commercial property, German property, Karoo Investment Funds, KWG Kommunale Wohnen, Laxey, Margin of Safety, NAV discount, Net LTV, Principle Capital, residential property, Sirius Real Estate, special situations, SRE, Weiss
I’ve completely disposed of my remaining Sirius Real Estate (SRE:LN) holding. [I previously noted a small sale in August, reducing my portfolio stake to 2.8%]. This is a rare event – in the past year, my selling’s been mostly limited to top-slicing as certain stocks neared/exceeded my price target(s). Crikey, I must sound like a bloody buy & hold investor!? Rarer still, I think it’s only my second disposal of an investment that clearly hasn’t been working out. [Cresud (CRESY:US) was the first – a v different macro decision. Fortunately, the right decision…the stock’s down nearly 25% since!]
I actually managed to avoid a loss in both instances – not what you’d expect from stocks that haven’t worked out..! Obviously, there was plenty of luck involved – but I’d definitely credit a good entry price as a key saving grace. Having the discipline to demand an adequate margin of safety for each purchase isn’t just about increasing your potential upside – it can also save your bloody ass when things go wrong. Let’s take a closer look (using my original Sirius post for reference) & see if there’s anything to learn here:
Investment Opportunity & Crisis Hedge: My investment thesis identified German property as a secular investment opportunity – it’s cheap in absolute terms, the German economy’s perhaps the most resilient in Europe, and Bund yields remain incredibly supportive. I continue to believe this thesis is correct, but actual property & share price gains to date have been mostly enjoyed by the residential sector. [Check out my German property series: Parts I to V]. I also suggested German property might be a good hedge against any further unraveling of the European sovereign debt crisis. Fortunately, sentiment’s improved dramatically this year – it’s interesting to see German residential share prices peak & then trade sideways/lower for much of the year, as investors migrated back into higher risk European exposure.
Diversification: I also noted I had a 4.2% portfolio stake in Deutsche Wohnen (DWNI:GR) at the time – putting my total German property allocation at 8.3%. Since then, I’ve sold DWNI & basically exchanged it for a larger 6.4% portfolio holding in KWG Kommunale Wohnen (BIW:GR). I’ve also become that much less risk-averse (in line with the market) – so now I’d prefer to limit (or even marginally reduce) my overall German property exposure, in favour of other opportunities. In turn, that caused me an increasing level of discomfort with the size of my SRE holding.
Leverage: With any property company, the very first & sometimes only thing you should focus on is leverage. We all lost our heads a little pre-financial crisis, but since then I limit myself to companies with a maximum Net LTV of 60-65%. And that’s an absolute limit (which I think is quite appropriate for German property) – depending on the country, level of development exposure, management & so on, I might actually restrict myself to significantly lower leverage. At the time, Sirius enjoyed a 57.6% Net LTV.
Unfortunately, as of end-March, Sirius was reporting an LTV of 65.4% – due to continued (negative) property revaluations, and a disappointingly small & slow level of (non-core) property sales. Admittedly, there’s been some mitigation since, via subsequent property sales (see Note 12) & a recent equity & bond issuance – but I certainly didn’t expect SRE’s leverage to march steadily higher!? Quite the contrary – in fact, at one stage, I anticipated ending up with a significantly larger SRE holding, predicated on the company achieving key Net LTV milestones.
Property Fundamentals: The current valuation for the core portfolio is EUR 416 per sqm. With average in-place rent at EUR 4.44 per sqm, and a current occupancy rate of 77%, that puts the portfolio on an average gross yield of 9.9%. Granted, we’re talking about secondary assets (edge of town/converted light industrial) here, but that valuation still seems extraordinarily cheap – in absolute & relative terms. Particularly when you consider average rent & new rent (at EUR 5.13 per sqm) levels have been increasing, and occupancy’s been stable. I also note recent sales were at a EUR 513 per sqm valuation, albeit this was achieved on just EUR 16.3 mio of sales.
But then again, I argued/presented pretty much the same story about SRE’s portfolio & valuation two years ago! So I’m a little perplexed by the continuing write-downs – when are they going to bloody end?!
Shareholders: Sirius appeared to be the perfect special situation, with a number of activist shareholders on the register & the board. I expected this mix of activists could/would act as a potent catalyst – if necessary, they’d force a sale or liquidation of the company to realize shareholder value. But the activists now appear to have lost the board-room battle & perhaps even their interest in the company itself…
Laxey Partners has sold out of the company entirely. Weiss Asset Management has sold almost half their shareholding in the past month or so – and I wouldn’t be surprised to see them sell off their remaining 7.8% stake. One of their directors was voted off the board, and the other director they nominated doesn’t actually represent them (I believe). [Rolf Elgeti, CEO of TAG Immobilien (TEG:GR) – I presume they nominated him as an industry expert]. Principle Capital actually does have a director on the board, James Peggie, but they’ve also reduced their stake – to 8.2%. However, it’s worth noting Frank & Kevin Oppenheim have an additional 8.8% stake. [Taube Hodson Stonex Partners have another 5.5% stake, but there’s nothing to suggest they’ll take an activist stance].
Finally, we’ve got Clearance Capital (Karoo Investment Funds), with a 24.6% stake. Considering the size of this voting block, I suspect Karoo was instrumental in voting off the Weiss & Laxey directors. Quite unusually, they were the sole investor in a EUR 5 mio convertible loan issuance by Sirius (which could potentially raise their stake to 28.9%). They were also a key subscriber to the more recent EUR 6.5 mio equity raise. Which all seems to suggest Karoo’s now well & truly in the driving seat here.
Net Asset Value: Continued (negative) revaluations, dilutive equity (& potentially, convertible) issuance, plus the impact of leverage, have all reduced SRE’s average (EPRA & IFRS) NAV by 36% to EUR 0.456, as of today. Ouch!
All in all, I really don’t see any significant error in my investment thesis, or stock analysis. [In the grand old Maoist tradition, please feel to comment below if you can point out the true error of my ways!] In essence, Sirius was a special situation stock for me – noting particularly my preference for German residential property – and I believed the presence of multiple activists would be a catalyst for an eventual sale or liquidation. In my opinion, that doesn’t appear to be true any longer here (if it ever was) – management (& presumably Karoo) has a fairly limited disposal programme in mind. And their stated focus is now on re-establishing a dividend, continuing asset management initiatives, and the pursuit of new growth opportunities.
But that isn’t what I signed up for..!
As I’ve said before, if a catalyst isn’t realized within 1-2 years, it’s probably best to bail. More generally, if it becomes apparent your investment thesis isn’t working out – or it’s dead wrong – yes, it’s probably time to exit. This is especially true if you’re in a loss-making position – beware the mind, it’s highly adept at selectively assembling the facts to support a brand-new bullish view! [See Greed & Fear (I) & (II)]. But how genuine will your conviction be from that point forward? And what about the potential opportunity cost – is it better to redeploy your funds, rather than hanging on & hoping for a silk purse out of a possible pig’s ear?
Yes – sometimes investment theses and/or catalysts simply don’t work out as expected! And sometimes that just boils down to bad luck… But I believe this investment still offers a valuable lesson: If you can enter at an attractive enough price (and with reasonable leverage, in this instance), there’s a good chance you can still exit at a decent price even if things don’t work out (and NAV declined 36%!).
In finishing, I should highlight Sirius isn’t necessarily a bad share at this point, by any means. The company now aspires to become a regular (German) commercial property company, offering a mix of dividends & capital growth – which may be exactly what you’re looking for! And it’s arguably a value stock still, trading at a 0.56 Price/Book ratio. Even the technicals look promising again – a decisive break of this EUR 0.255 level could see a quick run to EUR 0.31 (and EUR 0.365 is the next key level after that). Disposing of SRE may well turn out to be a mistake…
But it’s difficult to know how long it might take to realize the upside here, in the absence of a catalyst. [And I don’t believe a 1.0 P/B multiple will be achieved, unless a sub-60% & improving Net LTV is established]. Hopefully, redeploying these funds into other positions will prove a wise decision.