value and opportunity

After my post from Friday, I got a lot of comments.

One major argument is that the non-payment of the interest is a signal of weakness on IVG’s side and that this will negatively impact IVG’s ability to conduct business and get capital in the future. Here I strongly disaggree. First of all, after the 100 mn plus loss in 2011, everyone should know already that IVG is in a relatively weak or distressed position anyway.

Both, for shareholders which had to come up with additional money and didn’t get dividends for the last few years, as well as for senior holders, it would have been a really bad sign if IVG would have continued paying the hybrid coupon. It should be pretty clear that IVG might need more equity capital in the future as well as more senior funding,so it doesn’t make sense to offend those two groups. However it is extremely unrealistic that IVG is able to issue hybrid capital or another unsecured senior bond at any point in the near future.

So from my point of view this move has increased IVG’s credibility with equity holders and senior creditors.

Most of the commnets were right to the extent that my assumption of IVG not going bankrupt in the nect two years is maybe not an overly convincing investment case if one cannot quantify the downside scenario (bankruptcy).

So let’s look into the annual report 2011 to get a feeling about the potential liquidation value of IVG.

IVG’s business activities can be divided into 4 areas:

1. Own real estate
IVG owns a potfolio of around 3.8 bn of real estate. They show 227 mn net rent income which translates into a 6.0% yield on assets. The portfolio is 87% Germany based with a large share located in the booming Munich and Hamburg regions.

6.0% yield sounds like a relatively reasonable yield for German prime office real estate. Maybe 7% would be more conservative.

2. Real estate developement
This is of course the “problem child”, generating ALL the losses for IVG. Developement assets are booked under “inventory” and amount to 1.0 bn EUR. Here I would take a 50% haircut to reflect the risk of the largest developement project, the “Squaire” project in Frankfurt.

3. Oil & Gas caverns
This is the “crown jewel” of IVG. Few people know this, but IVG used to be a Government owned company (“Industrie Verwaltungsgesellschaft”) and was IPOed in 1993. The Oil and Gas Cavern business is a remainder of the old “Industrial Administration” business. Basically IVG has the license to develope and build underground storage caverns for oil and more important for natural gas in Germany.

As one can imagine, with the nuclear energy exit, natural gas storage is a big issue.

Without a 1.4 bn sale of caverns in 2008 into a special fund, IVG would have been most likely bankrupt by then. As a consequence of the sale, IVG now is obliged to sell most of the caverns which they currently develop into the fund. However as they manage the fund themselves, they are of course in a relatively good position to realize a fair price for them. Additionally they earn some nice management fees from the cavern fund.

Current book values of Caverns (at cost) are 770 mn EUR, IVG estimates the market value being 325 mn EUR higher. As a conservative approach I would only take 50% of the markup into my valuation.

4. Third party property fund management

They have two divisions: Insittutional fund management with ~12 bn EUR under management which generated 18 mn EUR EBIT in 2011 and a private investor fund management unit which genrated -5 mn EBIT having 3 bn under management.

In my opinion, IVG could profit from the closure of the open ended Real estate funds because they never participated in this market.

I would value the third part Asset management at between 1-2% of Assets under Management, giving a valuation of 150 -300 mn or 275 mn as mid point.

Summary valuation of Assets

	2011	Adj. Val	Comment
Intangibles	251	0	100% write off
Inv. Property	3,964	3,398	scaled to 7% yield
PPE	157	118	25% discount
Financial Assets	189	142	25% discount
equity part	95	71	25% discount
DTA	404	0	100% write off
Receivables	60	45	25% discount
Inventory	1,025	513	50% discount
Receivables	179	134	25% discount
Cash	238	238	0% discount
AFS	341	256	25% discount
Asset Management		275	1.5% of AUM
Marekt value caverns		162.5	50% of disclosed adj.
Total	6,903	5,351

In this table I have applied the discussed adjustments plus 100% “write offs” on intangibles and DTAs as well as a 25% write-off on anything else than cash.

Based on this we get around 5.4 bn EUR “Net Asset” Value which should be a proxy for a liquidation value.

If wee look at the liability side, we can see that we have a total of 5.5 bn Liabilities including the convertible bond, therof 4.9 bn financial liabilites and 0.6 bn other liabilites (excluding the hybrid).

Interestingly, “only” 2.8 bn of the loans are “secured” loans. For the sake of simplicity, I assume that all other financial liabilites are “pari passu” in a liquidation.

This leads us for the following estimation of a “unsecured” recovery:

	mn EUR
NAV	5,351
-secured	2,764
NAV for unsecured	2,587
unsecured	2,736
coverage unsecured	94.6%

Under my assumptions, the downside case for unsecured senior is around 95%. Howver this also means that in the case of bancruptcy, not only equity holders but also Hybrid holders get wiped out completely.

One final word to “comparable” situations, especially Pfleiderer which gets mentioned often internet boards:

The main difference to Pfleiderer is in my opnion the structure of creditors. At Pfleiderer, the banks sold the loans at large discounts to Hedgefunds. For those HEdgefunds, which maybe bought at 40-60 cents on the EUR, a quick bankruptcy is the best case, because then tehy can take possesion of the underlying assets and realize close to nominal value.

For IVG this is not true. At least to my knowledge, the IVG loans are held by banks at nominal value, so taking possesion of the underlying assets would not yield a direct profit, but would increase the required capital to be held on a bank balance sheet, which the banks cannot afford.

To cut it short: As soon as Hedgefunds enter the secured loans at a discount one has to watch out, but in a “normal” situation, going concern is in the interest of all parties (Management, Secured creditors, shareholders etc.).

Summary: In my opinion, the IVG convertible represents “good value” if my assumptions are correct. However it should (as any distressed situation in general) viewed as a risky asset. You don’t get 15% p.a. (at 79%) for nothing.

For the portfolio, I think it is an intersting diversification play, because as long as banks struggle, they will support IVG.

P.S.: Just a a funny coincidence, IVG reported today that they rented out one of their Hamburg propoerties to no one other than PRAKTIKER !!!!!