Some more thoughts on IVG & “ESUG” special

DISCLAIMER
As always do your own research. Don’t follow tips blindly. In this specific case I would not recommend any private investor to invest in this security as the situation is very complex and more bad news should be expected.

Just a remark at the beginning:

Some people asked me why I post so much on such a crappy company like IVG and do not post more about “great value stocks” like IGE & XAO. The answer is quite simple: First, I don’t find that many attractively priced value stocks any more. Secondly, the blog was always meant to be a value AND opportunity blog. Opportunities in my definition are one-off situations where the payout is relatively independent from overall market movements. Additionally I think the IVG case is so interesting, that it would be a crime not to look at this in detail. Complicated capital structure, new German insolvency law, US hedge funds, real estate exposure etc. There is so much to learn here.

Back to IVG:

Lets start with a question from the comments:

Now regarding the convertible I have some questions
1) Going concern scenario:
a)How likely is it in your view that they keep as a going concern in 2014 (ie are able to refinance the convertible)
b) At what value will IVG refinance the convertible
c) How are they going to do it (sell property, give equity …)
3) Bankruptcy
a) How much will be the recovery value
b) How long does to realize the recovery value
c) Is the IRR worth it?

Well, the answer is: I don’t know. But we can start with a very easy guess (and of course everyone can criticize and make it better):

1) Start with 50/50: That would be the base assumption if you don’t know better with every binary “option”.

At the current price of ~60% we can work back the recovery quite easily (very simplified:

60% = (0,5*100 %) + (0.5*x%) with x being the recovery.

So the implicit recovery would be (60%-50%)/0.5= 20%.

But attention: those 20% would represent the market value of the then defaulted security. If we assume that the workout period is 3-5 years in a real “messy insolvency”, and buyers of defaulted securities charge at least 20% p.a., then this implies a current recovery value between 20% * (1.2)^3 = 35% and 20% * (1.2)^5 = 49%.

So to make this clear: If the current ultimate recovery is 50% and they need 5 years to distribute the liquidation proceeds, the current price of the convertible is a fair price !!! It would be a very big mistake to calculate the current value of the underlying assets and not take into account the time delay. (This is by the way one of the lessons from Zeke Ashtons presentaton to which I linked in the last post).

As I mentioned before, in my opinion, the current asset value is more like 80%, so I would expect (immediately after insolvency) a price range of 32%- 46%. Based on a 50/50 percentage, this would move the current fair value to a range of 62-73% of nominal, slightly above the current value of 60%.

Based on this binary scenario alone, I guess the convertible bond would not merit an investment at the moment, as the downside is quite significant.

However as most things in live, also the IVG situation is not binary. As it was discussed in the blog already quite a few times, some hedge funds are looking into “restructuring” the company without a liquidation in the end.

Logic behind the restructuring idea – REIT & Taxes

In my opinion, the restructuring idea does have some logic and might even create value. Why so ?

As far as I understand, the Hedgefunds want to lower debt in order to be able to transform IVG or a part of it into a REIT and in that process sell down/spin-off the other stuff like the asset management and the Caverns.

IVG in its current form does not make a lot of sense for investors. If you invest int IVG because of the real estate, the profit gets taxed 2 times, once on the corporate level and then again on investor level. A real estate investment via a REIT gets taxed only at the investor level, there are (almost) no taxes on the corporate level. If we assume 30% taxes, a fully equity financed real estate portfolio would be 30% more valuable in a REIT than in a normal company. Adding debt reduces the difference but even with debt at the level of IVG, there is still a tax disadvantage of maybe 15% or so of the current IVG vs.a REIT.

Another point which might make a restructuring event much more likely than a liquidation are taxes. On the one side I assume that the DTA will stay in a restructuring event, therefore greatly enhancing the overall value, secondly, there is no need to sell the real estate and pay property transfer taxes (up to 5% in Germany). So the restructuring alternative sounds like a no brainer compared to the liquidation scenario for almost every party involved in this.

How would/should the restructuring work (“ESUG”) ?

Well, this is the hard part and I do not have a lot of experience with that in detail. Plus we have a relatively new insolvency law in Germany (“ESUG”) which has not yet been tested in such a big case.

Let us look into the “ESUG” (“Gesetz zur Erleichterung der Unternehmenssanierung”) a little bit more closely. ESUG is meant to bring the concept of the American chapter 11 to Germany. Up until now, it was very difficult under German bankruptcy law to really restructure a company. The new “ESUG” which came into effect in MArch 2012 should change this.

However, until now there are not that many succesful restructuring stories in Germany.

If one googles “ESUG” one can find a lot of issues with the new law, for instance here at WiWo or here at Handelsblatt.

The best overview about the current status of the ESUG that I found was this study from Roland Berger. A very good document how the debt/equity swaps works can be found here.

To summarize what I have learned from this:

– there seems to be a big issue currently for holders of subordinated bonds, as they are not represented separately within the ESUG process. Another reason to avoid the IVG HYbrid.
– so far, there is no precedent for a debt/equity swap. Unchartered territory so to say, especially for senior unsecured holders
– However, there seems to be checks and balances in place that unsecured holders receive shares etc. according to the “fair value” of the claims.
Decisions are taken by simple majorities. I guess this is done by debtor group. So “hold-outs” do not really matter in the restructuring scenario anymore

What does that mean for IVG ?

In my opinion, the restructuring case via ESUG is the most likely one. Thinking it through, it is even for the convertible holders most likely a lot better than liquidation. The DTA could remain in place (and have value), one doesn’t have to pay property transfer tax etc. The question is clearly how much of that value will be shared by the “super senior” creditors.

One the one hand, IVG will be “THE” test case for the new law and people involved (advisors etc.) will make sure that senior holders will be treated fairly to a certain extent so that this kind of restructuring will happen more often (and create fat fees for advisors….). On the other hand, the Distressed debt players with a lot of restructuring experience could try to use this to make a absolute “killing” on the back of the unsecured holders. As the Jackpot is quite high with 4 bn plus, this is a real concern.

So after this preliminary ESUG analysis, I think now that the restructuring event is very likely.

Back to the calculation

So finally back to a calculation of a fair value. Staying with simple 50/50 rules I assume the following:

1) There is a 50% chance for a proceeding according to ESUG. Within the ESUG process, I assume with 25% propability that the unsecured holders get screwed (25% recovery), and a 25% probability that the unsecured holders get a fair share (75% recovery)
2) for the remaining 50% probability I will again divide into 25% for the payback at par and the liquidation scenario.

So my current fair value for the convertible looks like:

0.25 x 75% + + 0.25 * 25% + 0.25 x 100% + 0.25 x 40% = 60%

Of course, this calculation is highly subjective and any of the assumptions can change pretty quickly and will not remain stable over the course of time.

So under this asumption, the convertible is fairly priced, no big upside from an intrinsic value point of view.

What now ?

To be honest, I am not so sure anymore. Do we see something like a short bounce if they come up with some sort of rescue attemptlike at Prakiker ?there I got out too early, howver now the bond is already back to deeply distressed levels:

I would argue that this is less likely for IVG as the small investors will not touch this due to the high nominal value and the “pros” are a little bit more cautious here.

On the other hand it could be an interesting situation once the “ESUG” restructuring is running or even as restructtured equity play.

Summary:

Looking a little bit deeper into the different possible outcomes, for me a few important take aways remain:

– the likelihood of IVG “surviving” long term in my opinion is very small or even zero. So equity and hybrid should be avoided
– the restructuring scenario (ESUG) might not be so bad for the senior bonds as many fear although it is unknown territory
– there is still the possibility that IVG manages to repay the convertible at par, but it is not very likely as for most secured creditors, a ESUG style reorg would not hurt that much
– buying inot the secured loans at 80% looks like a lot better value, however I can’t do this as private investor

Overall, for the portfolio I would for the time being sell down the position at current rates and eat the loss. I am pretty sure that I am too early but as I know that I am a rather bad short term speculator, I want to play this safe.

To Do: Read more about ESUG. Any tips for a good book are highly appreciated !!!

DISCLAIMER
As always do your own research. Don’t follow tips blindly In this specific case I would not recommend any private investor to invest in this security as the situation is very complex and more bad news should be expected.

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