Description

Summary

We believe that an investment in Grivalia Property Real Estate Investment Company (“GRIV” or the “Company”) represents a very compelling opportunity to play the asset recovery story in Greece. Our analysis suggests that there is a c.50% upside from current levels, while the downside is well protected.

GRIV is the largest listed investment property fund in Greece with current market value of c. €900 mm. It owns a portfolio of high quality properties throughout Greece, mostly Athens, as well as nearby countries– Serbia and Romania. It has a noteworthy mix of blue chip tenants locked into long-term leases and has relatively low vacancies even by global standards.  Most remarkably, it has a rock solid, cash-rich balance sheet, a rarity among real estate owners, which not only mitigates risks but also provide a unique opportunity for growth.  Lastly, it is managed and owned by a group of savvy investors / operators with interests closely aligned with shareholders. The legendary contrarian value investor, Prem Watsa – CEO of Fairfax Financial, is a major shareholder with board representation and early this year he significantly increased his stake in the Company through a rights offering.

GRIV’s management pre-emptively raised funds to take advantage of opportunities emerging in the severely depressed Greek real estate market. Commercial real estate values dropped 50-60% during the crisis. Funding is quite limited so having access to capital does provide a huge leg up, placing the Company ahead of its peers. Three years of severe economic depression have created quite a few bargains for savvy investors. The Company is uniquely positioned to take advantage of such opportunities through its strong balance sheet and deep connections in the local markets.

A real estate investment company with such characteristics would normally trade at a superior valuation in any other market. However, GRIV is being offered at an attractive valuation discount bases on its pro-forma NAV and dividend it. This discrepancy is due to the fact that it operates and trades in Greece and therefore it’s tainted by the country’s negative general perceptions.  However, there is mounting evidence that certain Greek economic indicators are beginning to trend up, suggesting that the outlook for this deeply impacted country might be brightening.  Of course, there is considerable risk of relapse but it is our view that Greece has already taken firm steps towards fixing its fiscal and competitiveness issues and that provides for an improved investment environment.

What We Like About GRIV

• High Quality Property Portfolio: We consider the property portfolio of GRIV to be of very high quality because of its asset diversity and location as well as its blue-chip tenant mix:
  • GRIV is the largest publicly listed real estate investment fund in Greece with 60+ buildings located primarily in Athens and the Rest of Greece (c. 90%), with the balance in Bucharest and Belgrade.
  • Its diverse asset base consists of offices (62%), retail (19%), mixed use (12%) and logistics (7%) located in prime locations.
  • The strategic locations and quality of the assets explain the high level of occupancy for GRIV’s portfolio – 94%. For comparison purposes, in the US, the average nationwide office real estate occupancy is 83%. US neighbourhood shopping centres have a 90% occupancy nationwide, while malls are at 92%. In Greece, the average occupancy is 80% i.e. GRIV’s asset mix is of substantially above-average quality.
  • Furthermore, the tenant mix occupying the properties is stellar: Eurobank, Bancpost, Carrefour, Praktiker, H&M, L’Oreal, Proctor & Gamble, Marks & Spencer, GE etc.
• Solid Operations – Historically and Projected: The Company has generated very strong historical operational results:
  • The Company generated steadily growing Funds from Operations (FFO, FFO is defined as NI + D&A + Non-Cash Items) during the last 5 years despite operating in a country that endured a deep economic depression.
    • While Greek Nominal GDP declined -18% since 2008, GRIV grew cash flows +12% during that period in a steady and consistent pace of +3% p.a.
    • This speaks very highly of the stability of its operations even through the deeply depression-like period that Greece went through.
  • The Company’s lease structure ensures that projected financial results will be similarly stable and consistent.
    • The Company has 12 year lease terms with the average remaining term for the portfolio being 10.4 years
    • A large portion of the leases, 83%+, expire post 2018. Only 5% of the leases expire in 2014 and most of the leases have been already negotiated in the last 5 years.
    • Virtually all rents are tied to inflation – CPI + % providing opportunities for upward adjustments
    • During the recent process of renegotiation the Company tied some of its rents (retail) to revenues, therefore as the economy recovers and sales pick up there will be an additional boost to the top line.
  • Despite the stability in rents, the Company has used the crisis to rationalize its cost basis. Its total expenses were reduced from €7.5mm in 2008 to €5.5mm in 2013.
  • Almost 80% of the operating costs are fixed and accounted for 12% of the rental revenues, providing for significant operating leverage when the top line begins to expand.
• Bottoming Market Fundamentals – Emerging Investment Opportunities: The Greek commercial real estate market has suffered a severe downfall during the depression. Rents have declined c.35% since 2008 while rental yields have increased 250-300bps. Commercial real estate values dropped 50-60%.
  • The GRIV management expects fundamentals to start bottoming in the coming months with rents beginning to largely stabilize and vacancy rates to remain decent for prime assets due to lack of supply.
  • Due to the high cost of capital and limited financing alternatives there are attractive opportunities beginning to emerge for cash-rich investors including assets owned by the public sector
  • In order to meet its fiscal obligation the government is expected to start divesting government-owned assets, including real estate. Some preliminary estimates point to total proceeds from such sales of €10 – 20 bn – clearly a substantial amount for investors to choose from.
  • Furthermore, there is good supply of secondary assets trading at double digit yields that could present opportunities for a savvy and connected buyer such as GRIV.
  • Given the strength of the Company’s balance sheet and its size, it is often the only buyer in town for certain assets.
• Recent Opportunistic Acquisition: GRIV had a very busy late 2013 announcing €210+mm of acquisitions. These acquisitions are very positive. They not only added €21mm of incremental rental income (with opportunities for growth) but also significant upside in terms of future upward appraisals.
  • The Company is purchased a portfolio of 14 government assets (Ministry of Health, Ministry of Education, Ministry of Justice, Police Department etc.) with 20 year leases and significant protections for the landlord. The portfolio was purchased at an entry yield at 9.6%. Closing is still pending.
  • GRIV also purchased 3 logistics facilities in Attica with an entry yield of 11.6%. The transaction is in the process of closing and should impact 2014 financials.
  • The Company purchased 4 retail boxes at an entry yield of 11%. The assets are mostly leased to blue-chip clients such as Praktiker Hellas, Carrefour-Marinopoulos and McDonalds. The acquisition resulted in negative goodwill, suggesting an attractive entry price and positive accounting impact.
  • The weighted average yield of these acquisitions is 11%. The Company believes that it can find similar quality assets at such attractive rates (10-12%).
• Greece - Improving Macro Momentum: A number of economic indicators are beginning to show improvements:
  • General government deficit as a % of GDP has declined to 4% in line with European averages.
  • The 10-year Greek Bond Yield has “collapsed” from c.40% in 2012 to c.8% currently (and as low as 5.75% in late summer).
  • Unemployment has stabilized albeit at very high levels.
  • Bank deposits have started to grow again.
  • The Stock market is up 100% since the bottom in June 2012.
• Improved Regulatory and Tax Framework: In May 2013, the Greek Parliament enacted new rules governing Greek real estate investment companies (REICs).
  • It provided greater flexibility in terms of the type of assets that can be included in the REIC structure (i.e. residential assets, new development etc.).
  • Furthermore, it expanded the borrowing limits for up to 75% of the asset base (from 50% before), increased the minimum dividend distributions to 50% of net profits (previously at 35%) and allowed for up 100% dividend pay-outs, and it also improved accountability and transparency.
  • Lastly, Greek REICs pay very low taxes – they are exempt from income, capital gains and dividend taxes and are being taxed on NAV at a very low rate linked to ECB. GRIV’s effective tax rate has largely varied between 5-10% of income.
  • The real estate purchase process has been streamlined (lower transaction costs, fewer bureaucratic hurdles, greater transparency).
• Rock-Solid Balance Sheet: GRIV has a rock-solid, cash-rich balance sheet:
  • It currently has over €100mm of net cash on its balance sheet vs. a current market capitalization of c. €900mm (c. 11% net cash coverage. Very few real estate owners in the world enjoy such a cash cushion.
  • Its cash earns c.5% in Greek bank deposits while its weighted average cost of debt is 3%, floating rate, creating a positive carry (b. deposit rates are so high to prevent flight of capital abroad).
  • Greek REIC regulations allow for use of leverage up to 75%. Assuming 60% LTV implies “fire power” of nearly €500mm. However, the Company has guided towards using €400-500mm, including existing cash, for purchases.
  • In addition to the abundance of cash, the management has been conservative in marking down its properties during the crisis, creating the opportunity for substantial revaluation up (see valuation below) and offering downside protection.
  • Over the last couple of years the management has used its cash to opportunistically buy its own shares suggesting savvy use of capital. GRIV bought recently shares at average prices of €7.60-7.70.
• Strong Management and Ownership Base and Transparent Corporate Governance: The management of the Company has a vested interest in the business and adheres to transparent, shareholder-friendly Corporate Governance rules:
  • The Company is led by George Chryssikos, a Columbia MBA / UC Berkley graduate with experience in private equity and real estate. He is very well respected in local real estate circles.
  • Upon taking reign of the Company he restructured management’s incentives aligning them closely to shareholders’ interest and improved transparency and accountability.
  • He has also instituted a share buyback selectively repurchasing shares at attractive prices.
  • The improved governance, along with the presented opportunities, attracted legendary value investor Prem Watsa (Fairfax Financial) to take an initial 19% stake in the Company and place a member on the Board in early 2013.
  • Fairfax Financial has subsequently increased its ownership in the Company to 42% post the recent rights offering.
  • GRIV is also owned by Eurobank – one of the four largest and best capitalized banks in Greece. Eurobank is not only a tenant in many of GRIV’s building but also could serve as a financing partner as well as a source for investment opportunities.
  • In addition to its relationship with its banking partner, the management is very well connected throughout the Greek / Southern European real estate markets which enable it to source investment opportunities without having to engage in competitive bidding.
  • Fidelity, Wellington and Capital Research also own shares – another supportive evidence of strong governance and upside potential.
• Attractive Valuation: GRIV trades at an attractive valuation:
  • The Company trades at a discount to pro-forma NAV, despite significant downward mark-to-market adjustments to NAV taken over the last three years. GRIV decreased its NAV by €170mm (the asset base, pre-recent acquisitions, was €520 mm).
  • This write-down equates to €1.70 per share (current price is €8.80). During the first quarter in 2014, the Company, for the first time in 4 years, took a positive “write-up” of its asset base. It was small and related to a recent acquisition but clearly shows that the era of write-downs is over and positive, upward appraisal are on the come. Reversing the €1.70 of negative marks should provide a powerful boost to value.
  • The current pro-forma NAV is €8.32 however that does not factor the accretive application of the Company’s acquisition “fire power”. Growth from current income, successful M&A and some market price recovery could bring this pro-forma NAV in excess of €13 over the next 2-3 years, possibly even sooner.
  • The Company’s is trading at an expected dividend yield of 5%+ while, on average, European and US REITs, are trading at 3.5-4%.
  • Compared to other European REICs, GRIV trades at a substantial Cap Rate discount despite stronger balance sheet, better operational metrics and opportunities for expansion.

 Risk Factors

• Operations in Greece: While we recognize that there are emerging investment opportunities in Greece, as the economy is beginning to stabilize, the overall environment is still unsettled and fragile. The new government rules by a coalition with a relatively small margin of majority. Therefore the political environment could be subject to change and hence potentially derail any future economic recovery. Lastly, Greece is still dependent on the EU and therefore future conditions / restrictions placed on the country could have an adverse impact as well.
• Large Tenant: Eurobank Ergasias is a large shareholder as well as a significant tenant of Eurobank Properties (approximately 30% of rental income). The Greek banking sector has been restructured, consolidated and recapitalized with Eurobank emerging as one of the largest financial institutions in the country. However, any potential adverse development at Eurobank could impact their real estate strategy and hence GRIV.
• Third Party Relationships: The presence of Eurobank as a tenant, shareholder and lender is a positive, as this integral relationship benefits both parties and insures fairness and oversight. GRIV’s strong corporate governance policies provide for an arm’s length approach. There are no apparent abuses of this relationship as per Company’s disclosures. However Eurobank’ ownership declined post the rights offering. Eurobank is still the second largest shareholder but any future significant declines to the ownership percentage may impact the relationship. Furthermore, Fairfax has effective control of the company. While Prem Watsa is a well-respected value investor and business operator nevertheless on certain matters his company’s goals might differ from those of other shareholders.
• Fluctuations in Property Values: The Company marks-to-market its property portfolio on a quarterly basis. It has taken a €170 mm write down over the last 3 years. We believe this process is about to reverse but if it doesn’t, any further negative changes will impact market values for the Company.
• Non-Performance of Tenants: While GRIV has a blue-chip, diversified tenant mix, there is still a risk that the austere economic conditions might impact adversely some of the Company’s tenants.
• International Operations / FX: GRIV derives about 10% of its income outside of Greece – namely Romania and Serbia. Any adverse political and economic developments in this region may impact the revenues generated in these three countries.
• Investment Mistakes: The Company conducted a relatively dilutive rights offering to raise capital. This will provide needed cash for attractive acquisitions, however any investment mistakes will exacerbate the dilution of the rights offering.
• Interest Rate Risk: The Company’s debt financing is priced off of floating rates. Furthermore, GRIV has deposited its cash in long-term deposits in local banks. The average debt financing cost is 3%, while GRIV earns 5% off its cash deposits in Greek banks. Any changes to the respective interest rates will impact net income for the Company:
• Inflation Risk: The Company has linked its rental increases to CPI + 1%. Any rapid rise in inflation may cause a lag in rental adjustments. However given the current deflationary conditions this risk is currently minimal.
• Regulatory / Legal Risk: The regulatory / legal framework improved significantly for Greek REICs in 2013. Any reversal of these policies will have negative impacts on the Company.

Valuation and Investment Recommendations

GRIV valuation is trading at an attractive valuation regardless of the appraisal methodology deployed. We believe there is upside from several tailwinds: 1) multiples’ rerating, 2) yield compression, 3) normalization of rents and 4) NAVs reversing recent declines as well as from accretive acquisitions. We have factored all of these three drivers into the calculation of the target price.

There are no meaningful comps to GRIV in Greece, so we have reverted to pan-European REICs for multiples’ comparison. Real estate investors approach valuation based on 1) earnings yields – i.e. what is the cash-on-cash income an owner is receiving on his or her invested capital – these yields are usually expressed in the form of inverse multiple ratios, namely measured by EBITDA / EV or FFO / Price; 2) discount to the assets’ fair-value – as measured by Discount to NAV.  Certain investors also look at P/E ratios but those are somewhat less relevant due fluctuations in non-cash items (fair-value adjustments, dispositions etc.).

We have compared these metrics across a large group of continental European and UK REICs and have found that on average the sector trades currently at approximately 4-4.5% yield (EBITDA / EV%) with the UK trading slightly more favourably than the continental Europe. Analysts expect cash flow (EBITDA) for the European REICs to grow on average in the range of 4-7% over the next 3 years. GRIV trades at an EBITDA / EV% (pro-forma for recent acquisitions) of 7.8% i.e. 40-50% discount to European peers. In terms of NAV discounts, the group trades at 0-10%, with the lower end of the range associated with 2014 NAV and the higher end with 2015 NAV.

We should note here that we believe that the long-term prospects for GRIV are significantly better than the majority of the pan-European REICs, in addition to it having a much better balance sheet (LTVs for the pan-European REICs are in the 70-90% range vs. net cash positive for GRIV). However, given the “Greek discount” we have assumed in our analysis that the Company rerates to an approximately 20%+ discount to its northern peers. We should note here that some Greek Banks, a favourite of many US investors to play the country’s recovery, are already trading at premiums to US and European peers, so there is precedent for Greek companies’ rerating.

Furthermore, rents in Greece declined c. 35% since the beginning of the crisis and have not fully stabilized yet. Similarly during the Lehman crisis, US nationwide commercial office rents US declined by 12% from the peak in 2008, while the average retail rent went down 6%. Since the bottom in US commercial real estate, marked in late 2010, rents have already recovered by at least 5% and more in some cases. We expect that Greece will follow a similar path once the recovery begins. Given the much more severe decline in rents, and the fact that supply for new properties has been severely curtailed during the crisis, the rebound should be even more pronounced.

The Company is allowed by Greek Regulations to pay up to 100% of its net income in the form of dividends (it must pay a minimum of 50%). We have assumed an 80% pay-out, which indicates a 5+% dividend vs. US and European REITS at 3.5-4%, again at a discount to global peers.

Lastly, we have assumed that the proceeds from the rights offerings, together with some moderate amount of debt financing, will be used to make accretive acquisitions. All-in-all we have taken the Company’s guidance of €400-500mm of “firepower”. Assuming the lower-end of €400mm and 10% cap rate on acquisition (below recent 11% averages) and a 5% dividend yield, this combinations implies NAV upside of €3+. 

Therefore with conservative assumptions of current NAV of €8.30, €1.70 of potential mark-up reversals and €3+ of acquisition accretion gets us to a potential NAV of €13+ in the next 2-3 years. Applying a small discount to NAV implies a price target well in excess of €12, up from €8.50-€9.00 current price range. Adding 5% dividend yield offers a total return of c.50% over the next 2-3 years and possibly sooner.

Conclusions and Investment Recommendations

We are attracted to the GRIV story because it offers the opportunity to participate in a recovery of the Greek economy in one of the least risky ways. The Company possesses a very high quality portfolio of properties occupied by a blue chip mix of tenants. Its solid operations withstood unscathed the most severe depression in Greek’s modern history. The Company’s rock-solid, cash-rich balance sheet mitigates risks and provides for a unique opportunity to capitalize on emerging investment opportunities. Under the stewardship of a properly incentivized management with deep experience and relationships and with funding provided by savvy shareholders such as Fairfax Financials, Fidelity and Eurobank, GRIV is uniquely positioned to take advantage of the possibilities ahead of it. The catalysts that will provide for value appreciation include additional acquisitions, economic recovery in Greece, rent increases, real estate asset value expansion, share repurchases, dividend increases and a possible sale to a larger pan-European real estate fund.

Catalyst

acquisitions, asset revaluation, multiples rerating, yield compresions