Adler - We've slept better
All,
Please refer to our unchanged analysis of Adler here.
We have been wavering a little recently. The Bafin probe did not come entirely unexpectedly, but now that it’s here it means this process could take a big leg down without further announcement. As we have said time and again, the capital structure - through the equity - is well covered with assets. So what keeps us up at night?
Shareholder Class Action over Damages:
- The one big spectre in the room is a giant class action law suit by shareholders over the damages suffered as a result of balance sheet manipulation and the publication of misleading capital market information.
- Such law suits have been made possible in Germany since Deutsche Telekom shareholders said in 2001 and in 2005 Germany passed a special law called the Capital Markets Model Case Act or 'Kapitalanleger-Musterverfahrensgesetz (KapMuG)’.
- We note that a class action law suit is in principle possible at any time, provided enough plaintiffs see sufficient ground to file for / join a proceeding for a model case in Frankfurt’s district court - then passed on to the regional court for consideration.
Timing:
- In Steinhoff’s case for instance, the OLG Frankfurt held its first hearing two years after CEO Jooste resigned and the company sent its infamous Dec. 5th 2017 Ad-Hoc release confirming investigations into the accounting scandal. This would suggest that Adler, who are remaining solvent - would have to honour our Consus converts maturing in November.
- In the case of Wirecard, the process was quicker. The initial Zatarra report may have been from 2016, but events were really kicked off (at first in the wrong direction) when the FT published their article in January 2019. KPMG then took a year to declare they had not received sufficient information and a search of the head office, €1.9bn of missing cash and a CEO arrest later, the company filed for insolvency within two months. Key here is, however, that Adler do not seem to be missing cash. So whether or not and to what extent the Adler board has done wrong will likely be a matter of much longer wearing discussion and dispute.
- Grenke only took some 9 months altogether, but if matters had become more complicated, it would probably have taken longer as well.
Asset Valuation:
- That the yielding assets are fine seems to be beyond dispute outside the most removed circles of the real estate markets. The investigation ought to centre entirely on valuation of the Consus assets.
- After purchasing the outstanding CG shares, Consus consolidated Inventory and Investment assets of €2.5bn, which Adler gave project by project detail on last year. We note that these figures do not include any of the €1bn goodwill or the receivables.
- Some of these assets have made very little progress in the last two years. The Kreisle in Steglitz being one of them.
- For the most part however, discounting used in the valuation of these assets is generally comparable to that used by other market participants, if very aggressive where a project has barely been started.
The Hole:
- We see potential for value correction in three areas:
1) Projects that have made too little progress in recent years to continue being valued in the same way as before. (Sarria: no estimate - €150m maybe).
2) Projects valued on a residual value (discounted GDV) basis that have barely been started. (Sarria: €230m impairment).
3) Receivables from unaffiliated parties that seem awfully affiliated and from other past transactions that appear well overdue. (Sarria: €400m Provision). But note that these include some €250m risks from counterparts including Corestate and Accentro, which would not have had to be taken into account in Dec 2020. So for balance sheet restatement purposes there are perhaps €150m remaining and the auditor could have a tough time arguing that those provisions have to be made - retroactively even.
- Moreover, under (1) above, the estimated €150m would have been less in Dec 2020, when the Pandemic had only just started in Germany.
- So in total above between (1) and (3) we see perhaps €200m of risk that the 2020 accounts did not accurately reflect.
- Remains the practice of aggressively valuing an early stage Development, on a discounted GDV basis (2). This is a problem the industry at large would have and arguably therefore not fraudulent.
- Total potential for restatement: €430m.
Impact:
- Such a restatement would be easily sufficient to require a restatement of accounts and possibly retroactively breach all kinds of covenants. Not being lawyers, we are not sure if that would actually trigger any event if covenants were being complied with now or at the time such corrections would have to be taken.
- In case those covenant breaches could be cured with additional equity, it looks like there would be a list of buyers who would take up any additional rights - including Vonovia.
- Such corrections could also provide grounds for shareholders to sue for damages - especially if the state attorney finds fraud. Apparently it is difficult however, to prove exactly how much value was lost as a result of the misstated accounts. The market cap dropped by some €1.5bn in total since 2020, but in the case of Grenke for instance shareholders found it difficult to make a claim.
- Of the shaky German RE candidates, we think Adler is vulnerable, but there are other names, including Corestate that have us more worried.
Vonovia:
- The appointment of Dr. A. Stefan Kristen to the board is positive, but not as much as one might think. The Vonovia ex CFO (and still on Vonovia Finance BV’s supervisory board) is not exactly throwing his whole weight into the ring. That’s mostly because he has joined the ‘wrong’ board. Adler Group’s Verwaltungsrat is more of a Supervisory Board than Executive Board. Joining a Verwaltungsrat is altogether a more cautious move, carrying less liability in case things go wrong.
- Still, his involvement is interesting from two perspectives:
1) he has excellent financing contacts. Adler will need all the strength in that department that they can find after what they’ve pulled off with the Consus acquisition.
2) despite all the noise around KPMG special audit and Bafin investigation, Vonovia are clearly still interested in staying close to Adler. Not that Vonovia would have ordered him to join, but clearly they did not prevent him either and he himself seems to see a continued chance for an acquisition. Why else would he risk a CV like his? Vonovia’s continued interest in turn is important, because the German rival will not want those ADO assets to go into insolvency. On the one hand that would damage all German RE assets and their share packages and on the other, it would render the assets subject to public auction as opposed to a well-timed takeover at a discount.
Next Events:
+ LEG execute their option and buy Brack. That would take Gerresheimer from the table. The ‘misguided' transaction with Caner’s brother in law has been unwound however, and so - similar to Grenke - any restatement of past balances for this reason would no longer present news to the market. It would provide German authorities with a wonderful compromise between finding fault and preserving peace. Grenke playbook.
+ Adler signalling of further provisions would do more of the above. Inform the public of value corrections where they might have to be made retroactively, before the big Ad-Hoc mail comes, admitting to KPMG complaints.
+ Vonovia make a bid for Adler.
- Entering into transactions with Adler or Adler shareholders now is difficult (Vonovia / LEG). If the prosecutors find fraud, then Vonovia could be on the hook for the damage claims. LEG by contrast could be ordered by a potential future administrator to return the assets and unwind the purchase (unlikely as for book value, but possible).
- As at Wirecard, KPMG could come out with a statement that they have not received sufficient information to conclude their review. That would hand us some sizeable losses and we’d dump everything.
- We could learn of a criminal probe against Adler or other executives, in which case we would sell the lot. The state prosecutor is in touch with Bafin and all other parties. If they decide to probe for criminal charges, they are usually just looking for the final nail in the coffin and we’d have only weeks before people get arrested (see Wirecard). In this context we continue to monitor the departures of Sebastian Ernst and Johannes Merklin from Corestate. We have so far not heard of any enquiries being made and their departure may have been required to position Corestate further away from Adler/Aggregate ahead of Corestate's own challenging refinancing.
Thoughts:
- The choreography of the authorities so far resembles an altogether collected approach. KPMG cause a postponement of the accounts (to show that they are not letting Adler off lightly), Bafin make a point out of being neutral in their investigations, also looking at Perring’s behaviour (to keep the moral high ground) and the prosecutor signals involvement behind the scenes, but refrains from action until the auditor says 'top or hop'.
- The Bafin probe may not be unexpected, but it is news nonetheless and concerning news. It also should make any transactions with Vonovia and LEG more difficult, therefore removing short-term events to the upside.
- The hastily arranged press releases of a Landgericht Berlin failing to order Viceroy to amend their research, or even of the beefing up of Adler's Verwaltungsrat cannot make up for that. As things stand for now, the next potential negative events could hurt.
- In the short term, the biggest risk comes from a criminal investigation kicking off somewhere at Adler or in the vicinity. A KPMG conclusion should be a little further away.
- Structurally any class action would be levelled at Adler Group S.A., the old ADO entity and issuer of most of the debt. Our position in the converts by contrast sits in Consus RE GmbH. Exactly how much by way of assets remains in that company is difficult to say, but its central position in the refinancing of 2021 should motivate everyone around to keep these bonds whole.
Positioning
- Quality of sleep is important and we’ve lost a little in recent days. The sheer length of this note is testimony to that. But without new information, we have little ground to change our minds. I am personally reminded of an event at sea, where I was missing a buoy in the fog. I was ordering to turn the boat around when a very sr. confronted me with a “Why?". I said I might have made a mistake in my calculations, to which he retorted that the boat had been happy to sail by those calculations so far and that my loss of confidence would be unsettling. Sure enough, a minute later we heard the buoy (and I looked like a kid).
- So for the moment, we hold on to our positions in Adler shares (2% of NAV), Consus converts (2.5% of NAV) and Aggregate SSNs (5% of NAV).
- We remain alert and should sleep not return as required, we will be reducing our position or rather take a partially offsetting short in the longer dated Adler bonds if we can find that.
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003