Orco Germany: Commercial real estate in Berlin

[warning: The low freefloat makes Orco Germany's share rather illiquid, but could also be a reason for inefficient pricing.]
What made researching this company interesting were insider purchases. Furthermore I already knew the parent company from searching Eastern Europe for value assets. ORCO Germany S.A. (Orco) is a subsidiary of ORCO Property Group. ORCO Property Group was established in 1991, is registered in Luxembourg and listed on the NYSE Euronext, Paris, Prague, and Warsaw stock exchanges. It operates primarily in the Czech Republic, Hungary, Poland, Russia, Croatia, the Slovak Republic and Germany.

Date	Name Insider	reason	buy/sell	#shares	price	volume
22.10.2013	PAULIACO ENTERPRISES COMPANY LIMITED (Jean-Francois Ott)	CEO	B	1,336,364	0.44	€ 588,000.16
18.06.2013	COURCELETTE HOLDINGS LLC (Brad Taylor)	Director	B	525,757	0.44	€ 231,333.08
18.06.2013	Yves Désiront	CFO Orco property group	B	340,909	0.44	€ 149,999.96
17.06.2013	PAULIACO ENTERPRISES COMPANY LIMITED (Jean-Francois Ott)	CEO	B	2,272,727	0.44	€ 999,999.88
17.04.2013	ROXANNIA ENTERPRISES COMPANY LIMITED (Jean-François Ott)	CEO	B	16,000	0.42	€ 6,720.00
16.04.2013	TOMSAFE SRL (Nicolas Tommasini)	Deputy CEO and COO	B	60,198	0.42	€ 25,283.16
07.01.2014	Yves Désiront	CFO Orco property group	S	15,000	0.539	€ 8,085.00

 In comparison to the current price of 0.55 the insiders are already sitting on a proft. But it's no use to anchor on past prices and better to start fresh and try to figure out if Orco offers still a good risk/reward profile.



Company profile
The company describes itself as follows:
ORCO Germany S.A. is a real-estate company. Effective 28 December 2012, the shares of ORCO Germany S.A. moved from the Prime Standard segment to the General Standard segment.The company has been operating in Germany since 2004, focuses on property investment and project development, and is mainly active on the Berlin market. The group’s strategy as well as all decisions are made by the Management Board located in Paris, led by Jean-Francois Ott, CEO of ORCO Germany, who also owns shares of the parent Orco property group (9.66%).

The company strengthened its project development operations in 2006 by the strategic acquisition of Viterra Development. In 2008, Viterra Development was converted into ORCO Projektentwicklung GmbH.
ORCO Germany S.A. expanded its property portfolio in Berlin in June 2007 by taking over the Gewerbesiedlungs-Gesellschaft mbH (GSG). GSG was established in 1965 and is the leading supplier of commercial space in Berlin with about 815,000 m² of office and multifunctional space. ORCO-GSG owns more than 40 commercial areas and centres and 117 residential units – most of the properties are in inner-city locations with excellent connections to the Berlin transport network.

At the end of 2008, ORCO Germany started its transition from an expanding cash-requiring developer into an investor with exposure to the Berlin market.

Business segments

• Property Investments (core segment)

 Investments in commercial properties, in particular through acquisition and asset management.

• Development

Development of predominant commercial projects. This includes property acquisition, planning and obtaining building rights, project implementation and sale/rental of the realised projects to investors and tenants. Going forward development activities will mostly focus on developing or redeveloping ORCO-GSG land or properties as well as Gebauer Höfe which are classified as investment properties.

Development increases risk compared to plain asset management. Although "following ORCO Germany’s decision to focus on Property Investments the Development business line has been progressively ran-down."

Operating figures

in EUR thousands	30 June 2013 unaudited	30 June 2012 restated unaudited	31 December 2012 audited	31 December restated 2011 audited	31 December restated 2010 audited
Turnover	30,271	32,277	181,032	63,765	150,898
Operating result	29,427	3,077	19,212	55,278	62,426
Profit before tax	28,045	-8,328	-3,926	30,852	16,984
Net result to Owners	21,618	-12,277	-15,773	21,276	5,596
Total balance sheet	651,244	634,718	634,805	792,235	863,407
Shareholders’ equity	200,483	158,146	168,148	65,598	45,877
Gross financial debt	295,316	322,385	322,985	545,260	620,570
Cash and cash equivalent	8,840	7,675	7,767	14,797	17,939

Due to the restructuring of the company, the past results are not relevant but give a clue how the company has evolved in the past years. Non core assets were disposed of (lower total assets) and capital structure restructured (higher equity, lower debt).

	30.09.2013 Berlin	31.12.2012	31.12.2011	31.12.2010	31.12.2009	31.12.2008	30.06.2007
Net commercial rents (€/sqm)	5.25	5.20	5.01	4.86	4.8	4.66	4.49
Commercial occupancy rate (%)	84.9%	80.9%	78%	77.2%	76%	73.5%	68.8%
Total occupancy rate - all uses (%)		80.2%	77.8%	77.2%	76.2%	74.6%	70.5%

Rents and occupancy rate have been improved in the past years. Vacancy has still room to decrease and thereby increase cashflows. In 2013 numbers are for Berlin assets, before the numbers were for assets of the subsidiary GSG. Net commercial rents for 2012 were 5.20 according to the annual report, but 5.18 according to the half-year report, whereas occupancy was the same. I couldn't find an explanation for the discrepancy.

Bond restructuringand share capital

The lower debt and higher equity was mainly achieved via bond restructuring.

bond equitization	new shares	for bonds	valued at	conversion price
06.06.2013	28,028,982	22,885	19,956,635	€ 0.71
27.09.2012	153,256,130	125,130	109,118,365	€ 0.71

To put this in historic perspective:

'000	04.12.2013	06.06.2013	27.09.2012	31.12.2011
shares outstanding	344,656	230,056	202,027	48,771
increase	114,600	28,029	153,256
reason	"pursue opportunities"	bond equitization	bond equitization

114,600,000 shares issued for 0.47€ following a capital increase on 04.12.2013 to Tandis are currently sequestered by court order due to a request by some shareholders of the parent company Orco property group.
Furthermore Capstone equities came out with a letter.

At a price of €.47, this would imply an 8% capitalization rate including G&A (9.5% capitalization rate without G&A) or €462 per square meter for the underlying real estate. This is incredibly cheap for Berlin real estate. 

I agree with their letter. It's positive to have them on board. Generally speaking I don't like companies increasing their share count, but cannibals. The share count was increased many times over. Bond equitization was at a conversion price above current market price of 0.55, which may indicate value. The dilutive issue in December will maybe be reverted.

Shareholder structure has evolved as follows:

04.03.2013	Number of Shares	% of capital	% of voting rights
ORCO Property Group S.A	184.639.960	91.39%	91.39%
Brillant 1419. GmbH & Co. Verwaltungs KG	11.531.259	5.71%	5.71%
Orco Grundstück und Beteiligungs GmbH	1.900.000	0.94%	0.94%
Other	3.956.244	1.96%	1.96%
Total	202.027.463	100%	100%

03.12.2013	Shares	%
ORCO Property Group	190,039,935	55.14%
Tandis, a.s. and Mr. Vitek (sequestered)	114,820,850	33.31%
Kamoro Limited	19,900,000	5.77%
Brillant 1419 GmbH & Co. Verwaltungs KG	11,531,259	3.35%
Directors and Managers of Orco Germany	4,681,895	1.36%
other	3,682,506	1.07%
total	344,656,445	100%

The 1,900,000 treasury shares and 1,150,000 warrants, owned by the subsidiary Orco Grundstück und Beteiligungs GmbH, were sold to the parent company for 0.8M in 2013. If the warrants are worthless this comes in at about 0.42 per share, which was advantageous for the parent company at the expense of the minorities at Orco Germany.

In 2007 the Company issued bonds with 9,328,851 repayable subscription warrants (Exercise price 15.6 and Exercise period until 30 May 2014), which are deemed anti-dilutive due to the low share-price.

Accounting

During the establishment of the 2012 annual financial statements it has been identified that a trade receivable linked to the sale of a commercial development in Berlin is overvalued since 2009 by EUR 4.0 million in the consolidated accounts. As the error occurred before the earliest prior period presented and in application of IAS 8.42b, the omission of neutralization of the overvaluation in the 2009 financial statements represents a prior period accounting error which must be accounted for retrospectively in the financial statements. Consequently, the Group shall adjust all comparative amounts presented in the opening balance of assets, liabilities and equity. As the correction of the error is applied to all comparative periods affected by the omission, the 2012 year Profit and Loss is therefore unaffected by the correction of prior period adjustment. The statements and notes impacted by this prior-year adjustment are the “Consolidated statement of financial position”, the “Consolidated statement of changes in equity”, the note 3.1 and note 5.

This caused restatements. I generally don't like companies who have to restate anything. This is a redflag, although the misstake was from 2009. Directors get no pay, but it's better to pay someone than have no efficient audit.

There were no emoluments granted in respect of the financial year to the executive members of the Board of Directors (2011: EUR 0). The Company did not grant any advances, loans or pension schemes to its Directors.

Overall the key personnel comes cheap for Orco Germany:

The members of the Board of Directors of the Company, the CEO, the Deputy CEO&CFO and the General Secretary of Orco Germany, the Managing Director of ORCO Germany subsidiaries, the CFO and COO of GSG are considered as the key management personnel of the Group. Over 2012, key management personnel received a global remuneration of EUR 1.2 million (EUR 1.2 million as at 31 December 2011).

Property investments segment
The results were in the past clouded by the development segment. A look at the property segment alone may reveal the underlying value of the company. As interest expenses are not broken down, they are for the whole company. Services to tenants include high-speed network and IT services “Hofnetz” and are continuously expanded, thus producing additional income.

property investments segment	30.06.2013	31.12.2012
lettable space [sqm]	836,726	839,847
investment property '000	519,919	501,995
value per sqm	€ 621.37	€ 597.72
rent '000	25,530	48,245
services '000	4,488	8,092
implied rental yield	9.82%	9.61%
implied rental+services yield	11.55%	11.22%
EBITDA before fair value+disposal	16,286	27,764
Interest expenses	6,762	23,624
normalized earnings before tax	19,048	4,140

Interest expenses decreased as a consequence of the successful refinancing of the GSG loan at lower interest rates and a lower volume, the repayment of the Sky Office loan in December 2012 and the successful bond restructuring.

The total lettable space was not broken down further in the reports, but it seems to belong to the  property investments segment. After all the develpment segment's assets stood at 4.8M (30.06.2013) and 5.2M (31.12.2013) respectively and the segment produced negative results for both periods.

The implied rental yields are high. 9.82% for the segment is slightly higher than 9.5% for the whole company according to the Capstone equities letter, mentioned above. The high yield suggests the property value is not overstated, but it's rather understated.

19M(2xH1) EBT per year seems to be reasonable, although operating income for the whole company in the first two quarters excluding far value gain was 15.2M compared to 6.1M for Q3.

Based on EBT of 19M annualized and the rising trend of in-place rents, a low estimate of the segment's value would be ~200M.

NAV

NAV	30.06.2013	diluted
Consolidated equity	200,564	254,426
Fair value adjustments on inventories	254	254
Goodwill	-42,622	-42,622
Net asset value	158,196	212,058
Deferred taxes on revaluations	101,378	101,378
EPRA Net asset value	259,574	313,436
Net asset value per share	€ 0.69	€ 0.62
EPRA Net asset value per share	€ 1.13	€ 0.91
shares outstanding	230,056	344,656
share price	0.55	0.55
P/NAV	0.80	0.89
P/EPRA NAV	0.49	0.60

The deferred taxes have a high influence on the valuation of Orco Germany. The capital increase from December 2013 @0.47 per share would have been dilutive. The company itself calculated LTV for 30.06.2013 at 51.7%. This doesn't imply need for more equity at any price. The new equity was issued under NAV, which means RONIC would have to be higher than in the past to not be dilutive and there is no clue as to why this may be the case.

LTV

Based  upon the signed sales contract for Leipziger Platz additional 30M are expected to inflow after the finalization of the project. Deferred consideration on the sale of Leipziger Platz amounted to 27.8M as of 30.06.2013. How to adjust for this matters for LTV. One possibility is this:

30.06.2013	company	conservative
Financial debt	296,274	296,274
Cash and cash equivalents	-8,840	-8,840
Net debt	287,434	287,434
Financial assets at fair value through profit or loss	-255	-255
deferred consideration on the sale of Leipziger Platz	-27,815	-25,034
Revaluation gains on projects and prop.	-254	-254
Bonds	42	42
Derivative instruments assets	0	-1256
Derivative instruments liabilities	0	1268
Retirement obligations 1/2	0	4,494
Minorities @book	0	82
sum	261,253	268,412
Investment property	522,669	522,669
Own-occupied buildings	2,884	2,884
Inventories	2,101	1,891
sum	527,654	527,444
LTV	49.51%	50.89%

The company calculated LTV as follows, adding the deferred consideration to property value:

30.06.2013	company
Financial debt	296,274
Cash and cash equivalents	-8,840
Bonds	42
Net debt	287,476
Financial assets at fair value through profit or loss	255
deferred consideration on the sale of Leipziger Platz	27,815
Revaluation gains on projects and prop.	254
Investment property	522,669
Own-occupied buildings	2,884
Inventories	2,101
sum	555,978
LTV	51.71%

As stated above LTV doesn't suggest an urgent need for equity. Additionally operating cashflows for H1/2013 was more 2x net interest paid. This would suggest the company has the means to pursue opportunities organically, albeit small opportunities.

Conclusion

Orco Germany is cheap but the management in place does not seem to be a prudent capital allocator, if one believes the newly issued shares to be value dilutive. On the other hand they may just do not respect the minority shareholders. As the hedge fund complains in its letter the equity was offered to only one shareholder, Tandis, which is an entity related to Mr. Radovan Vitek.
 Remuneration at the company level does not indicate to be an incentive for empire building. One would have to take a closer look at the parent company Orco property group. As the CEO owns 9.66% of the parent company and bought shares worth more than 1.5M of Orco Germany in 2013 his interests should have been aligned with shareholder's, but he has an incentive to transfer profits to the parent company, where he has a higher stake. Then there is the uncertainty what will happen with the sequestered shares, until then the company cannot put the new equity at work and may spend money for litigation. I don't feel my money would be protected as a minority shareholder, although valuation is a puffer. No Position.