A second bite of the apple?
Corem at 22, NAV 29.60 and growing rapidly
Markets are moving fast currently. Please note that I am referring to closing prices as of Friday March 4th in this piece.
In my original write-up of Corem I argued that the stock was the way to stay in closest alignment with Rutger Arnhult. The Nordic real estate industry had overwhelming reasons for consolidation and Arnhult’s sphere doubly so. This went from not at all reflected in the price in early 2021 to more than fully reflected at the end of the year. And now in 2022 we are back where we started.
In between, they conducted a large merger which I hadn’t originally anticipated, where the smaller Corem gobbled up Klövern, essentially creating a more levered and smaller copy of Castellum. Castellum themselves proceeded to swallow Kungsleden shortly after Arnhult got board control, meaning he is now the controlling shareholder in two of Sweden’s largest commercial real estate companies, a duo with largely similar profile and assets. Corem also owns 2.57% of Castellum. Arnhult owns 16.84% of Castellum via his private holding company and 30.31% of Corem (his brother owning another 13.87%).
My contention has always been that the end game is the combination of all of Arnhult’s companies. The market seemed to ignore that possibility for a while but warmed up to it throughout last year, possibly guided by some encouraging comments from Arnhult himself. On Castellum’s latest conference call, however, Arnhult seemed to have changed his tune slightly, emphasizing the need for Castellum to integrate Kungsleden. It’s possible that the market took those words to heart and downgraded their expectations for a merger in the next 12 months. If so, I think the market is too negative.
The basic logic of a merger is intact, if not strengthened. Firstly, with size comes lower financing costs. Secondly, the valuation ratio between Castellum and Corem is now more amenable than at any time after Arnhult took control of Castellum.
THE RATIO
This deal is likely to be structured as an all-stock deal. Arnhult doesn’t want more cash for his Corem shares and it’s in everybody’s interest to shore up the balance sheet of the combined company as much as possible as to keep the rating agencies happy. Since Arnhult and his brother owns a larger share of Corem than Castellum, it would be great if they could get a favorable amount of Castellum stock per Corem as payment.
But that is also a balancing act. It’s not in Arnhult’s interest to sour the market participants on Castellum and he is additionally already fighting an uphill PR battle. Most specifically foreign institutions and the second and third largest shareholder, APG and Blackrock, seem suspicious of Arnhult. My impression is that they had a cozy relationship with the ousted board members and are wary of what we could diplomatically call loosening corporate governance. This impression of mine was strengthened by the tantrum thrown in the share price on the day Arnhult fired the former CEO and took on the role himself, passing on the chairmanship to an ally of his. A move that cannot conceivably have changed anything material in future capital allocation decisions at the company, since he was already in control of those via the board.
Personally, I think it is entirely positive that Arnhult is as hands-on as possible. He has real skin in the game, as opposed to the bureaucratic board that he replaced. They may have done things completely by the book and said all the correct things, but there’s no doubt in my mind that Arnhult has way better incentives to maximize shareholder value. On the other hand, shareholder value is not necessarily the primary concern of all institutional shareholders and soothing the nerves of these constituents is now a crucial part of Arnhult’s job description. Partly for that reason, the merger was rather unlikely to happen while Corem traded at a higher valuation to NAV than Castellum. With Castellum now clocking in at 17% below NAV on Friday’s closing price and Corem at a 25% discount, this is no longer the case.
Arnhult has shown himself a good pragmatic by being relatively generous to Klövern shareholders in the Corem takeover despite holding a larger share in Corem. It was clearly more of an objective to get an overall sensible deal done than to squeeze every last cent. This logic should hold true in the case of this coming deal too.
The relative valuation is of utmost importance, but it is also as good that the takeout offer is now not required at a premium to NAV, creating goodwill and loan-to-value headaches at Castellum. Corem steadily growing NAV while the share price has decreased has quickly changed up this situation.
THE BUYBACK(S) AND THE DIVIDEND CUT
Both Corem and Castellum had strong Q4s with a lot of NAV accretion. Yield pressure is probably largely over, but it seems to me that the CPI mediated uplifts in commercial contracts may still be underappreciated from a deleveraging perspective going forward. While CPI may understate inflation in totality, it’s still eats away pretty quickly at net indebtedness for real estate companies at these levels. And Sweden today doesn’t strike me as the kind of climate where commercial tenants will take extra issue with 4% rent hikes while other costs are up much more.
As I had guessed in my last post, Castellum started quietly buying back stock after their Q4. This is pretty well in line with Arnhult’s historical modus operandi. He has often grabbed large chunks of stock quickly when he saw value. Currently, Castellum is buying back for about 30-40 million SEK per day, a yearly rate of +10% of shares outstanding. Will this pace be kept up for long? I kind of doubt it can be. At least not without changes to the balance sheet. But it’s pretty clearly value accretive for what it is. And if they can do disposals at above NAV while buying back stock significantly below, what’s not to like? They also have some additional room due to dividing up the dividend in 4 instalments vs 2 last year.
For me it’s clear to see that this has — perhaps unintentionally — provided some support for the Castellum share, which has a large free float and has tended to trade weakly compared to peers of similar size, especially in past downturns like the Covid crash.
Meanwhile, Corem’s stock price has been increasingly weak after their Q4. The report was in line with my expectations (which were pretty high after seeing NAV growth in peers) and more of that is yet to come, most especially if the NYC developments are filled up in the coming 12 months like management says.
What on the other hand surprised me was a dividend cut from 0.65 per share to 0.40. On the one hand, the rationale is crystal clear: the main objective is deleveraging the company and moving towards an Investment Grade rating. What caught me off-guard here is that I asked management about a dividend decrease in connection with the Klövern merger and they responded something to the effect of “well, historically we have always raised it”, which made me put away that thought completely. Clearly, that was a mistake. Presumably the board had a differing opinion from that of management. The dividend cut is likely a contributor to the languishing stock price.
On Corem’s conference call, the issue of buybacks was raised by a questioner and management provided a non-committal answer which seemed to indicate that it really wasn’t on the table at the time. Lo and behold, in another reversal of capital allocation policy, two weeks later Corem alerted the market that they would begin repurchasing shares. Maybe somebody else expressed opinions on the matter?
No shares seem to have been repurchased in the single trading day since, so the question remains how much the mandate will be used. It’s hard to see how Corem can be as aggressive as Castellum when taking account of both daily traded average and the free float. The stock has traded about 1/10 the volume of Castellum lately with Castellum only having ~2.5x the market cap. Corem also doesn’t currently have the finances to sustain a long-duration and deep repurchase program. Additionally, if they would go in guns blazing “the Castellum way”, they would likely move their share price even more, bearing in mind the figures above…
A curious thing here is that Corem informed the market that they would restart repurchasing while Castellum just went ahead and did it completely without fanfare (the opposite of how it was handled about a year ago by previous management, by the way). Make of that what you will.
THE SPIN-OFF
Another lever Corem is making use of is through the creation of a JV focused on primarily high-rise developments in Stockholm with ALM Equity. These residential assets from Corem’s side consist largely of Tobin, a company that was bought out by Klövern a few years back when almost all smaller developers imploded. These days, assets of this type are more appreciated and will likely trade at a substantial premium to Corem when listed. Additionally, it will be possible to offload some debt this way. The intention is to IPO the JV in Q2, making this the likely next important step on Corem’s journey. The mega-merger with Castellum will probably have to wait for this to happen first, as long as the market conditions are amenable to an IPO.
THE FUSION STRUCTURE?
Now, I’m not a lawyer. But I think it would be possible to structure the Castellum deal as a fusion, instead of going the regular buyout offer route. This would entail only needing a majority decision at an EGM at each company to get the greenlight, instead of the usual 90% acceptance from the entire shareholder base of the acquiree. What would be the reason behind such a structuring? It could shorten the time needed to complete the deal, but the best feature in this situation is that it forces 100% of Corem’s shareholders into accepting a share consideration. In a regular merger deal there are always at least a few percent non-answers, which will result in an ultimate squeeze-out with cash compensation. Both Castellum and Corem already have some liabilities of that nature from recent mergers. As protecting the capital ratios of Castellum is important, a fusion could be a way to minimize the increase in leverage from swallowing Corem by avoiding having to ultimately pay cash for the.
Well, anyway this idea is not all that material, just something I want to put out there and see if it actually happens that way.
… OR DELEVERAGING BEFORE THE MERGER
Another way to make the process even easier is for Corem to sell off portfolios. Corem could sell off entire cities like Kalmar, Halmstad or Sundsvall. Or they could package and sell off logistics properties. At least up until very recently the Swedish transaction market has stayed healthy and liquid. If significant divestments is the route, then this could allow considerable value accretion through buybacks in both Castellum and Corem without necessarily delaying a merger unnecessarily.
The thing that makes me doubt this a little bit is that Corem should have done already done it. There has been ample time to sell portfolios after the Klövern merger and very good demand for them at least until the war started. At this very moment, things may be a bit more uncertain. Certainly, there will be further divestments, as the market allows. But I somewhat doubt that they will be of enormous size.
In summary
The outlook in Europe is murky for known reasons. We are unsure what will happen to the bond market and asset prices generally. Can the ECB really remain as loose with inflation jumping up everywhere and now going into overdrive with wheat, fertilizer and energy prices skyrocketing from the war in Ukraine? What will be the secondary effects of all the sanctions? I don’t know, I don’t think I can guess about these things any better than anyone else. What I think I do know is that there was a merger put present in Corem’s market price as recently as a few weeks ago and now it seems completely gone, while peers — including Castellum — have performed significantly better.
Given that we avoid a WW3 scenario and a nuclear winter, where both Corem and Castellum as well as all other Swedish RE is equally screwed no matter M&A prospects or current LTV levels, this seems wrongly handicapped by the market. We are back at early 2021 levels for Corem, where they are almost at the bottom of the heap valuation-wise. The only real estate companies at higher discounts to NAV are Pandox (hotel pure-play), Hufvudstaden (trophy assets in Stockholm but a decade or more of stasis and suboptimal balance sheet) and Eastnine (Baltic office buildings, nosediving recently due to Russia fears). Corem doesn’t share any of those obvious issues and has taken a huge step in eliminating its cross-shareholding since the last time its relative valuation was this low.
I’m betting that the consolidation will make sense again soon enough. If not next week, then maybe next fall or next year.