Aurelius AG (AR4 GR)

Aurelius is a bet on a management team with an excellent record for growing shareholder value. For some background on the company, please see nha855’s writeup from March 2012. I believe that an investor today is paying a discount to fair value for their current assets in the belief that they can continue to outperform in the future.

• Discount to NAV: While not nearly as cheap as it was two and half years ago, an investor today is arguably paying a 10-20% discount to fair value of the current portfolio.
• You get paid a growing regular base dividend of ~2.5% while you wait (2013: 70c), with additional special dividends along the way (35c in 2013).
• Call option on management continuing to compound shareholder value at ~10-20% over time.
• Aligned incentives. Management owns over 30% of the shares.
• The company generally does not need to raise capital to grow.

Background:

Aurelius is a German private equity firm which specializes in acquiring and turning around distressed businesses. It has been publicly traded in Germany since 2006. There is significant insider ownership - the CEO, Dr. Dirk Markus, owns about 26.5% of the shares outstanding, and the board members collectively own 34.5%.

The current portfolio includes 17 investments of various sizes, and the company also has net cash at the parent level. There is no specific sector focus and acquisitions have included hotels, chemical and industrial businesses, cruise ships, beverages, education and IT consulting among others. Targets are often acquired as “orphans” within larger organizations (a hotel chain from Deutsche Post, IT group from KPN), from bankruptcy or from succession issues in family-owned businesses - classic special situations, predominantly in Northern Europe.

Management is very accessible and there are good English language financials and a presentation are available on the company’s website: http://www.aureliusinvest.com/index-en.html

Most investments involve distressed or unprofitable businesses with bloated cost structures or large liabilities such as pensions or leases. As a result, Aurelius generally pays a very low price (and in some cases, is paid to take the liability off the books of the previous owner) and is usually able to create significant value by addressing the liabilities for far less than the seller’s estimate.  Each deal is structured as its own special purpose entity, with little recourse to Aurelius beyond its investment, to limit risk. From there, Aurelius follows the usual private equity playbook of cost-cutting, liability management, selective investment and tuck-in acquisitions. The CEO has said that they generally create most of the value in the first four years, and will often look to harvest value through a sales process beyond that point so as to free up capital and management time for new deals.

The company pays both regular and special dividends (the latter usually after any large sale realizations). Though it typically generates more cash than it needs for its business, Aurelius raised capital in a share offering in 2013 to increase their “cash buffer” for new investments. It quickly found itself back in a capital surplus situation after selling several holdings in 2014, and is now allocating capital to share buybacks as well as dividends.

Performance:

The table below shows book value growth and dividend payments over time.

Book value is far from a perfect proxy for NAV. Book represents historic cost of investment and realized gains, and for the most part Aurelius buys distressed assets for low upfront investment (occasionally negative cost). Significant unrealized gains are not reflected, and in addition liabilities tend to be overstated. That said, it gives some idea of value creation over time.

The trend from 2007 through 2012 is steady compounding of value over time, through growth of book value and dividends. Depending on your start and end dates, the typical return in terms of compounding book value adjusted for dividends is mid to high teens (I tend to exclude the huge growth in 2007/8 which would distort the numbers upward). There was dilution in 2013 caused by issuing shares as discussed above, but after several large realizations in 2014, the company has now reversed course and is buying back shares.

Given the changing nature of the portfolio, it’s hard to read too much into growth of revenues and especially EBITDA period-to-period, so I have not included them here. There are significant non-recurring losses (restructuring) and gains (“bargain purchase income” from reversing liabilities, and gains on sale of holdings). In addition, the investment cycle works against growing EBITDA - a stable portfolio generally shows growing EBITDA as holdings benefit from investment of time and capital, whereas realizations tend to cull the better performing businesses and new investments often tend to be losing money when acquired.

Valuation

Valuing a portfolio with only aggregate information is not an exercise in precision. Here are a couple of stabs at it.

1. EBITDA-based.

Operating EBITDA for 2013 (excluding restructuring, and one-time gains) was €106 million. EBITDA for the first half of 2014 was €51 million. That includes corporate overhead, losses from recent acquisitions which have yet to be turned around. I think around €110 million run-rate exiting 2014 is reasonable, and possibly conservative. Using a 7.5-8x multiple (Deutsche Beteiligungs AG and MBB Industries AG trade around 8x), with roughly €50 million of cash net of financial liabilities and minority interest, we get around €900 million of Equity value. On 32mm shares, that gets us to about €28 /share.

     2. NAV-based.

Aurelius just began publishing an NAV for its portfolio, with an initial estimate of €33/share, about 20% above the current share price. There are reasons to be skeptical of such “self-graded exams”, but it is a data point.

Net asset value of AURELIUS Group companies:

So with some hand-waving, roughly €28 to €33 of portfolio value today.  I would argue that we are buying at a slight discount to fair value. I think there will be further improvement in portfolio companies, and management has a history of creating value from the balance sheet by managing down liability costs, and of course through continued M&A activity.

The real reason to own Aurelius is if we believe that they can continue to compound value at a reasonable rate going forward, like the 15-20% range that we have seen in the past.  That’s far from a given, but I think over time 10-20% is reasonable. The bonus is regular dividends (and occasional special dividends) while we wait.

Risks:

• Past returns may not be a proxy for future performance and one should probably heavily discount a track record that benefits from the timing of buying distressed assets in 2008-10 and selling them 2013-14.  There have been dud investments in the past and there will undoubtedly be again in the future, though the discrete nature of the investments as SPEs will limit any damage.
• The current European recovery is still fragile, and the goings-on in the Ukraine aren’t helping. Any downturn would affect the portfolio holdings, many of which are cyclical businesses (in particular SECOP, which I hope to see sold soon). A mitigant would be that Aurelius does not need to raise capital and a downturn might offer better buying opportunities to drive returns down the road.
• Increased competition: Large US and European PE firms, other mid-market German rivals (including other publicly traded PE firms) and industry buyers all compete in the M&A market. So far the company has been able to find deals, helped by its focus on distress and quick turnaround situations. Increased ability to invest in add-ons and organic growth in its existing subsidiaries should help. On the sourcing side, the firm has opened up offices in London and Stockholm as well as Munich, and has continued to staff up.
• Size matters. As the portfolio grows, Aurelius may struggle to find enough deals on attractive enough terms to move the needle. Returning capital through dividends and share buybacks mitigate this risk somewhat.
• Insider sales: Management did sell a small portion of their shares in the 2013 offering. I never like to see that, but given their large continued holdings I regard this as justifiable diversification.