.

Obviously this is only one piece of the puzzle given the proposed acquisition of Klovern, dilution, etc. but Corem looks cheap relative to what it owns today - especially for industrial real estate where demand is extremely strong on both the occupational and investment side of the equation.

Have you looked at Stendorren (STEF.B)? Seems similarly valued (~SEK 1,250 PSF / ~5% cap rate), majority of portfolio in Greater Stockholm, controlled by EQT, who own 70%+ of the shares.

 

[alwaysinvert]

I think the correct approach now is to view it as a mixed player on the verge of achieving scale/getting IG. The best peers in terms of assets are probably Castellum and Kungsleden, although they are both less geared (Kungsleden 45% LTV, Castellum about 40%) and with only one share class. Odds are Arnhult moves to split Castellum in A,B and D shares soon enough, to match the setup of the new Corem. Perhaps Corem should trade at a discount to those two, but on the other hand it has a pretty clear implicit buyout put. If you buy the entity via Klövern now it is at a 30% discount to NAV. I think anything above a 15% discount is too high on a relative basis, but I obviously have no set timeline on it shrinking.

 

Maybe when they publish their first NAV as a combined entity, it will wake up some more mechanically oriented traders and firms. Even on its own, the company will be able to work their financing costs way lower going forward. Provided bond markets stay liquid, naturally. Obviously I'm working off the assumption of no real deal risk here, which may be a touch aggressive, but I'm pretty confident in that judgment.

 

I have looked at Stendörren and I'm told that they are well positioned in terms of what they own - but they are very small. It's certainly possible that they are in play for consolidation, both with who their largest shareholder is and from a financial POV. Still, I'm unsure if the valuation leaves enough upside here. Even if cap rate is the same, the merger logic is often more compelling with discount to NAVs, as that makes share-based payment easier. It could still be a good bet with their developments on a standalone basis or for EQT to take it private (which they have tried in the past).